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3 of the Cheapest Pure-Play Marijuana Stocks

Sean Williams, The Motley Fool

Following years of debate, Canada's big day is just over a month away. As of Oct. 17, adults aged 18 or 19 and over (depending on the province) can legally purchase recreational marijuana in licensed dispensaries. This'll make Canada only the second country in the world and the first industrialized country to legalize adult-use weed.

Though sales estimates rightly vary for an industry that has very little legal precedence, the consensus is that legal pot in Canada could generate an additional $5 billion in annual revenue. This should come atop what the industry is already pulling in from domestic medical weed sales and via exports to countries where medical marijuana has been legalized.

A magnifying glass behind held over a newspaper that's highlighting the words, market data.

Image source: Getty Images.

Most pot stocks boast nosebleed valuations...

It's no secret that investors expect to see green when the proverbial green flag waves. However, they've bid up the valuations of marijuana stocks well in advance of the Oct. 17 launch date. Between ongoing capacity expansion, brand building, and international infrastructure, most growers are spending a lot of money at the moment. In fact, even with triple-digit percentage annual sales increases this year and next year, there's no guarantee they'll be profitable.

If you'd consider yourself something of a value investor, then the marijuana industry is going to be an utter nightmare for you. The two largest pot stocks by market cap, Canopy Growth Corp. and Tilray, aren't even expected to be profitable this year or possibly even next year.

Meanwhile, Aurora Cannabis and Cronos Group, which are two other major production players, have forward price-to-earnings ratios of around 150. To say the least, expectations of strong demand, sales growth, and eventual profits, appear to be more than baked into a majority of pot stocks.

... But there are a few exceptions

However, there is a small group of pure-play marijuana stocks that, between their forward price-to-earnings ratios and sales growth, may actually be a reasonable value.

A person holding a cannabis leaf in the middle of a grow farm.

Image source: Getty Images.

Aphria

Though it may not look like a great value at the moment, rapid top-line growth from Aphria (NASDAQOTH: APHQF), along with an end to some high-cost projects in the near future, could help it generate healthy profits.

As things stands now, Aphria is expected to slide in as the third-largest grower by peak production potential. There are, essentially, four key cogs to Aphria:

  • Aphria One: This is the company's organic, four-phase project that, when complete in January 2019, will span 1 million square feet and yield 100,000 kilograms annually.
  • Aphria Diamond: This is a joint venture with Double Diamond Farms that'll produce around 120,000 kilograms a year when it's complete this coming January.
  • Broken Coast Cannabis: Aphria acquired Broken Coast and is in the process of maximizing its production potential to 10,500 kilograms annually.
  • Extraction center: Lastly, the company somewhat recently announced the intent to build an extraction center that could yield 25,000 kilograms of cannabis-equivalent concentrates when fully operational.

Add this up, and you get about 255,000 kilograms per year at peak production. With Aphria One and the retrofit of Aphria Diamond's greenhouses nearly complete, expenditures should drop, giving Aphria the ability to generate healthy profits.

Currently, Aphria has a forward P/E of 38, but given its triple-digit sales growth rate, the company's PEG ratio is probably well below 1 (there are no five-year growth estimates from Wall Street, so this is an author estimate), which would make it a compelling value.

An indoor commercial cannabis grow farm.

Image source: Getty Images.

Innovative Industrial Properties

Although it's not a grower, real estate investment trust (REIT) Innovative Industrial Properties (NYSE: IIPR) might as well be considered a marijuana pure play since its entire revenue stream is based on weed.

As a REIT, Innovative Industrial Properties aims to buy medical marijuana producing greenhouses and processing facilities in the United States, then leases out these facilities for an extended period of time. Of the more than half-dozen leases signed by the company so far, they've all been for between 15 and 20 years, with annual rental increases and property management fee hikes tethered to the lease. This gives Innovative Industrial Properties predictable annual cash flow that should allow it to stay ahead of the inflation rate. And, should the company no longer wish to lease out some or all of its properties, it can presumably sell them in the future for a nice profit.

The added beauty of the cannabis-REIT model for investors is that, as a REIT, the company is required to return a majority of its profit to shareholders in the form of a dividend. This is how REITs avoid having to pay normal corporate income tax rates. For the time being, it means a $0.25 dividend per share each quarter.

Understandably, Innovative Industrial Properties' revenue growth rate is tied to its annual rental and property management fee increases, as well as new property acquisitions. Or, in another context, it's going to grow revenue at a considerably slower pace than pure-play growers. But its forward P/E of 21.6 is also lower than any other pure-play pot stock, making it potentially worth a closer look.

An indoor hydroponic cannabis grow facility.

Image source: Getty Images.

CannTrust Holdings

However, the best overall mix of growth and value might just be Ontario-based CannTrust Holdings (NASDAQOTH: CNTTF).

Like Aphria, CannTrust is a cannabis grower that's angling for its share of a very large and growing Canadian and global market. What it doesn't have is nearly the same production potential. Nevertheless, it could prove to be one of the most cost-efficient producers of the group, which is why its margins may lead to superior profits per share.

CannTrust's big project at the moment is the expansion of its flagship Niagara Greenhouse facility. When complete, it'll span around 1 million square feet and should allow CannTrust to join the relatively elite 100,000 kilogram-and-up annual production club. What makes Niagara so unique is the fact that it's employing hydroponics -- i.e., growing plants in a nutrient-rich water solvent -- as well as a perpetual harvest system with moving containerized benches. This should make CannTrust's harvests less lumpy and more predictable. 

The company has also been a major proponent of cannabis oils for medical patients. Clearly, the legalization of recreational weed will create an uptick in dried cannabis sales, but no company in the early going has been more committed to higher-margin cannabis oils than CannTrust.

With Wall Street calling for a forward P/E of 33.4, but sales growth expected to be in the triple digits in each of the next two years, CannTrust is arguably the best deal in the cannabis space.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.