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So Nice, I Did It Twice: I Bought Another Pot Stock

By Sean Williams - May 14, 2019 at 6:06AM

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This marijuana stock might have the lowest forward price-to-sales ratio in the industry.

On the surface, the marijuana industry looks like a once-in-a-generation growth opportunity. It generated $12.2 billion in global sales in 2018, and Wall Street investment firm Cowen Group is calling for $75 billion in global annual sales by 2030. If Cowen's estimate is accurate, we'd be looking at an industry capable of a compound annual growth rate of almost 17% over the next 12 years.

Growing pains kept me away from this budding industry for years

But this is also an industry facing some very apparent teething pains, especially in Canada, which became the first industrialized country in the world to legalize recreational pot, in October 2018.

An up-close view of a flowering cannabis plant growing indoors.

Image source: Getty Images.

Our neighbor to the north has been hit with a significant and persistent shortage of cannabis, dating back to the first day recreational weed became legal. Part of the problem relates to red tape surrounding Health Canada. The regulatory agency responsible for overseeing the industry and approving cultivation, processing, and sale applications had a backlog of more than 800 applications in January. These licensing applications often take months, if not longer than a year, to review, slowing the process by which product is getting to market. A new rule change, announced last week, may alleviate a good portion of this backlog.

But Health Canada doesn't shoulder all of the blame. A shortage in compliant packaging solutions, coupled with the lengthy amount of time it's going to take for growers to construct their cultivation facilities and ramp up production, is also at fault for Canada's weed shortage.

These early-stage hiccups, along with persistent operating losses from most marijuana stocks, are why I had kept my money far away from pot stocks until recently.

Things change: I bought my first marijuana stock earlier this month

However, things changed 12 days ago. After years of analyzing the industry, I became an investor by purchasing shares of CannTrust Holdings ( CNTTQ 0.00% ).

Cannabis plants in a hybrid cannabis-growing greenhouse.

Image source: Getty Images.

CannTrust had tanked following the pricing of a $170 million stock offering at $5.50 a share, which was almost 15% below where the grower had closed the previous day. While not oblivious to the negatives of share dilution, I saw this as my opportunity to enter what I believe to be one of the least expensive growers based on peak production potential (200,000 kilos to 300,000 kilos) at a discount. Plus, with plenty of cash now in its coffers, CannTrust has the capital to complete its aggregate 200-acre land purchase, and develop this land for outdoor growing.

This outdoor crop will add 100,000 kilos to 200,000 kilos a year, and I'd expect it to be instrumental in providing CannTrust with ample cannabis for extraction purposes. The yield of cannabidiol (CBD) and tetrahydrocannabinol (THC) from this outdoor cannabis can be used in higher-margin derivatives (e.g., oils, edibles, infused beverages, vapes, and topicals), many of which will be legal in Canada by this October. THC is the cannabinoid that gets users high, whereas CBD is the nonpsychoactive cannabinoid best known for its perceived medical benefits.

But little did I know at the time that I wasn't done dipping my toes into the cannabis pond.

It happened again: I've bought a second pot stock

A week later, on Thursday, May 9, I purchased my second pot stock. After more than a year of hemming and hawing over this ancillary cannabis play, I purchased shares of my favorite marijuana stock for 2019, KushCo Holdings ( KSHB ).

An assortment of legal Canadian cannabis product on a counter.

Image source: Getty Images.

KushCo, which is perhaps best known for providing packaging and branding solutions to the cannabis industry, has underperformed its peers pretty significantly in recent months. Arguably the biggest issue for the company was the announcement on April 11 that it had uncovered accounting errors that would cause it to restate its 2018 and 2017 financial results. Corporate governance issues have been (unfortunately) a far too common occurrence with pot stocks, and this announcement shook faith in the company's management team.

Similarly, KushCo has taken heat for the packaging shortage in Canada. While it's far from the only packaging solutions company, it's one of the largest, so guilt by association has led to a lot of finger-pointing at management by investors.

Clearly, KushCo isn't perfect. Then again, no stock is. But perfection isn't needed to see that there could be incredible value in KushCo's stock right now if its three business segments take off.

As noted, KushCo is best known for its packaging and branding solutions. It works with more than 5,000 marijuana growers in 25 countries to ensure that they remain compliant with federal, state, and/or local laws, as well as works with companies on branding and packaging solutions so they can stand out in an increasingly crowded field. As the marijuana industry blossoms, KushCo should become an indispensable middleman between growers and retailers.

A vape pen, vial of cannabis oil, and dried cannabis, sitting on a table.

Image source: Getty Images.

Secondly, KushCo manufactures vaporizer products, including cartridges and heating elements, for the marijuana industry. Even though dried cannabis flower has long been the face of the weed industry, it's the preferred product of generations past. Rather, the new generation of cannabis users prefer derivative products. In Canada, a number of new derivative options, including vapes, should be legal by no later than October. Since these derivative products offer considerably higher margins than dried flower, investors can expect marijuana companies to place extra attention on them, which bodes well for KushCo's vaporizer products division.

Third and finally, following its purchase of Summit Innovations in 2018, KushCo supplies hydrocarbon gases and solvents. Hydrocarbon gases are essential for the production of high-margin oils, while solvents are used in making cannabis concentrates. The point being that KushCo has yet another business segment where it holds a niche position as a needed middleman.

In addition to viewing KushCo's positioning within the cannabis industry as highly favorable, I also chose to take the plunge because the company's accounting restatements had no material impact on the company's cash balance, cash flow, or total sales. Make no mistake about it, I wouldn't go so far as to spin an accounting error as something good. But it's clearly not as bad as some investors might think.

We're also talking about a company that has consistently met or surpassed sales expectations. Having initially forecast $110 million to $120 million in 2019 sales at the beginning of the year (up from $52.1 million in 2018), management substantially increased this range to between $140 million and $150 million in April. Assuming Wall Street's consensus sales forecast for 2020 is correct ($242.5 million), KushCo is valued at less than 1.8 times next year's sales. That might be the cheapest forward price-to-sales ratio of any pure-play pot stock. 

It's for all of these reasons that I've made KushCo Holdings my most recent investment.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Kush Bottles, Inc. Stock Quote
Kush Bottles, Inc.
CannTrust Holdings Inc. Stock Quote
CannTrust Holdings Inc.
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