Following a more than one-year downtrend, there's no longer any doubt about it: Marijuana stocks are back in a big way.
Cannabis projects as one of the fastest-growing industries this decade, with a report from New Frontier Data suggesting that U.S. pot sales could potentially triple by 2025 to as high as $41.5 billion annually. Finding customers won't be difficult. Rather, it's a matter of legalizing cannabis and progressively moving consumers from illicit to legal channels.
Cannabis stocks were on fire in February
The excitement surrounding pot stocks was readily evident when analyzing their monthly returns in February. Whereas the benchmark S&P 500 ended last month higher by 2.6%, 10 marijuana stocks crossed the finish line with a gain of at least 20%. In descending order, the best marijuana stocks of February were:
- MedMen Enterprises (MMNFF -1.16%): Up 208%.
- OrganiGram Holdings (OGI -4.29%): Up 66%.
- Sundial Growers (SNDL -0.69%): Up 63%.
- Aphria (APHA): Up 46%.
- GW Pharmaceuticals (GWPH): Up 40%.
- Tilray (TLRY): Up 35%.
- Planet 13 Holdings: Up 29%.
- Harvest Health & Recreation: Up 27%.
- Curaleaf Holdings (CURLF 1.88%): Up 22%.
- Cresco Labs: Up 20%.
This might seem like a random mashing together of cannabis stocks, but three trends stood out as catalysts behind these enormous gains.
The Reddit community fell in love with penny stocks
Arguably the biggest factor that pushed marijuana stocks higher in February was the retail investor-fueled rally originating from Reddit. Initially, retail investors chose to focus on stocks that were heavily short-sold. But this quickly manifested into a movement that targeted highly liquid penny stocks. Not surprisingly, the three biggest gainers in February -- MedMen, OrganiGram, and Sundial -- are all penny stocks.
What's worrisome is that penny stocks often have low share prices for a very good reason. Sundial, for example, has yet to crack the code to generating a profit, and is in the midst of a business transformation that'll see it focusing on retail instead of wholesale. This will push its opportunity be profitable even further out. It also doesn't help that the company has issued more than 1.1 billion shares via offerings and debt-to-equity swaps in just five months.
Meanwhile, MedMen Enterprises isn't even a certainty to survive. The company's previous management team was far too aggressive with its expansion efforts. Plus, being based in the U.S. means it's had very limited access to capital (short of dilutive share offerings). MedMen's operating losses could quickly eat up what cash it has left.
OrganiGram is the lone marijuana penny stock that looks like a long-term winner. It operates a single facility, which makes it easy to adjust its supply chain to account for prevailing market conditions. Further, the use of a three-tiered growing system should help maximize yield in its licensed indoor cultivation rooms. And as the icing on the cake, OrganiGram has heavily skewed its future sales toward higher-margin edibles and beverage additives.
Excitement is building when it comes to U.S. legalization
Another defined catalyst in February is the expectation that we'll see the U.S. federal government enact meaningful cannabis reforms in the not-so-distant future.
Canadian licensed producers like Tilray, Aphria, and OrganiGram, have been trudging higher since November, following Joe Biden's victory for the presidency. This optimism received an added boost in early January when Democrats won back to the Senate by the slimmest of possible margins. It's no secret that Democrats have a considerably more favorable view of marijuana than Republicans. With an all-time record 68% of respondents in Gallup's annual survey wanting to see cannabis legalized nationwide, it would appear that the prospects for federal legalization are greater than they've ever been.
Canadian licensed producers have all agreed not to enter the U.S. marijuana market until the federal government legalizes weed in some capacity. This is to avoid legal issues, as well as ensure that they aren't delisted from the major U.S. exchanges. Since cannabis is illicit at the federal level, U.S. pot stocks can't list on the major U.S. exchanges.
Aside from Canadian marijuana stocks being able to enter the U.S. market, legalization could also offer benefits to U.S. multistate operators like Curaleaf. Legalization would allow for easier access to basic banking services from financial institutions, and it would end the need to have redundant facilities in each state where the company has retail operations. If interstate transport becomes legal, it would no longer be necessary to have growing and/or processing facilities in all of the nearly two dozen states where Curaleaf has dispensaries.
Dealmaking is picking up
Finally, it's pretty clear that merger and acquisition activity in the cannabis space is helping to drive this outperformance.
Last month, specialty drug developer Jazz Pharmaceuticals (JAZZ -1.71%) announced that it would acquire cannabinoid-focused drug company GW Pharmaceuticals for $7.2 billion. GW Pharmaceuticals' Epidiolex has established itself as a leading treatment for two rare forms of childhood-onset epilepsy, and had its label expanded to include tuberous sclerosis complex in 2020. Jazz's highly profitable product portfolio and ample cash flow will serve GW Pharma well in helping to fund additional cannabinoid-focused research.
Additionally, the marijuana industry is still rallying following the merger announcement of Aphria and Tilray in December. The combined company has the potential to lead all pot stocks in annual sales. Aphria and Tilray also have extensive international networks, which should help diversify sales over the long run outside of North America.
While I'm "jazzed" about GW Pharma getting a hefty premium, I'm not as excited about the Tilray-Aphria tie-up. Aphria has a seemingly successful operating model that includes traditional pharmaceutical distribution in Europe. Meanwhile, Tilray has been losing quite a bit of money, and it's been forced to sell stock or issue debt to raise capital. This combination is great for Tilray; but if I'm an Aphria shareholder, I'm not so thrilled about it.