You could rightly say that this has been a bipolar year for marijuana stock investors. It began with an incredible run that saw the Horizons Marijuana Life Sciences ETF, the first tradable cannabis ETF, gain more than 50% during the first quarter.
Then the wheels fell off the wagon at the beginning of April. Canadian supply issues continued to rear their head, and high tax rates in the U.S. slowed the transition of consumers to legal channels. The result was that nearly three-quarters of cannabis stocks declined during the second quarter, with close to two-thirds of pot stocks losing a double-digit percentage in July. It's certainly been a tale of two halves, that's for sure.
While the industry still has a lot of growing up to do, this persistent decline in recent months has created an intriguing buying opportunity for a handful of cannabis stocks. In July, I chose Florida-focused, vertically integrated dispensary operator Trulieve Cannabis as the then-most-attractive marijuana stock. In August, niche dispensary operator Planet 13 Holdings was my top cannabis stock to buy given the unique buying experience it can offer consumers. Now with September around the corner, my attention turns to a new top marijuana stock to buy. Ladies and gentlemen, let me introduce you to MediPharm Labs (MEDIF 3.93%).
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The rise of derivatives creates a unique opportunity for MediPharm Labs
As you've undoubtedly begun to notice, I believe that the best values in the marijuana space exist below the radar. While it's very possible that well-known growers like Canopy Growth and Aurora Cannabis could do just fine over the long run, I don't see them offering intriguing value at the moment, even after sizable declines.
That brings me back to MediPharm Labs, a provider of extraction services for Canadian marijuana and hemp growers. The bull case for MediPharm boils down to the rise of derivative products in Canada.
Although dried cannabis flower is the product that most consumers and investors associate with the marijuana industry, it's also the easiest product to oversupply and commoditize. In mature U.S. markets such as Colorado, Oregon, and Washington, we've witnessed a fairly precipitous decline in wholesale cannabis pricing on a per-gram basis, all because of dried flower oversupply. This means that Canadian cannabis companies absolutely must diversify their product offerings to avoid what looks like certain margin deterioration if they're too reliant on dried flower. This is where derivatives come into play.
Marijuana derivatives are high-margin, non-dried-flower products, such as edibles, vapes, infused beverages, topicals, and concentrates. They're in relatively no danger of oversupply and have few if any pricing pressures, making them ideal for Canadian pot stocks to prioritize in their portfolios.
According to regulatory agency Health Canada, laws governing derivatives will go into effect on the one-year anniversary of recreational marijuana's legalization (Oct. 17), with derivative products beginning to hit dispensary shelves by mid-December.
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MediPharm is expanding, landing big-time contracts, and is already profitable
With pot stocks needing to diversify their product portfolios, MediPharm Labs is in perfect position to take cannabis and hemp biomass and transform it into resins, distillates, and targeted cannabinoids -- tetrahydrocannabinol (THC) and cannabidiol (CBD) -- that pot growers can use in branded derivative products. As a refresher, THC is the cannabinoid that gets users high, while CBD doesn't get users high and is best known for its perceived medical benefits.
According to MediPharm, via its second-quarter operating results, the company is currently working on expanding its Barrie, Ontario, processing facility to handle 300,000 kilos of annual extraction capacity, with the ultimate goal of increasing its capacity to 500,000 kilos in the not-so-distant future. My suspicion is that MediPharm won't have an issue contracting out this extra capacity, especially given the deals it's already landed.
MediPharm currently has processing contracts with a number of major Canadian growers, including Canopy Growth, premium-quality pot grower Supreme Cannabis Company, and TerrAscend. But the biggest deal it signed came from Cronos Group (CRON 4.66%) in May. The extraction deal will allow MediPharm Labs to supply Cronos with $30 million in cannabis concentrates over an 18-month period, with Cronos Group holding the option to up the contract to $60 million worth of concentrates over a 24-month period. These contracts, which typically span more than a year, provide some semblance of predictable cash flow in an industry where very little is predictable at the moment.
This is also a company that has international ambitions. In June, MediPharm Labs received an import permit from, and completed a cannabis concentrate shipment to, Australia. The Australian pot market could eventually grow into a multibillion-dollar industry, and MediPharm is the only Canadian extraction-services provider to have a permit to export cannabis concentrate to Australia.
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Of course, what really matters is a company's bottom line, and MediPharm has not disappointed. The company grew sales by 43% in the second quarter from the sequential first quarter, with gross profit of 11.3 million Canadian dollars, or 34% of sales. After subtracting for rising costs, which are expected with the company expanding its extraction capacity, MediPharm still managed to deliver a CA$0.01-per-share profit, on a diluted basis. That may not seem like much, but CA$4.1 million in reported net income is incredibly impressive given that MediPharm had no sales at this time last year and only began extraction during the fourth quarter. It demonstrates just how quickly demand is ramping up in the extraction-services space.
Wall Street's consensus also portends strong growth in the quarters that lie ahead. Wall Street's 2019 forecast calls for nearly CA$84 million in sales and a modest full-year profit of CA$0.04 per share, with 2020 sales surging to CA$150 million with a profit per share of CA$0.19. Although cannabis stocks have struggled mightily to meet Wall Street's projections, MediPharm's contracts, expansion, and early stage profitability suggest it's very much achievable.
That's what makes MediPharm Labs my top marijuana stock to buy in September.
