For the better part of six years I've been tirelessly following the progress of the cannabis movement. Over that time, cannabis has progressed from being a topic that was predominantly swept under the rug by lawmakers into one that's arguably mainstream throughout North America and much of Europe.
Today, more than 40 countries worldwide have given medical marijuana a green light, in some capacity, with Canada and Uruguay the only countries that allow adults to use pot for recreational purposes. However, Mexico looks to be perhaps a few months away from becoming the third country to do so.
What can't be denied is the sales potential of this budding industry. Depending on your preferred source, global weed sales could hit $50 billion to $75 billion annually by the end of the next decade, and could one day push as high as $166 billion a year, according to analyst Christopher Carey at Bank of America.
But what can be -- and has been -- questioned up to this point is whether marijuana stocks have come too far, too fast.
Here's why I hadn't bought a pot stock until now
Historically speaking, no "next big thing" investment has launched into the stratosphere without coming back to Earth at least once. Investors have a habit of overestimating the profit potential and adoption of next-big-thing products and services, which in many cases leads to a bubble. Over the past quarter century we've seen this happen with the Internet, genomics, business-to-business commerce, 3D printing, and blockchain technology. This isn't to say that these new technologies and services weren't (or won't be) wildly successful over the long run, but there was certainly an extended teething period following monstrous run-ups for stocks focusing on these new products and services.
We haven't really witnessed much of a teething period for pot stocks, save for the abysmal performance they delivered during the fourth quarter of 2018, which is when the entire stock market suffered its worst decline in almost a decade. It's for this reason, and the expectation of ongoing losses for most marijuana stocks in the near term, that I chose to watch pot stocks from afar without actually owning them.
But something changed last week. After six years of being an armchair observer, I stepped onto the green and bought my very first marijuana stock.
Mind you, I also somewhat recently purchased CVS Health, which announced plans to begin carrying cannabidiol topicals and creams from the likes of Curaleaf Holdings in roughly 800 stores across eight states. But just because a small sliver of CVS Health's front-end sales could be derived from CBD doesn't make it a marijuana stock. Rather, I'm talking about purchasing a pure-play pot stock.
Ladies and gentlemen (and cannabis enthusiasts alike), I now own shares of CannTrust Holdings (NYSE:CTST).
What's gone wrong for CannTrust?
For those who may not recall, in mid-March I offered my take on CannTrust and suggested that while I found the company's long-term strategy attractive, I didn't believe the stock itself was a buy above its then-$9 share price. Instead, I pegged the "low $6 range" as the point at which investors would be getting a great value on CannTrust.
Not long after offering my take, CannTrust reported its fourth-quarter and full-year results, which weren't received well by Wall Street. Despite ending a spat with the town of Pelham (in Ontario) in mid-January over the desire to expand its Niagara facility, CannTrust announced plans to acquire 200 acres of land to double or triple its projected peak cultivation capacity through outdoor grow farms. This essentially meant higher-than-expected near-term costs, which would push out any chance for recurring profitability a bit further.
Shortly after its earnings release, CannTrust also announced a shelf offering for up to 700 million Canadian dollars ($521 million), which at the time represented about 70% of the company's market value, if fully exercised. It meant that a serious amount of share-based dilution could be on the way. This turned out to be the case, with CannTrust pricing a $200 million offering last week (that's in U.S. dollars), of which $170 million in capital was raised, with the remaining 15% of the offering comprised of existing investors unloading their shares. The price of this offering was $5.50, or almost 15% below the previous day's closing price for CannTrust stock, demonstrating weakness for the newly issued shares. And, don't forget, CannTrust still has more than CA$425 million in offerings at its disposal, should it choose to issue more stock.
In other words, CannTrust's stock lost 44% of its value between March 27 and May 2, and in my mind it made the company worth a nibble.
Here's why I bought into the CannTrust story
So, why CannTrust and not any one of the dozens upon dozens of other publicly traded marijuana stocks?
For starters, while production isn't everything, it's certainly worth something. Although CannTrust provided a wide range of 100,000 kilos to 200,000 kilos for its outdoor grow farms, it'll likely slot the company in as the third-, fourth-, or fifth-largest producer in Canada by peak annual output. Remember, CannTrust was already on track for 100,000 kilos from its aggregate 840,000 square feet at Niagara and 60,000 square feet at its Vaughan campus, thus putting it on track for 200,000 kilos to 300,000 kilos a year once its outdoor grow farms are fully operational. Assuming the company's phase 3 Niagara expansion is complete by mid-2020, and the company's outdoor growing is ready for cultivation around the same time, CannTrust would be a perfect target to sign lucrative long-term supply deals with provinces and wholesalers.
To build on this point, there's virtually no pot stock you'll find that offers higher production potential relative to market cap than CannTrust. Inclusive of its newly issued shares, and the 8% rally the company experienced on Friday, it ended the weekend with a market cap of around $815 million. Even assuming a midpoint of 250,000 kilos at its peak, this works out to about $3,260 in market value per kilo of weed. Comparatively, a company like Cronos Group is toting around a $5.55 billion market cap with a company-estimated peak output of around 117,500 kilos. That's over $47,200 in market cap per kilo. Yes, Cronos has a lot of cash thanks to its equity investment from Altria, but there's virtually no major grower offering cheaper access to production than CannTrust.
I'm also a big fan of CannTrust focusing on hydroponic growing methods in Niagara and Vaughan. Hydroponics, which involves growing plants in a nutrient-rich water solvent as opposed to traditional soil, can be a high-yield and cost-effective means of growth if a company has easy access to cheap sources of water and electricity, which CannTrust certainly does in Pelham, Ontario, for its Niagara facility. With above-average yield per square foot, at least 100,000 kilos of CannTrust's production should be at below industry average per-gram costs.
While I was a bit skeptical at first about CannTrust's outdoor growing costs, my expectation is that the company will use a good percentage of this production for cannabinoid extraction purposes. In layman's terms, it's going to create high-margin oils, extracts, topicals, and other derivatives rather than be reliant on dried flower, which has been commoditized and oversupplied following recreational legalization in a number of U.S. states.
Lastly, I'm willing to wait for CannTrust to put the puzzle pieces together. I would expect recurring profitability by fiscal 2020, and Wall Street seems to agree, with the company valued at "only" 28 times next year's earnings. That's pretty inexpensive considering CannTrust's triple-digit sales growth rate over at least the next two years.
I fully expect a bumpy ride that could be met with additional share-based dilution. But, a couple of years from now, assuming CannTrust doesn't get acquired, I expect the grass to be much greener on the other side.