The cannabis space is growing like a weed, thanks largely to Canada's legalization of recreational marijuana last October along with an increasing number of U.S. states giving the green light to the drug for medical use. Moreover, the industry is widely projected to be one of the fastest growing over at least the next decade as more countries -- including the United States -- are expected to eventually fully legalize marijuana. So it makes good sense for risk-tolerant investors to want exposure to the cannabis realm.
To help you cut through the dizzying array of stock choices, we asked three Motley Fool contributors who cover the space and own at least one cannabis stock to explain why they bought one of their holdings. Below are their buy theses for MediPharm Labs (MEDIF +1.88%), Canopy Growth (CGC +0.00%), and OrganiGram Holdings (OGI +0.00%).
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Avoid growers -- bet on other parts of the value chain
Jim Crumly (MediPharm Labs): With Canadian marijuana producers racing to increase production in a supply-constrained market, one thing's as certain as tomorrow's sunrise: The price of cannabis in Canada will eventually tumble. One promising strategy for investing in marijuana is to avoid betting on the farmers and instead invest in other parts of the value chain.
Companies that produce cannabis derivatives, such as oils and tinctures, have a couple of advantages. Not only is plant material an input, providing some protection from price deflation, but the market for concentrates is about to boom in Canada when they become legal this fall. So I bought a small position in under-the-radar MediPharm Labs, the leading Canadian cannabis-extraction company.
MediPharm performs contract processing for some of the biggest licensed producers such as Canopy Growth and Cronos Group. But it also buys dried cannabis from smaller producers and manufactures private-label and white-label concentrate products for companies that want to sell these products under their own brand. Longer term, MediPharm plans to use a chromatography process to extract some of the 80 lesser-known cannabinoids for use as pharmaceutical ingredients in clinical research or to produce custom blends -- essentially, synthetic marijuana strains -- such as what Cronos aspires to create.
MediPharm, with a market capitalization of about $400 million, grew revenue 115% sequentially last quarter and generated positive operating cash flow. This year, it's expanding its annual extraction capacity 67%, to 250,000 kilograms in Canada, and launching operations in Australia.
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Cash is king and Constellation is queen
Beth McKenna (Canopy Growth): I agree with Jim that marijuana prices will eventually decline as growers ramp up production, making it generally better to invest in companies downstream from growers and/or in ancillary cannabis companies. But I think Canopy Growth, a Canadian cannabis grower believed to have the second-largest production capacity behind Aurora Cannabis, has a good shot at proving to be one of the exceptions because it's aggressively vertically integrating.
I bought shares of Canopy largely for its double-C advantage: cash and Constellation Brands (STZ +0.18%). The company has boatloads more cash than its peers, thanks to its partnership with the alcoholic beverage giant. Last fall, Canopy received $4 billion when the maker of Corona beer upped its ownership stake in it to 38%. It had over $3 billion of cash as of the end of its most recent quarter.
Canopy's deep pockets have been allowing it to make aggressive moves to position itself for long-term growth. For instance, in April, it announced that it was buying the rights to acquire Acreage Holdings (ACRGF +0.00%), a U.S.-based, multistate cannabis operator. This creative, one-step-ahead-of-the-competition deal has Canopy paying $300 million in cash upfront for the right to acquire Acreage for $3.4 billion if the U.S. federal government legalizes marijuana.
Its Constellation partnership should provide Canopy with benefits beyond cash, including giving it access to the alcoholic-beverage maker's extensive global distribution network. This benefit should begin to be realized soon, as the two partners are developing cannabis-infused beverages, which are one of the value-added product categories that will be legal in Canada later this year. Indeed, Canopy is focused on developing a wide range of valued-added products, which will help greatly mitigate the risk Jim mentioned.
All that being said, I'm planning to revisit my investing decision after the company's recent firing of its founder and co-CEO Bruce Linton.
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Low-cost production could be key to long-term profit
Todd Campbell (OrganiGram): After writing about marijuana for a while, I finally began buying shares in marijuana stocks in 2018. So far, I've started small positions in a slate of companies, but OrganiGram is the most recent pot stock I bought.
OrganiGram employs a three-tier grow approach that allows it to be one of the lowest-cost marijuana producers. Last quarter, it attempted a new grow process in hopes of further improving yields and lowering costs. Unfortunately, its attempt didn't pan out, but OrganiGram's still positioned to deliver some of the industry's best margins despite the disappointment.
In its most recent quarter (ending May 31, 2019), net marijuana sales, excluding excise taxes, totaled 24.8 million Canadian dollars, up 621% from the same quarter last year. Its adjusted gross margin in the quarter dipped to 50% from 60% because of its failed production test, but that's still better than most of its peers.
Overall, OrganiGram's net loss was $10.2 million Canadian dollars last quarter. I expect losses to continue as it reinvests to capture more market share for recreational-use marijuana in Canada. But its rapid revenue growth should eventually reward investors with positive net income or earnings. Currently, annual production is 61,000 kilograms, up from 36,000 kilos in the previous quarter, and it should reach a 113,000-kilogram annual pace by the end of 2019.
Given its increasing production, I think OrganiGram's positioned nicely to profit when value-added consumer products, including vapes and edibles, begin being sold in Canada later this year. If I'm right, then my decision to buy shares could pay off nicely.
