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The 1 High-Risk Marijuana Stock I Just Bought

Todd Campbell, The Motley Fool

Marijuana sales eclipse $150 billion annually, and while most of those sales happen in the shadows of the black market, momentum to legalize marijuana is growing worldwide. In the U.S., 66% of Americans favor legalizing cannabis, according to a recent Gallup study, and in November, Michigan became the 10th state to approve recreational marijuana while Missouri and Utah became the 32nd and 33rd states to approve medical marijuana laws.

North of the border, Canada's national medical marijuana market is already producing about $600 million annually in revenue, and after electing the liberal party to office in its last election, the country opened its recreational adult-use marijuana market to fanfare in October. Headway is also being made to clear obstacles to marijuana use in other large countries, including Germany and Australia.

The potential for a significant amount of money to move from the black market to regulated marketplaces is an opportunity that may rival the alcohol and tobacco markets, so investors are understandably interested in buying marijuana stocks. A lot of companies are angling to generate meaningful sales from producing, distributing, and selling marijuana, but during last week's marijuana stock sell-off, I bought the marijuana packaging supplier KushCo Holdings (NASDAQOTH: KSHB) instead. Here's why I want to own this small, high-risk marijuana stock.

A businessman falling in the sky wearing a parachute.

IMAGE SOURCE: GETTY IMAGES.

Risks galore

Make no mistake, marijuana stocks are risky. There's a very good chance that many marijuana companies won't survive and that ultimately only a few will grow into companies big enough to support the valuations they're already being awarded by investors.

Nevertheless, I think there's good reason why KushCo Holdings can be one of the companies that not only survives, but thrives as marijuana goes Main Street.

The company doesn't make its money by cultivating cannabis it can sell in dispensaries. Instead, it sells the highly regulated packaging that legal marijuana marketplaces require for pot products.

This picks-and-shovels supplier strategy makes it somewhat agnostic which company winds up winning the most market share in medical and recreational markets. After all, every one of these upstarts, big and small, needs to package its products according to the rules set by each jurisdiction, and those rules can vary, making it necessary to work with a trusted vendor like KushCo.

Various packaging options for marijuana.

IMAGE SOURCE: GETTY IMAGES.

The business so far

KushCo produces a wide variety of packaging products, including bottles for oils and single rolled products, and it also markets products like solvents that are used by producers to extract cannabinoids from marijuana to make oils and other products. Additionally, it acquired a creative design agency for cannabis and non-cannabis brands earlier this year called The Hybrid Creative.

Since its inception, it's already sold more than 1 billion products, and because its products are sold to 5,000 medical and adult-use dispensaries, growers, and producers globally, no single company accounts for more than 10% of its sales. With that kind of diversification, I think it's pretty well insulated against the risk associated with customers going bankrupt.

Last fiscal year, its preliminary total sales grew 171% to $51 million, including $19 million in fiscal Q4, which ended Aug. 31. 

A row of ascending stacks of coins with marijuana plants growing on top of them.

IMAGE SOURCE: GETTY IMAGES.

Opportunity ahead

KushCo Holdings sales will benefit from more states passing pro-pot legislation likely to include stringent packaging requirements and producers growing focus on using marijuana as ingredients in value-added products that command more pricing power and offer them higher margins.

Legal marijuana sales represent a small share of the $50 billion of marijuana sold annually in the U.S., but legal sales are growing quickly. For instance, Colorado operates one of the most successful marijuana markets, and its sales were $1.5 billion last year, up from $684 million in 2014. In California, the biggest U.S. market, legal sales could grow to $7.7 billion in 2021 from less than $4 billion this year, according to BDS Analytics. Maturing markets, more product choices, and more states passing laws ending prohibition could lead to legal medical and recreational revenue of $96 billion in 15 years in the U.S., according to wine, beer, and spirits company Constellation Brands.

There's also a lot of potential for KushCo to supply products elsewhere. The Canadian recreational market could generate billions of dollars in new sales during the next 12 months, and new products using cannabis as an ingredient, such as vapes, edibles, and beverages, could win a regulatory OK in Canada in 2019, providing even more demand for KushCo's packaging, extraction technologies, and advertising expertise. According to Deloitte, adult-use sales in Canada could eclipse 4 billion Canadian dollars next year, and in 15 years the Canadian medical and recreational market could be worth $11 billion, according to Constellation Brands.

Marijuana surrounding a maple leaf.

IMAGE SOURCE: GETTY IMAGES.

Europe represents an intriguing opportunity for growth, too. Germany's emerging medical marijuana market already serves up to 50,000 patients, and industry watchers think it could be a bigger market than Canada over time. For perspective, Aurora Cannabis, one of Canada's biggest cannabis companies, recently reported its European cannabis revenue surged 127% year over year last quarter. If more countries legalize marijuana, then Constellation Brands thinks cannabis products could be hauling in $200 billion in 15 years.

If Constellation Brands' forecast is anywhere near close to the mark, then KushCo Holdings should enjoy plenty of chances to win business, boost sales, and eventually turn a profit. 

But plenty could go wrong for the company, too. Marijuana is still illegal in the U.S. at the federal level, so Washington, D.C. could crack down on individual state markets. If they do, then it would be bad news for KushCo Holdings. Similarly, regulators outside the U.S. could balk at legalization, crimping the global market opportunity for the company.

Furthermore, KushCo Holdings is an expensive stock to buy using traditional valuation measures; it trades on the lightly regulated over-the-counter market; and it doesn't have a lot of cash on its balance sheet compared with the Canadian marijuana producers. This summer, the company added $32.9 million from a direct stock offering to its $3.6 million cash balance exiting May, but that still pales in comparison to the $147.8 million in cash that Aurora Cannabis has at its disposal.

Nevertheless, I still bought some shares in KushCo Holdings last week when marijuana stocks dipped because I think the reward justifies the risk. It's anyone's guess where this stock will trade in the coming months, but I think the odds favor it being a much bigger company in 10 years than it is today.

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Todd Campbell owns shares of KushCo Holdings. His clients may have positions in the companies mentioned. The Motley Fool recommends Constellation Brands and KushCo Holdings. The Motley Fool has a disclosure policy.