Marijuana stocks' sky-high valuations have been coming back to earth in 2019 on worry that Canada's legal, adult-use market sales are stalling and fervor over growing legalization in the United States is overdone. The tumble in marijuana market caps, however, could offer growth investors a second-chance opportunity to pick up pot stocks at bargain prices. There are a lot of pot stocks you can choose to buy on this dip, but I think HEXO Corp. (HEXO 1.79%), CannTrust Holdings (CNTTQ 0.00%), and OrganiGram Holdings (OGI 6.31%) may offer the best bang for your investment buck.
This pot stock has big plans
Canada's marijuana market is valued at an estimated 6 billion Canadian dollars per year. The prospect of shifting those sales to legal, regulated companies rightfully has a lot of investors excited, but the total dollar potential to marijuana companies could be much bigger. Why? Because most of Canada's illegal marijuana market is for dried flower, not value-added products like oils, edibles, and other consumer products such as beverages and lotions.
Recognizing there's a lot of potential profit in marketing finished products that use marijuana as an ingredient, HEXO has taken steps to position itself as a major player in what could be the next big driver of demand.
In August 2018, HEXO inked a joint venture with beer giant Molson Coors Brewing to create cannabis-infused beverages. That company, Truss, is already deep into developing products that could hit the Canadian market as soon as the end of 2019, if regulators cooperate.
HEXO is also putting in place a U.S. consumer goods strategy that seeks to take advantage of December's passage of the U.S. Farm Bill, which removed hemp -- a strain of cannabis sativa -- from the controlled substances list. The move clears the way toward enabling companies to market products consisting of hemp-derived cannabidiol (CBD), a chemical cannabinoid found in marijuana and hemp that's associated with wellness.
HEXO's management recently disclosed its inked supply agreements that provide the company with 260,000 kilograms of hemp through 2020. Its goal? To extract CBD from it for use in products that it can sell in up to eight U.S. states as early as next year.
The possibility of new products on the horizon is exciting, especially since HEXO's guidance already calls for significant revenue growth, in part because of additional marijuana grow capacity that's coming on line. The company's annual marijuana capacity is currently about 9,800 kilograms, but investments have it on track to reach annualized production of 150,000 kilograms. The increase in production prompted management to set a goal of CA$400 million in sales in fiscal 2020 (12 months ending July 2020).
A big, beat-up bargain with lots of risk
CannTrust has been a disaster stock for investors this year, and it's arguably the riskiest pot stock with the greatest potential reward from here. Let's begin by listing all the bad news that's derailed this company this year:
- March 28, 2019: Reported quarterly results shy of industry watchers' predictions.
- April 22, 2019: Diluted existing investors by announcing a $200 million stock offering (which went off at a disappointing price on May 2).
- May 14, 2019: Reported quarterly results showing little sequential revenue growth.
- July 3, 2019: Ratcheted back expectations for outdoor marijuana grow production from up to 75,000 kilos in 2019 to 0 to 15,000 kilos because it had yet to receive a license for its newly acquired acreage.
- July 8, 2019: Reported it had grown cannabis in five unlicensed rooms from October 2018 to March 2019, resulting in the halting of sales on over 12,000 kilograms of product.
- July 12, 2019: Suspends all sales and shipments pending regulatory review of its noncompliance.
Needless to say, investors can't be blamed for souring on CannTrust given that onslaught. There's undeniably no telling how this shakes out, but it's not out of the question that a path emerges that allows CannTrust to get back to business, rewarding investors in the process.
For instance, regulators could limit their action to a fine and greater oversight, rather than a revoking of CannTrust's license. Couple such an outcome with the resignation of the company's CEO -- a must in my view -- and a healing process with shareholders could begin.
There's plenty of potential if -- and this is a big if -- this best-case scenario plays out. CannTrust's current expansions could result in annualized production of 50,000 kilos in Q3, and if it finally gets its acreage licensed, outdoor growing could increase production to 200,000 kilos in 2020, making CannTrust one of the largest second-tier Canadian growers.
Nevertheless, it could be an even bigger disaster if a regulatory verdict doesn't go CannTrust's way. Since we don't know what's going to happen, only those who can withstand a complete loss should probably consider buying this one off the clearance rack.
Potentially the top pot stock
A three-tier grow system allows OrganiGram to produce a lot of high-quality marijuana indoors on the cheap, and that may make it the most attractive beat-up pot stock to buy on this list.
Last quarter, OrganiGram's net revenue jumped 620% year over year to CA$24.75 million, and over the past nine months its sales were CA$64.1 million. Its quarterly sales performance was driven by a sharp increase in kilograms sold to 4,615 kilos that only hints at the potential revenue associated with its planned increases in production.
OrganiGram's current annual production capacity is 61,000 kilos following it securing licenses for its phase 4A expansion last month. It's already in the process of filing rooms from its phase 4B expansion for approval, and if licenses are granted, that would add another 28,000 kilos of production per year. Finally, it's targeting the filing of its phase 4C rooms for approval by year's end, which would increase total production to 113,000 kilos if regulators give them a green light.
That's a substantial increase that could allow the company to make big headway toward profitability. OrganiGram's gross margin dipped because of lower yields associated with a pilot grow program that didn't pan out last quarter, but management expects margin to return to industry-leading levels. For perspective, before dipping to 50% last quarter, its gross margin was 60% two quarters ago, which was miles higher than many of its peers.
If OrganiGram can hold the line on its expenses and its yields recover to where they were before its failed pilot program, then a substantial increase in sales resulting from its production capacity growth could position it perfectly for best-in-class operating margin someday, making it my favorite of the three to buy on sale.