Editor's Note: This article was updated June 7, 2019 for accuracy. The previous version incorrectly interpreted the balance sheet and included a mathematical error.
The marijuana industry is shaping up to be a once-in-a-generation investment opportunity, although it'll require the patience of long-term investors.
On the surface, the legal weed industry looks to be on track for between $50 billion and $75 billion in annual sales by the end of the following decade. That's up from just $12.2 billion in worldwide revenue in 2018, according to Arcview Market Research and BDS Analytics. Assuming you're invested in a basket of pot stocks, this growth should translate into at least some of the companies you own turning out to be winners.
Then again, the short term brings numerous hurdles. Canadian supply has been severely constrained, with regulatory agency Health Canada completely bogged down by more than 800 cultivation, processing, and sales license applications, and compliant packaging solutions lacking. This had led to falling sales and profit estimates for most marijuana stocks, thereby testing the patience of investors, and the premium bestowed upon pot stocks.
One of the most popular pot stocks that's caught in the middle of this bull-bear debate is British Columbia-based Village Farms International (NASDAQ:VFF). Although it's reasonably small at a market cap of $667 million, as of this past Thursday, May 23, it's hands down the top-performing marijuana stock in 2019. Year to date, Village Farms' share price has surged more than 310% (in Canada).
The big question is: Should investors still be buying Village Farms International?
The way I see it, there are two valid reasons to buy into the company here, and two reasons to stick to the sidelines. But, the intriguing aspect is that the two reasons to stick to the sidelines are probably the biggest reasons why investors have bought into this stock.
Two reasons Village Farms shouldn't be bought
Why avoid Village Farms International? For starters, I'm not impressed with the company's cannabis operations, and I don't believe you should be, either.
Back in 2017, Village Farms and Emerald Health Therapeutics (NASDAQOTH:EMHTF) entered into a 50-50 joint venture that would see at least 1.1 million square feet of greenhouse space previously owned by Village Farms for vegetable production retrofit to grow cannabis. This joint venture, known as Pure Sunfarms, now features two facilities: Delta 3 (the original greenhouse) and Delta 2, which the Pure Sunfarms joint venture recently exercised its option to acquire. All told, the 2.2 million square feet of combined space yields about 2.1 million square feet of cultivation space that's capable of 150,000 kilos of peak output, per the company.
The beef? At 150,000 kilos, but with approximately 2.1 million square feet of growing space, Village Farms and Emerald Health are producing at a yield per square foot lower than some of its peers in the industry. Sure, the duo saved a bunch on construction costs since Village Farms already had existing greenhouses, but the efficiency of its cannabis farms is in question.
Additionally, with the exception of Pure Sunfarms essentially selling a sizable portion of its supply back to half-owner Emerald Health, it's done very little on the supply deal front, which could leave the joint venture exposed if and when dried flower oversupply becomes a problem in Canada.
The second reason not to buy Village Farms: its latest earnings report.
Some folks would argue that the company's first-quarter profit makes it a screaming bargain. But there wasn't a lot to cheer about in its Q1 report that didn't involve a one-time sale or adjustment. When Emerald Health and Pure Sunfarms agreed to acquire the Delta 2 facility, Village Farms recorded a $13.6 million gain on the contribution of fixed assets. Without this one-time gain, the company would have posted a loss in the first quarter. Optimists would like to spin the first quarter as a positive from a fundamental perspective, but it wasn't on an operating basis.
Two reasons Village Farms deserves serious consideration
The good news is that there are two reasons to genuinely be excited about this company over the long run -- and neither is its cannabis operations.
To begin with, Village Farms looks as if it's ready to become a hemp superstar in the United States. Texas' state legislature recently passed a game-changing hemp law that will allow Village Farms to retrofit up to 5.7 million square feet of West Texas greenhouses to grow hemp. Hemp is a considerably easier-to-grow plant, relative to cannabis, and also less costly.
Of bigger importance is the fact that hemp is rich in cannabidiol (CBD), the extremely popular cannabinoid that doesn't get users high but is responsible for a number of perceived medical benefits. The market for CBD products is exploding, with the Brightfield Group calling for CBD-related sales to rocket from less than $600 million in 2018 to $22 billion globally by 2022.
On top of its Texas-based greenhouses, the company has established two hemp-based joint ventures in the United States, one of which (Village Fields Hemp) has begun planting more than 800 acres of hemp across three states, with harvesting beginning by this summer. Hemp, not cannabis, is why investors should be excited about Village Farms International's long-term potential.
Secondly, Village Farms deserves consideration for its safety-net operations: vegetable-growing. Although growing vegetables isn't exactly a high-margin business -- and margins can be completely dependent on the weather in a given year -- this established business segment has been responsible for generating reasonable cash flow for a while, thereby minimizing the share-based dilution that most marijuana stock investors have contended with. Even with some of its vegetable-growing space being converted for higher-margin ventures, this ancillary business plays a big role in putting a floor under this stock.
So, to sum up: Don't buy Village Farms because it's growing cannabis and reported a "profit" in Q1, but do consider buying it because of its burgeoning hemp business and the relatively steady cash flow from established vegetable-growing operations.