You likely don't need the reminder, but there aren't many industries expected to deliver a faster or more consistent growth rate over the next five to 10 years than legal marijuana. A newly released report from Arcview Market Research and BDS Analytics calls for more than $40 billion in global licensed-store sales by 2024, which is almost quadruple what was generated in 2018. Then, by the end of the next decade, cannabis cheerleader Cowen Group has called for $75 billion in annual worldwide sales.
But there's an even larger growth trend within the marijuana industry that has the full and undivided attention of Wall Street and investors. Namely, cannabidiol (CBD).
CBD is the hot commodity
Cannabidiol is the nonpsychoactive cannabinoid best known for its perceived medical benefits. The Food and Drug Administration does recognize its benefits in treating two rare types of childhood-onset epilepsy, but otherwise doesn't denote CBD as having any other medical benefits.
This hasn't slowed the uptake of CBD-containing products in the United States. Suggested as a treatment for pain, anxiety, and a host of other ailments, CBD is viewed by the cannabis industry as a means of attracting consumers who might not otherwise try marijuana products. As an added bonus, since CBD is almost always infused in derivative products (e.g., oils, edibles, infused beverages, tinctures, and topicals), and derivative products bear much higher price points and margins than traditional dried cannabis flower, this means better margins for the companies behind these products.
All told, the Brightfield Group has forecast that U.S. CBD sales will soar from $591 million to $22 billion between 2018 and 2022, which works out to a compound annual growth rate of 147%.
Given this information, it's no surprise that cannabis investors are angling to take advantage of this growth with direct players. In the U.S., Charlotte's Web and CV Sciences have been gobbling up hemp-derived CBD market share and significantly expanding the number of stores where their topicals, capsules, and oils are sold. We've also seen close to half of all major Canadian cannabis players announce their entry into the U.S. hemp market (with the intention of developing CBD products for sale), with another three big producers expected to enter the space within the next year.
CBD extraction-service providers could be a sneaky stable play
But what if this isn't the best or safest way to take advantage of the rise in CBD? A potentially sneakier, yet smarter idea might be to focus on the companies handling the extraction of CBD from hemp and cannabis biomass. Although CBD can be extracted from cannabis, hemp is often much cheaper and easier to grow, which usually makes it the preferred source of high-quality CBD extracts.
The intrigue of buying one or more extraction-service providers is that their contracts are often for two or three years and have stated minimum hemp and cannabis biomass amounts that they'll be extracting. In other words, these fee-for-service contracts create minimum amounts of predictable cash flow each year, which ensures that these companies can spend their capital wisely. It also tends to make Wall Street happy, since uncertainty is the enemy of investors.
Within the CBD extraction space, there are three companies that have landed some big-name contracts to date, and thus might be worth a closer inspection.
First up is Valens GroWorks (NASDAQOTH:VGWCF), which claims to be the largest third-party extraction-service provider in Canada in its press releases. Although Valens has landed a number of deals with major marijuana growers in Canada, the most notable is its two-year agreement with Quebec-based HEXO for an aggregate of 80,000 kilos of cannabis and hemp biomass. Valens' service agreement with HEXO is back-end loaded, with at least 30,000 kilos of biomass being extracted in the first year and at least 50,000 kilos in the second year.
Just last week, Valens announced that business has been so good that it's upped its annual extraction capacity to 425,000 kilograms, with plans to boost its yearly capacity to more than 1 million kilos in the first half of 2020. This added extraction space will also expand capacity to create white-label capsules, vaporizers, topicals, edibles, and concentrates, according to the company's press release.
Neptune Wellness Solutions
Although Neptune Wellness Solutions (NASDAQ:NEPT) is an under-the-radar extraction service, it has managed to land a couple of very large contracts. Three weeks ago, Neptune and Tilray inked a three-year agreement that'll see Neptune providing resins, winterized oil, and distillate extracts from an aggregate of 125,000 kilos of cannabis and hemp biomass. As is often the case with the extraction contracts, it's back-end loaded, with roughly 20% of this biomass coming in the first year. That's because most cannabis growers, including Tilray, are still ramping up capacity.
However, Neptune really put itself on the map by announcing the largest extraction deal to date just five days after signing its agreement with Tilray. The three-year deal with The Green Organic Dutchman will see Neptune taking on an aggregate of 230,000 kilos of hemp and cannabis biomass for extraction, with 20% of this total expected in the first year.
A third and final provider of extraction services that could be worth a look is Ontario-based MediPharm Labs (NASDAQOTH:MEDIF). It has signed up a number of big-time names for its services, including premium-quality producer Supreme Cannabis Company; Cronos Group; and Canopy Growth, the largest pot stock in the world by market cap. During 2019, MediPharm will be expanding its extraction capacity by 60%, from its current 150,000 kilos per year to 250,000.
One of the more notable deals landed by MediPharm Labs came in January, when it signed a three-year agreement with TerrAscend (NASDAQOTH:TRSSF). This deal will see TerrAscend providing MediPharm with dried cannabis flower that it'll use to create cannabis oil concentrates under the TerrAscend label. In return, MediPharm Labs is paid on a fee-for-service basis, with no aggregate amount of dried flower divulged in the agreement.
Companies like TerrAscend know that their ticket to better margins is through derivative products, which makes extraction companies a potential sneaky but smart way to play the CBD craze.