In the words of most marijuana stock investors, "goodbye and good riddance to 2019!" While 2019 was supposed to be the year that cannabis stocks put everything together and delivered profits, this didn't turn out to be the case. Persistent supply issues in Canada, high tax rates in a number of recreationally legal U.S. states, and a resilient black market throughout North America, made sure that pot stock investors had a bad time.
However, 2020 brings a clean slate to the marijuana industry, and hopefully will deliver the green to investors. After all, this is an industry where tens of billions of dollars of product is being sold annually in the black market, and it's not unrealistic to expect these sales to steadily transition to legal channels over time as new countries/states give weed the green light.
The question is: Which marijuana stock should you be buying to take advantage of the green rush?
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While it had an abysmal 2019, my top marijuana stock for investors to consider buying in January is California-based ancillary player KushCo Holdings (KSHB).
But before I get into the meat and potatoes of why I consider it a buy, let's first dig into the reasons behind its awful campaign last year.
Here's why KushCo's 2019 didn't go as planned
First of all, KushCo was clobbered by the aforementioned supply problems in Canada. This is a company that sells vaporizers, provides packaging and branding solutions, and supplies hydrocarbon gases that are used in the production of cannabis oils. In other words, it relies on global cannabis sales increasing, which didn't happen nearly as quickly as anticipated in 2019.
For instance, Health Canada has struggled to approve cultivation and sales license applications in a timely manner (e.g., it took Aphria north of 18 months to get the green light to plant at its flagship joint venture, Aphria Diamond), and it delayed the launch of derivative products by two months. Meanwhile, Ontario, the country's most populous province, only opened two dozen retail locations a full year after adult-use sales began. These bottlenecks are all bad news up and down KushCo's operations.
Secondly, the U.S. vaping-health scare really took the wind out of KushCo's sails. As of Dec.27, the Centers for Disease Control and Prevention (CDC) had identified 2,561 persons hospitalized with cases of e-cigarette, or vaping, product use-associated lung injury (EVALI), of which 55 people had died. The CDC appears confident in having labeled vitamin E acetate as the EVALI culprit, but has recommended that consumers not vape liquids that contain tetrahydrocannabinol (THC), the cannabinoid that gets users high. Considering that KushCo generates the bulk of its sales form vaporizers, this was a clear concern to its top-line growth.
Image source: Getty Images.
A third problem, along those same lines, is the ongoing trade spat between the U.S. and China. KushCo imports a lot of its vaporizers and accessories from China, meaning costs for these products have been rising due to tariffs. For a short period of time, KushCo decided to eat these costs, rather than pass them onto its customers. Unfortunately, this weighed heavily on the company's margins and pushed KushCo's bottom line into the red.
Lastly, blame the Golden State's tax situation. California is the largest marijuana market in the world, but sales have been stuck in neutral due to the state taxing the daylights out of consumers. The result has been a strong black market economy, and therefore fewer opportunities for KushCo.
This is why KushCo is the top cannabis stock to buy in January
While there's no denying KushCo had a forgettable 2019, the current year should be a lot greener.
In all likelihood, 2019 was a trough year for production and a peak year for problems throughout the North American cannabis industry. Let's remember that there is no precedent to adult-use marijuana being legal in industrialized countries, so Canada and select U.S. states are learning as they go, just as pot stocks are. There's bound to be some trial and error in this process, with 2019 being filled with a number of errors.
As the industry matures, we should see production and supply chains improve. For instance, with Ontario shelving its lottery system for retail licenses, it should have 10 times as many dispensaries open by the end of 2020. That means more opportunity for pot products to reach Canadian consumers, and for KushCo to play a key middleman role.
Next, investors have to appreciate the central role KushCo will play in the industry's growth. Vaporizer sales are expected to pick up in the second half of the year as consumers opt for legal-channel product following the U.S. health scare. Likewise, hydrocarbon gas sales should grow considerably as North American marijuana companies focus their efforts on higher-margin derivatives, such as oils.
Image source: Getty Images.
Investors will also want to take note that KushCo is putting its foot on the ground and standing by its revenue growth forecast. Whereas most marijuana stocks missed their lofty sales projections by a mile, KushCo did not. This is a company that's at least doubled its sales in four consecutive fiscal years (including 186% sales growth in 2019), and which is forecasting $230 million to $250 million in full-year sales for fiscal 2020. This would represent 61% year-over-year growth at the midpoint, and values the company at less than 1 times forecasted sales.
To build on this point, we've also witnessed significant margin improvement from KushCo throughout the previous fiscal year. Between the end of the first quarter and fourth quarter, KushCo upped its gross margin from 13% to 20%. While this is still lower than the company's target of 30%, the combination of cost-cutting via layoffs, and higher prices for its vaporizers to account for tariffs, is beginning to pay off. Wall Street's consensus is for KushCo to become profitable on a recurring basis in fiscal 2021.
A discussion of KushCo wouldn't be complete without also mentioning the company's innovation. In recent months, the company launched a number of low-capital input, high-margin initiatives, including a hemp-trading business that "connects verified buyers with in-network sellers of hemp commodities." At least 10% of KushCo's 2020 sales are likely to be derived from this hemp-trading operation, which is fantastic given that it requires virtually no capital input.
While there's no mistaking that the ride could be bumpy for the North American pot industry in the near term, KushCo is an ancillary player that's primed for long-term success.
