By one measure, marijuana stocks haven’t performed that poorly of late. The ETFMG Alternative Harvest ETF (NYSEARCA:MJ), a solid proxy for the sector, has bounced 54% from March lows. That’s a bigger rally than broad indices like the S&P 500 and even the Nasdaq Composite have posted.
Of course, unlike the broad market, marijuana stocks had been falling for some time. At the March lows, the MJ ETF was down roughly 75% in the span of a year. Many widely held names — among them Aurora Cannabis (NYSE:ACB) — had done even worse. The sector still has declined by more than half from past peaks, and most cannabis plays have posted year-to-date declines.
There are reasons for the selling pressure. Most notably, it’s become abundantly clear the industry significantly overbuilt capacity. That’s pressured pricing and profit margins across the industry. Regulatory news hasn’t helped. Save for a brief burst of optimism thanks to the late-2018 passage of the Farm Bill, movement at the federal level in the U.S. has been nil.
Increasingly, it looks like investors were far too aggressive in modeling the industry’s prospects. And so marijuana stocks might be cheaper after the selloff, but not necessarily cheap.
That said, there still are potential opportunities, particularly for investors still bullish on the long-term opportunity in marijuana. Investors should look for marijuana stocks that have performed well despite industry upheaval, and those companies with the balance sheet flexibility to take advantage of future disruption.
These seven marijuana stocks, for various reasons, fit the bill:
- Canopy Growth (NYSE:CGC)
- Cronos Group (NASDAQ:CRON)
- Scotts Miracle-Gro (NYSE:SMG)
- GrowGeneration (NASDAQ:GRWG)
- Innovative Industrial Properties (NYSE:IIPR)
- Village Farms International (NASDAQ:VFF)
- OrganiGram (NASDAQ:OGI)
Marijuana Stocks to Buy: Canopy Growth (CGC)
The case for Canopy Growth is well-known at this point. The company remains the largest player in Canadian cannabis. Thanks to a multibillion-dollar investment by Constellation Brands (NYSE:STZ, NYSE:STZ.B), Canopy has a fortress balance sheet. It’s been the simple pick for cannabis bulls since the Constellation deal was announced nearly two years ago.
But that simple case took a hit last month. After solid earnings from Tilray (NASDAQ:TLRY) and a blowout quarter from Aurora, it seemed like the industry was managing the novel coronavirus well. Canopy stock rallied in sympathy ahead of its own release on May 29.
Canopy promptly tanked the report. Revenue badly missed analyst estimates, and thanks in large part to non-cash charges the company posted a net loss over 1 billion CAD. CGC stock plunged 20%, and has traded mostly flat since.
But it’s worth taking a step back from the release and taking the long view. The reason Aurora stock, in particular, rallied after earnings was because the company announced an accelerated target for reaching profitability on an EBITDA (earnings before interest, taxes, depreciation and amortization) basis. The problem is that Aurora had no choice: Steady dilution and an overleveraged balance sheet required the company to slash costs in a bid to narrow operating losses.
Canopy will get to profitability, too, but at a slower pace. And that’s because it can take its time. Canopy closed its fiscal fourth quarter with 2 billion CAD in cash. That means it can invest in Cannabis 2.0 products. It can acquire smaller companies — or assets of firms who wind up in a restructuring.
In an uncertain market, flexibility remains hugely valuable. Canopy’s earnings report might look disappointing relative to reports from peers, but it also highlights the company’s edge going forward.
Cronos Group (CRON)
The case for Cronos stock is a smaller version of that of Canopy. Thanks to its own big investment — Altria (NYSE:MO) invested $1.8 billion in Cronos in late 2018 — Cronos too has a fortress balance sheet. It doesn’t have as much cash as Canopy, or nearly as much revenue, but a smaller market capitalization accounts for those differences.
In fact, the case for CRON perhaps is more intriguing for investors with a long-term focus. Cronos really doesn’t have much of a business at all right now: Net revenue over the past 12 months is less than $30 million. (Canopy’s fiscal 2020 sales were $323 million).
Given the plunging value of production assets, however, that’s not necessarily a bad thing. Cronos has focused on derivative products, which will have better margins and, in coming years, should drive stronger growth.
Indeed, there may not be a company better-positioned if the industry still has a few more years of upheaval left. Given overcapacity and the debt issues at companies like Aurora and Hexo (NYSE:HEXO), that wouldn’t be a surprise. And with CRON trading above $6 with nearly $4 per share in cash on the balance sheet, valuation at this point is not aggressive.
Scotts Miracle-Gro (SMG)
Source: Casimiro PT / Shutterstock.com
Savvy investors will say that the way to make money in a growing market is via so-called “picks and shovels” plays. This comes from the idea that the people who really made the money during the California gold rush were those who sold the picks and shovels, not those who actually mined for the gold.
