There's arguably no hotter investment opportunity at the moment than marijuana. If you thought the 17% return of the S&P 500 through the first four months of the year was impressive, then you've obviously not been following the very first cannabis exchange-traded fund, the Horizons Marijuana Life Sciences ETF, which has tripled the year-to-date return of the broad-market index through April.
The excitement surrounding cannabis likely stems from major countries giving the all-clear to the green rush. In October 2018, Canada became the first industrialized country in the world (and only second overall) to legalize recreational marijuana, and it now looks like Mexico is just months away from becoming the third country worldwide to given adult-use marijuana the thumbs-up. These legalizations all play into Wall Street's thesis that legal cannabis could be worth $50 billion to $75 billion in annual worldwide sales by the end of the next decade.
However, pinpointing specific trends and companies that will be definitive leaders in the cannabis space isn't so easy. That's because every cannabis executive who comments on their company more or less delivers the same optimistic spiel, making it difficult for investors to read between the lines to decipher broader industry trends.
This is potentially the biggest cannabis data reveal of the year
But this past week, Wall Street and investors received a real treat. During CNBC's "Squawk on the Street" segment, Curaleaf's (CURLF -1.75%) executive chairman, Boris Jordan, discussed the state of his company and that of the cannabis industry. While mostly touting the company's game-changing $949 million all-stock deal to buy Cura Partners and bolster its product portfolio with Cura's Select brand, he made what I'd deem the most important statement all year by a marijuana executive.
When asked about the state of the cannabis oil and flower market, Jordan had this to say:
What's very interesting is that if you were to look at the cannabis market even five years ago, 95% of all sales in cannabis in the United States, or around the world, was in flower form. If you look at it today, over 50% is cannabis oil. Cannabis oil is definitely the dominant product today in the market. People don't want to really smoke. There are some of what we call 'cannabis enthusiasts' that still smoke cannabis, but for the most part, particularly if you look at the younger generations that are growing older, or new people that are coming into the market, they tend to veer toward cannabis oils and cannabis products rather than the flower.
It's been pretty evident for some time that oils, or more specifically cannabidiol (CBD)-based oils, have been extremely popular throughout North America. But it was unclear just how much of the market these cannabis derivatives possessed. While there's not exactly an identifiable source for Jordan's all-important data point, it nevertheless places the spotlight on cannabis derivatives for the industry's near- and long-term growth.
Although dried cannabis flower can be substantially less costly to produce than oils, which require extraction from the hemp or cannabis plant, dried flower is also easier to oversupply and commoditize. Just ask pot growers in the states of Colorado, Washington, and Oregon, if you need confirmation. By focusing on oils and other derivatives (e.g., edibles, infused beverages, topicals, vapes, and concentrates), pot stocks will be placing their attention on a much higher-margin pathway than dried flower, as well as catering to the next generation of users that'll power the industry forward.
These pot stocks are all-in on marijuana derivatives
With more than 50% of all current cannabis sales in oils and derivatives, rather than flower, quite a few pot stocks stand to benefit.
For example, the largest marijuana producer in Canada, Aurora Cannabis (ACB 0.73%), has made clear that its focus will be on the medical marijuana community. Medical pot patients, according to the fourth-quarter National Cannabis Survey in Canada, are more likely to use cannabis, buy product, and purchase derivatives over flower than recreational users. As a result, Aurora Cannabis has turned its attention to hemp production, which provides a low-cost source of CBD, once extracted. CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits. Aurora is also working with Capcium (and holds an equity stake in the company) in producing softgel capsules filled with cannabis oil. Not surprisingly, Aurora generated more from medical marijuana sales in its most recent quarter than recreational revenue.
Cronos Group (CRON -1.43%), which has had very little production to speak of thus far, is also planning to focus on high-margin derivatives. In September, Cronos Group forged a partnership with Ginkgo Bioworks that could cost the company up to $100 million. In return, Cronos will gain access to Ginkgo's proprietary microorganism platform that'll allow it to develop yeasts to produce eight targeted cannabinoids, some of which are rare, at commercial scale. Since extraction techniques can often be costly, this nontraditional commercial production technique could save money, as well as line Cronos Group's pockets as it focuses on some rarer cannabinoids.
Likewise, the largest marijuana stock in the world by market cap, Canopy Growth (CGC 2.20%), is also ensuring that it has a diverse product portfolio. Interestingly, even though almost 80% of all cannabis sales in the fiscal third quarter for Canopy went to the recreational marketplace, the company remains committed to hemp production and processing, and actually beat Aurora Cannabis to market with softgel capsules. Also, with Constellation Brands being a 37% equity holder in the world's largest pot stock, Canopy Growth expects to collaborate with the beverage giant to develop a line of nonalcoholic cannabis-infused beverages.
In other words, the market for derivatives is booming, and it's only bound to get hotter.