There's no denying it any longer: Marijuana stocks have been a major disappointment over the past year. Despite opening 2019 with blazing-hot first quarter returns, supply issues throughout Canada and high tax rates in a number of core U.S. markets resulted in pot stocks vastly underperforming the broader market.
The good news, though, is that the long-term outlook for cannabis appears bright. Even with the growing pains the industry is currently contending with, Wall Street anticipates that worldwide weed sales will range between $50 billion and $200 billion by 2030. Considering that only $10.9 billion in global cannabis sales were registered in 2018, this still gives investors plenty of opportunity to benefit as the industry buds.
The question is: Which marijuana stock should you buy to take advantage of this inevitable expansion?
Image source: Getty Images.
While there aren't too many standouts to choose from at the moment, the one cannabis stock that investors should consider buying and hanging onto for some time is Canadian extraction-service provider MediPharm Labs (MEDIF -1.92%).
Here's why MediPharm Labs lost half its value over the past six months
While I believe there are a lot of reasons to be excited about MediPharm's long-term prospects, I'd like to begin by examining why it's lost about half its value since September. Having a better understanding of why it's down will make it even easier to see why it's such an incredible buy right now.
The most obvious reason for the persistent downside in MediPharm's share price is the ongoing supply issues throughout Canada. These supply issues have taken two forms. First, regulatory agency Health Canada has struggled to review cultivation, processing, and sales license applications in a timely manner, which has kept growers waiting in the wings to contribute.
The second component of these supply problems can be traced back to regulatory issues at the provincial level. Ontario, Canada's most-populous province, had been working with a lottery system to assign dispensary store licenses until the end of 2019. This led to only 24 retail stores in a province of 14.5 million people at the one-year anniversary of adult-use sales commencing (Oct. 17, 2019), which is far too few for a province of its size. The end result is a supply bottleneck for all types of cannabis products.
Image source: Getty Images.
Another reason for the decline was Health Canada's two-month delay in rolling out Cannabis 2.0 products. "Cannabis 2.0" refers to alternative consumption options, or derivatives, such as vapes, edibles, concentrates, topicals, and infused beverages. Since MediPharm is responsible for processing hemp and cannabis biomass to yield the resins, distillates, concentrates, and targeted cannabinoids used in the production of derivatives, this delayed launch meant a potential delay in the company's own sales ramp-up.
Funding concerns have also rattled the industry. While MediPharm Labs hasn't exactly raised any red flags on the funding front, there's certainly concern about the growers it has processing deals with. If a number of MediPharm's partners were to struggle to obtain funding, it could compromise their ability to expand their operations, or perhaps even pay MediPharm.
As an example, in late January MediPharm sued Quebec-based grower HEXO (HEXO) claiming that it was owed $9.8 million Canadian for breaching its contract due to nonpayment. This would normally not be a major issue, but MediPharm is still a nascent company, and HEXO is contending with a plethora of issues that have led it to idle a good chunk of its cultivation space and lay off 200 employees. With HEXO's financing in question, this lawsuit takes on greater meaning for MediPharm and the extraction-services industry.
Image source: Getty Images.
A laundry list of reasons for MediPharm to be in your portfolio
Now that you have a better idea of why MediPharm was pummeled over the past six months, let's take a closer look at all the reasons investors should be excited about its future.
The first is that this company is at the epicenter of the derivatives movement. As a reminder, derivatives are a much higher margin product than traditional dried cannabis flower, meaning these alternative consumption options are going to be a core focus for growers moving forward. With financing being a possible concern, going the third-party route (as opposed to building out processing infrastructure) on the processing front is going to be a potential smart move for growers, as well as a lucrative decision for MediPharm Labs.
To build on this point, MediPharm Labs has pretty much every angle covered on the derivatives front. In December, the company began shipments to three provinces (British Columbia, Manitoba, and Saskatchewan), and has a license to provide customers in four product categories (topicals, edibles, oils, and extracts). Derivatives are an especially popular consumption option with younger adults, making them the perfect means to bring new customers into the cannabis retail ecosystem.
Another key point here is that MediPharm Labs is adequately financed, with CA$67 million in aggregate liquidity at the end of December, and has put most of its expansion costs in the rearview mirror. While it's possible that MediPharm's top-line sales could fall short of its competitors (a function of the company aiming for 500,000 kilos of peak run-rate processing capacity over the long-term, while some of its peers focusing on 1 million kilos-plus), operating facilities with less peak operating potential than its peers should also allow MediPharm to better control its costs should demand for derivatives change.
Image source: Getty Images.
Speaking of demand, MediPharm is one of a select few pot stocks that's currently profitable on a recurring basis. Having begun its operations in Nov. 2018, it took less than two full quarters before the company was already generating an operating profit, without the aid of one-time benefits or fair-value adjustments. Considering that competitor Valens Company reported a significant increase in adjusted EBITDA during its fourth quarter, I have a strong suspicion that, even with the HEXO payment concern, this'll be the case for MediPharm, which is valued at a mere 19 times 2020's consensus profit forecast, according to Wall Street.
To add, MediPharm was clear in a press release in late January that its partners are well financed and there's little concern about collecting payment for its rendered services. As the press release notes:
As at December 31, 2019, the Company's unaudited past due balance was approximately [CA]$8.6 million, of which [CA]$7.7 million was related to the statement of claim. The majority of the other remaining outstanding balance has already been collected as of today. The Company is pleased to note that it expects to collect its existing receivables in the normal course of business and does not perceive any additional credit risk on its remaining customer base due to the high credit worthiness of these customers.
Last, but not least, Ontario's retail struggles should be coming to an end by the second half of 2020. Ontario has abandoned its license lottery system in favor of a more traditional retail license-vetting process. That should result in the issuance of about 20 licenses a month at minimum, beginning in April. More retail locations should help ease the derivative bottleneck currently plaguing the province.
While it'll take some patience, investors of MediPharm Labs should be handsomely rewarded over the long run.