Scotts Miracle-Gro is a classic picks-and-shovels play. Its Hawthorne unit targets cannabis growers. That’s important for two reasons. First, it insulates the business (and the stock) from pricing and margin pressure. Cannabis prices are the operators’ problem. All that matters to Hawthorne is the volume, which should rise going forward.
Second, SMG stock provides difficult-to-get exposure to the U.S. market. After all, Hawthorne serves licensed American growers, even though the lack of federal legalization keeps those companies from U.S. exchanges. Some do have Canadian listings, admittedly.
Hawthorne got off to a slow start, which pressured Scotts stock after a cannabis-driven rally. But both the business and the stock have recovered. Scotts last week raised its fiscal year guidance for both the legacy lawn and garden business and for Hawthorne, further confirmation that the business is back on track. As long as that’s the case, SMG stock should have more upside ahead.
GrowGeneration is another picks-and-shovels play on American marijuana growth. The company runs retail hydroponic and organic gardening stores across the U.S., with locations in ten states plus an online business.
What makes GrowGeneration stand out in the sector is that it’s profitable. And not just on an EBITDA basis. The company is guiding for pre-tax income of $5.5 million to $7.5 million this year. Analysts see after-tax earnings per share next year of 31 cents, suggesting a reasonable 21x forward price-earnings multiple.
There are longer-term competitive worries. An investor has to wonder if, in the event marijuana is legalized at the federal level, the likes of Home Depot (NYSE:HD) and Lowe’s (NYSE:LOW) would move more aggressively into organic and hydroponic products. But the expertise required to not only sell, but stock, the correct products, likely creates a solid moat for the business.
With reasonable valuation and years of growth remaining, GRWG stock is an interesting small-cap pick.
Innovative Industrial Properties (IIPR)
Real estate investment trust Innovative Industrial Properties is another derivative play with U.S. cannabis exposure. The company leases medical-use facilities to licensed growers in the U.S.
It’s been an excellent business so far, as Innovative has grown at a remarkable clip. Revenue went from $6.4 million in 2017 to $44.7 million last year. Assets rose by a factor of nine over those two years. Thanks to both acquisitions and organic growth, Innovative’s footprint has quickly expanded.
The growth isn’t surprising. U.S. cannabis startups don’t have the capital (or the access to capital) to buy growhouses. That makes Innovative an integral part of the marijuana supply chain. Looking forward, the focus on medical growers should minimize the company’s exposure to cyclical economic swings.
There are risks. A portfolio of relatively new, and small, tenants does suggest a higher chance of rising default rates. But new tenants presumably can be found, as long as medical cannabis growth continues over the long haul.
That seems likely. In the meantime, IIPR offers both growth and a 4% dividend yield, making it a attractive play for patient cannabis bulls.
Village Farms International (VFF)
VFF has been one of the best marijuana stocks in the market of late. Shares have bounced 179% from March lows. An 11% decline year-to-date isn’t anything to write home about, but still represents solid outperformance relative to the rest of the sector.
There’s a case for more upside. Village Farms has been solidly profitable for the past five quarters. Its legacy produce business gives it substantial greenhouse capacity in the U.S. That business drives current profits and presumably could be redirected toward cannabis production if and when legalization arrives. At the least, the expertise developed in growing produce like tomatoes and peppers should have some relevance toward cannabis production.
The company also owns a 59% interest in Canadian cannabis producer Pure Sunfarms. That business already produces the top-selling dried flower brand in Ontario. Pure Sunfarms recently launched in Alberta and British Columbia, and Saskatchewan is up next.
And so there’s a nice combination of growth and value with Village Farms stock. With a $310 million market capitalization, more success could make the company an acquisition target down the line once the supply-demand imbalance in the industry is resolved. In the meantime, VFF looks like at worst a “buy the dip” opportunity among marijuana stocks.
OrganiGram is one of the more intriguing high-risk, high-reward plays in the space. It’s much smaller than the likes of Aurora or even Hexo, but it faces similar issues. Earlier this year, the company had to amend the covenants on its debt — but only was able to do so until Aug. 31. Leverage is much lighter than that of Aurora, in particular, but the company still is burning cash. That needs to change at some point.
Still, there’s real potential upside here if Cannabis 2.0 can finally get the Canadian marijuana industry into gear. InvestorPlace Markets Analyst Luke Lango argued earlier this year, with OGI stock near its current price, that shares could double. He’s not wrong. OrganiGram has a solid portfolio, attractive derivative brands and a presence in the key province of Ontario.
OGI is one of the better stocks out there for big-time cannabis bulls. The catch at the moment is that after the last 15 months, there aren’t too many of those bulls left.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.
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