Chances are that you'd struggle to find a more impressive growth opportunity than legal marijuana. According to growth estimates from Wall Street investment bank Stifel, the legal weed industry could see worldwide sales soar from $10.9 billion in 2018 to perhaps as high as $200 billion a decade from now. That's enormous growth typically reserved for a technological advance, not the legalization of a plant. Nevertheless, it's bound to attract a lot of attention from investors.
Canopy Growth has long been the face of the cannabis industry
Heralding the charge pretty much since the get-go has been Canopy Growth (CGC +6.48%), the largest marijuana stock in the world by market cap. With few exceptions -- e.g., Tilray's moon shot following its initial public offering last year -- Canopy has firmly planted itself as the biggest cannabis stock.
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Part of the reason why this company is such a giant has to do with its top-tier pot brands (e.g., Tweed), as well as its projection as the second-leading producer, behind only Aurora Cannabis (ACB +2.91%). When fully operational, Canopy should have little issue producing more than 500,000 kilos a year from the 5.6 million square feet set aside for cultivation. Thus far, more than 5 million square feet has already been approved for cultivation by regulatory agency Health Canada.
Canopy Growth also has one heck of a war chest. In November, Modelo and Corona beer maker Constellation Brands (STZ +1.66%) made a mammoth $4 billion equity investment in the company, marking its third such investment since October 2017. The deal, which upped Constellation's equity stake to 37%, gave Canopy Growth free rein to expand internationally and acquire new businesses. Even after quite the spending spree, Canopy ended the most recent quarter with $2.36 billion in cash and cash equivalents, which is by far tops in the industry.
And, of course, there's the company's international presence. With a production, export, or research presence in 16 countries, Canopy Growth trails only Aurora Cannabis. These foreign markets should prove critical to the long-term success of the marijuana industry, especially if the domestic Canadian market becomes saturated with dried cannabis flower.
It's time for a changing of the guard
However, Canopy Growth hasn't looked like much of a leader in recent months. The company's stock has lost more than half of its value, and its most recent quarterly report featured a one-time loss of more than 1 billion Canadian dollars. In other words, it may soon be time for a changing of the guard among the biggest cannabis stocks.
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Although I've been highly critical of Aurora Cannabis in the past (and still remain somewhat critical of the company's growth tactics), I see far more downside potential built into Canopy's share price than Aurora's at this point. Mind you, there's still quite a gap between Canopy's valuation ($8.77 billion) and Aurora's market cap ($5.81 billion). But I can envision a scenario over the next 12 months where Aurora dethrones Canopy as the biggest pot stock in the world by market cap, and I have three reasons to back up this thesis.
To begin with, Aurora Cannabis has management continuity. The company's CEO, Terry Booth, helped found the company back in 2006, and he remains in his leadership role to this day. Meanwhile, Canopy's visionary co-CEO Bruce Linton was shown the door by the company's board in early July, and Mark Zekulin, the company's default CEO following Linton's firing, will be stepping down once a permanent CEO is found. In other words, it's unclear what direction Canopy Growth could be headed next. The only thing we know for certain is that Constellation Brands, which has two of its own executives and two independent directors on Canopy's board, could no longer tolerate Linton's aggressive spending and sent him packing.
Secondly, I can appreciate Aurora Cannabis' transparency. Aurora has taken the time to lay out production estimates for each of its 15 facilities for investors, provided revenue guidance in advance of its quarterly reports, and walked Wall Street through its expectations of reaching positive recurring EBIDTA (earnings before interest, taxes, depreciation, and amortization) in the fiscal fourth quarter. Comparatively, Canopy Growth hasn't offered anything in the way of peak production estimates, and CFO Mike Lee has largely distanced himself and his company from narrowing down sale and loss projections in the near term.
Thirdly, but most important, Aurora Cannabis looks to turn the corner to profitability at an earlier date than Canopy Growth. Even though both are on track to lose money in fiscal 2020, Aurora Cannabis is losing a lot less, and is probably on track to reach peak operating potential earlier than Canopy. Since earnings matter now, Aurora has the clear edge here over Canopy Growth.
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Keep those expectations realistic
Of course, there's a caveat to my prediction that Aurora Cannabis will dethrone Canopy Growth. This being that I expect weakness in Canopy's stock to narrow the market cap gap between the two far more than I expect strength in Aurora's stock to close it. In fact, it's possible that both companies could lose value from this point in time as the legal weed industry continues to find its footing and mature.
Remember, the entire Canadian pot industry has been contending with cannabis supply issues since recreational sales began on Oct. 17, 2018. Regulatory agency Health Canada has been bogged down with cultivation and sales license applications, although it's introduced a fix to the cultivation license process that should result in a slow but steady fix. Select provinces have also been slow to approve the licensing of retail locations. All of these issues are fixable, but it's going to take numerous quarters for supply issues to be resolved.
There's also the very real likelihood that, despite growing support for legalization among the public, the United States is nowhere near close to legalizing marijuana. Aside from legalization actually costing the federal government revenue, no reform bill stands a chance of reaching the Senate floor as long as Mitch McConnell (R-Ky.) is Senate majority leader. That's stymied the hopes of Canopy, Aurora, and their peers of quickly profiting from a surge in legal U.S. weed sales.
Investors also shouldn't overlook the fact that it's going to take time for Aurora's and Canopy's international markets to pay dividends. Exports are unlikely to generate a lot of revenue until demand in the Canadian market is satiated -- and given the supply issues noted above, that's still a long way off.
Yes, Aurora can surpass Canopy Growth as the face of the marijuana industry. But understand that this passing of the torch is likely to happen more out of weakness in Canopy's stock than due to strength in Aurora's stock.
