Interest in cannabis stocks has cooled off over the past 12 months, especially as most pot companies have developed a habit of delivering poor financial results. As a result, the marijuana sector as a whole continues to lag the market. Over the past year, the Horizons Marijuana Life Sciences ETF -- an industry benchmark -- is down by 55%, while the S&P 500 is up by 14% over the same period.
However, this doesn't mean that all marijuana companies are best avoided. After the beating many pot stocks have endured over the past year, as well as the recent market sell-off led by the technology sector, now may be a great time to shop selectively for promising cannabis stocks. Two that I think investors would do well to add to their portfolios are Aphria (APHA) and GW Pharmaceuticals (GWPH).
The case for Aphria
Investors were not pleased with the earnings release Aphria recently delivered for its fiscal fourth quarter, which ended on May 31. Perhaps the scariest metric in the update was its bottom line. The company's net loss came in at 98.8 million Canadian dollars, compared with net income of CA$15.8 during the prior-year quarter.
With that said, the sell-off that followed the earnings release may have been a bit exaggerated. After all, the company had some reasonable explanations for its seemingly poor performance: non-cash expenses.
Aphria incurred a non-cash expense of roughly CA$27 million related to the revaluation of convertible debentures (a type of debt instrument that can be converted to shares of a company's stock). It also incurred a massive non-cash expense in the form of an impairment charge of CA$64 million, due to the impact of the pandemic on some of its international assets. Note that Aphria's revenue during the quarter was CA$152.2 million, an 18.4% year-over-year increase.
And despite the COVID-19 pandemic, revenue continues to grow. Aphria now holds the No. 1 spot in terms of net revenue among all Canadian cannabis companies, and there are good reasons to think it can maintain its momentum.
The company is going after the potentially lucrative cannabis derivatives market, with a particular focus on vaping products, which it considers to be the most promising product segment. It's already the leading cannabis derivatives provider in Ontario, which is Canada's largest province by population.
Image source: Getty Images.
Also, Aphria's German subsidiary, CC Pharma, continues to make significant contributions to its top line. During the fiscal fourth quarter, CC Pharma recorded revenue of roughly CA$97 million, more or less flat compared with the prior-year quarter.
Based on these factors, investors can expect Aphria to continue delivering financial results that compare favorably to those of its peers. The company has reported positive adjusted EBITDA for five consecutive quarters, and while that's not the same as being profitable per se, it's a feat that few of its similarly sized Canadian competitors have been able to achieve. And given Aphria's reasonable 2.5 forward price-to-sales ratio, buying shares of this cannabis stock today would be a great move.
The case for GW Pharmaceuticals
GW Pharma markets Epidiolex, the first cannabis-derived drug approved by the U.S. Food and Drug Administration (FDA). The medicine is used to treat seizures associated with Lennox-Gastaut Syndrome (LGS) or Dravet syndrome, both of which are rare forms of epilepsy. These are difficult conditions to manage, and before the approval of Epidiolex in June 2018, most patients suffering from them needed to take multiple seizure medications.Between 30,000 and 50,000 patients in the U.S. have LGS, and between 15,000 and 20,000 have Dravet syndrome.
During the second quarter, GW Pharma recorded total revenue of $121.3 million, compared with roughly $72 million during the prior-year quarter. Epidiolex's net sales provided the lion's share: $117.7 million in Q2, up from $68.4 million the year before. Also, while the company's net loss per share of $0.02 compared unfavorably to the earnings per share of $0.21 it recorded during the year-ago period, it's important to note that in Q2 2019, GW Pharma benefited from $104.1 million in income from a one-time source -- the sale of a Rare Pediatric Priority Review Voucher, which lets the holder expedite the review of a new drug.
That means the company's bottom lines for these two periods aren't really comparable. With that said, we can expect GW Pharma to continue growing its revenue. In early August, Epidiolex received regulatory approval for use as a treatment for tuberous sclerosis complex (TSC), a genetic disease that causes tumors. Between 40,000 and 50,000 people suffer from TSC in the U.S. alone, and once the company starts selling Epidiolex into that market, its revenue should experience a noticeable uptick.
Lastly, GW Pharma has other potential growth drivers at its disposal. The company is developing Nabiximols as a treatment for muscle pain and spasms caused by multiple sclerosis, and estimates the market opportunity for this indication in the U.S. to be north of $400 million.
GW Pharma's price-to-sales ratio of 6.3 seems a bit high, but I think its growth potential justifies this valuation. In the long run, I expect the company to recover from its current woes, and anticipate that those who invest in it today will enjoy market-beating returns.
