Over the next decade, you'd struggle to find an industry that offers the growth potential of legal cannabis. Unlike new technologies, cannabis has been around for a long time and is a proven industry – at least in the black market, where tens of billions of dollars in sales are conducted each year. It wouldn't be all that difficult for the marijuana industry to continue shuffling consumers from the black market to legal channels over time.
Just how big could the cannabis industry become? Although estimates vary quite a bit on Wall Street, the consensus is that marijuana offers a double-digit compound annual growth rate over the next decade, with one investment bank calling for as much as $200 billion in sales. That's not the type of growth investors are going to overlook.
But as we learned from the dot-com bubble in the early 2000's, valuations are about more than just revenue growth. At some point, earnings actually start to matter, and we've begun witnessing that shift in the cannabis industry. When many of the most popular pot stocks, such as Canopy Growth (NASDAQ:CGC), Aurora Cannabis (NYSE:ACB), Cronos Group (NASDAQ:CRON), and Tiray (NASDAQ:TLRY), lift the hood on their quarterly performances, Wall Street and investors pay close attention.
Although operating profitability (sans one-time benefits) is pretty much out of the question for these popular pot stocks in 2019 – Cronos will likely be profitable in 2019 as the result of a non-cash unrealized gain on the revaluation of derivative liabilities – and perhaps even in fiscal 2020 as Canada continues to work through supply kinks, the focus turns to 2021. Will 2021 be the year that cannabis stocks finally deliver on the earnings front?
Canopy Growth may be the largest marijuana stock in the world by market cap, but that hasn't saved what's arguably the most visible cannabis stock from some recent tumult. This month we've witnessed the firing of former co-CEO Bruce Linton, and learned from CFO Mike Lee that there's a very real possibility that Canopy won't hit its own previous guidance of 1 billion Canadian dollars in 2020 revenue (Canopy runs on a fiscal year that ends on March 31). Following this weaker guidance, Wall Street is now pricing in a greater than CA$1 per share loss in 2020, and has reversed its forecast for a 2021 profit of CA$0.31 per share just a month ago to a consensus loss of CA$0.37 per share.
Even though Canopy Growth is one of the lucky few growers that's been able to get a good portion of its cultivation space licensed by Health Canada, supply concerns are likely to be persistent for many quarters to come. Newly implemented rules for submitting grow-license applications should help Health Canada reduce its more than 800-license backlog, but it doesn't change the fact that fewer than 200 total licenses have been issued in over five years. These changes are likely to take time to implement, and with Canopy reliant on the recreational side of the market, it'll be particularly vulnerable to these supply chain issues.
Canopy's acquisition spree, and the long-term-vesting shares that Linton gave to employees in order to improve retention, could be troublesome as well. Integration costs tied to acquisitions and share-based expensing could ensure that Canopy Growth is one of the last marijuana stocks to turn the corner to profitability.
Aurora Cannabis, the most popular of all marijuana stocks, and the most-held stock of any publicly traded company by members of online investing app Robinhood, looks to have a much better chance of being profitable in 2021 than Canopy, but it'll still need some things to go right for that to happen.
The thing to remember about Aurora Cannabis is that, while it should see in excess of 660,000 kilos of annual run-rate output by the time 2021 rolls around, it's predominantly focused on international markets. Rather than going all-in on adult-use marijuana, Aurora has chosen to focus on medical cannabis patients, which should be a prudent move given that medical pot patients use weed more often and buy higher-margin derivatives, such as oils, more frequently. Presumably, this suggests that Aurora should generate better margins than many of its recreationally focused peers.
The concern is that international markets probably can't thrive until demand is met in Canada, which still looks to be many quarters, if not two full years, away. Health Canada is counting on domestic producers to meet Canadian shortages first, then satisfy overseas markets. Even with Aurora Nordic 2 perfectly situated to supply the Scandinavian region with medical cannabis in 2020, Aurora may need supply issues to correct themselves quickly in Canada if it's to deliver the green in 2021.
Maybe the biggest question mark of these four pot stocks is whether or not Cronos Group can generate an operating profit (sans one-time benefits) by 2021.
The biggest catalyst for Cronos Group is the late-year rollout of derivative products in Canada. By mid-December 2019, edibles, vapes, infused beverages, topicals, and concentrates will begin hitting dispensary store shelves throughout Canada, and, as noted, these are considerably higher margin items than traditional dried cannabis. Cronos will be angling for a significant share of the vape market with tobacco giant and equity investor Altria in its corner, and has been actively working to expand its derivative product line. For instance, last year Cronos Group forged an up to $100 million partnership with Ginkgo Bioworks that'll see it utilizing Ginkgo's microorganism platform to develop yeast strains capable of producing targeted cannabinoids at commercial scale.
However, Cronos Group's investments have also left it late to the party, so to speak, on numerous occasions. The company's peak annual output doesn't even place the company in the top 10 among growers if you also count joint venture projects and royalty companies. That's pretty crazy considering that Cronos is a top-five cannabis stock in term of market cap.
My suspicion is that Cronos Group can be profitable by 2021, thanks to its significant focus on derivatives, but that its per-share profit will be marginal at best.
Lastly, there's former darling Tilray (NASDAQ:TLRY), which has given back a significant portion of its post-IPO gains.
When Tilray debuted on the Nasdaq roughly one year ago, it looked to have a well-known medical brand and a clearly defined game plan. It would begin by developing roughly 850,000 square feet of cultivation space, then potentially scale to north of 3 million square feet, based on its own projections in its S-1 prospectus. But things change, and Tilray investors have learned this the hard way.
With supply issues hitting the entire Canadian cannabis industry, Tilray's CEO Brendan Kennedy announced in March that his company would instead focus on opportunities in the U.S. and Europe, rather than Canada. Even though both the U.S. and Europe offer greater long-term sales potential than Canada, it's an odd move to make with Canadian sales only now beginning to ramp up.
Further, Tilray shifting its attention to overseas markets means having to pony up more in the near-term for investments. It also puts the company at the same disadvantage its peer Aurora may contend with -- namely, that domestic markets need to be satiated before international markets have an opportunity to thrive. Suffice it to say, Canopy Growth could have company in the loss department in 2021.