Since the beginning of February, momentum-chasing investors have arguably coveted no stock more than Canadian licensed cannabis producer Sundial Growers (SNDL -0.73%). Even though Sundial pulled back notably to end the previous week, shares of this penny stock are up 155% since the month began, and a staggering 1,350% since the end of October.
There are two factors behind the sudden love for Sundial. First, investors are clearly excited about the possibility of the U.S. legalizing marijuana at the federal level. Former Senate Majority Leader Mitch McConnell ensured that no cannabis legislation ever reached the Senate floor for a vote. New Senate Majority Leader Chuck Schumer, by contrast, has openly advocated for the end to cannabis prohibition at the federal level.
The other catalyst pushing Sundial Growers' stock into the stratosphere is the Reddit frenzy. Retail investors on Reddit's WallStreetBets (WSB) chatroom have effectively agreed to work together to drive heavily short-sold or low-priced stocks significantly higher. Sundial has been a favorite on the WSB boards in recent weeks.
The concern is that Sundial Growers simply isn't a very good company. While it's been able to build up a cash and cash equivalents position that totals approximately $610 million, it's done so by burying shareholders in equity offerings and debt-to-equity swaps. It's not normal for a company to more than triple its outstanding share count by issuing over 1 billion shares in just four months.
Sundial's operating results aren't much to write home about, either. It's currently shifting its business focus to higher-margin retail sales. Sundial's latest quarterly results featured a greater than 50% year-over-year decline in net sales.
These marijuana penny stocks are smarter buys than Sundial Growers
Rather than focusing on an unproven marijuana penny stock, there are three others you can buy right now that should yield much better long-term returns.
Instead of putting your money to work in a serial diluter like Sundial, consider buying into ancillary Canadian marijuana stock Valens (VLNS). Valens processes hemp and cannabis for businesses throughout Canada.
Why a processing company? The simple answer is that dried cannabis flower is relatively easy to oversupply and commoditize, which ultimately weighs down the margins of licensed producers. Selling higher-margin derivative products (e.g., edibles, vapes, concentrates, topicals, beverages, and oils) will make the real money over the long run in Canada. Few if any of these derivatives can be manufactured without extracting distillates and concentrates from cannabis or hemp. In other words, Valens should be a profitable third-party middleman in the most lucrative part of the cannabis industry.
If you're wondering why Valens' share price has been so battered if it's such an integral part of Canada's pot industry, look to regulators. Federal regulators in Canada delayed the launch of derivatives until mid-December 2019, and key provinces like Ontario were slow to approve dispensary licenses, creating supply bottlenecks. Once these kinks are resolved, Valens' processing capacity and the cash flow transparency of its processing contracts will come into play.
As one final note, Valens also handles white-label manufacturing. The company has recently been focusing its attention on value-brand oils to maximize its margins.
Another marijuana penny stock that would be a much better buy than Sundial Growers is U.S. ancillary player KushCo Holdings (KSHB). KushCo sells vaporizers and provides packaging and branding services to licensed producers.
Like much of the pot industry, KushCo was clobbered by early stage inefficiencies. The coronavirus disease 2019 (COVID-19) pandemic magnified these problems last year. For example, KushCo purchases most of its vaporizers from China. The initial wave of COVID-19 infections throughout China in early 2020 meant supply issues for KushCo. During the holiday season, KushCo again dealt with supply problems, as shipping ports were overwhelmed with goods.
The good news is that KushCo seems to be moving beyond these early struggles. It's reported two consecutive quarters of positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) and expects full-year EBITDA to come in between $5 million and $7 million. This suggests that recurring profitability isn't too far off.
KushCo's fiscal first-quarter report also notes that it signed a long-term contract with one of the five largest multistate operators in the United States. This might well be the reason the company upped its full-year sales forecast by $10 million on the high and low end of its forecast to a range of $130 million to $160 million.
As the U.S. economy continues to claw back, KushCo's top and bottom line should follow.
OrganiGram is a Canadian licensed producer just like Sundial. That means it's faced many of the same regulatory and supply issues that Sundial has, and has even gotten some love from the WSB crowd. But unlike Sundial, OrganiGram looks to have the tools necessary to become a profitable licensed producer in the near future.
OrganiGram is a major pot producer, yet it only has a single cultivation and processing site (Moncton, New Brunswick). Having only one site might sound limiting, but it's actually genius. Adjusting the company's supply chain to reduce costs or increase output is a lot easier when only one cultivation site is involved. Plus, with the company maximizing its licensed cultivation space with three-tiered grow rooms, it should sport some of the best yields per square foot in the industry.
OrganiGram has also wisely invested in high-margin derivatives. It spent $15 million Canadian on a line of automated equipment capable of making up to 4 million kilos of infused chocolates per year. The company also developed a proprietary powder that can be added to beverages to speed up the process by which cannabinoids take effect. As the Canadian market matures, it'll become easier for OrganiGram to get these derivative products on dispensary shelves.
Long story short, if you're intent on owning marijuana penny stocks, ditch Sundial Growers and move up to a company (or companies) with real potential.
This article represents the opinion of the writer, who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.