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This Pot Stock Looks Like a Genius Following Michigan's Legalization of Recreational Marijuana

Sean Williams, The Motley Fool

What had been dubbed the "most important midterm election of our lifetime" has come and gone. By the time the dust settled, Republicans has expanded their majority of seats in the Senate, while the Democrats had earned enough new seats to take back the House for the first time since 2010.

But depending on whom you speak to, the big winner of the 2018 midterms was the cannabis movement. Residents in four states voted on various marijuana measures this past Tuesday, and three states were successful in giving weed the green light.

A tipped over jar filled with trimmed cannabis buds next to a clear scoop that's holding a neatly trimmed cannabis bud.

Image source: Getty Images.

Marijuana was a big election night winner

In Utah, a traditionally conservative state, residents voted to legalize medical marijuana for qualifying illnesses. Similarly, Missouri residents voted in favor of Amendment 2, legalizing medical pot with a 4% tax. Missourians actually had three medical cannabis initiatives to choose from.

On the recreational side of the equation, North Dakota voters handily defeated Measure 3, which would have legalized adult-use weed and expunged the records of those previously convicted of a marijuana possession offense. However, Michigan's Proposal 1 to legalize recreational marijuana easily won, with just shy of 56% of the vote.

By the end of the evening, the number of states with broad-sweeping medical pot laws had risen to 32 states, while 10 states have now given the green light to adult-use cannabis. In nine of those 10 states, marijuana can be cultivated and sold to consumers in licensed dispensaries. (Sorry, Vermont.)

Despite hitting a snag in North Dakota, it was clearly a big night for the marijuana industry and investors. In particular, the hard-fought victory in Michigan opens the door to a market that could generate anywhere from $1.4 billion to $1.7 billion in annual sales within a few years, according to projections from Marijuana Business Daily. Though it'll depend what other states decide to legalize recreational weed, Michigan has a genuine opportunity to be perhaps the fourth largest state in terms of annual marijuana sales.

Beginning now, Michigan has one year to set up the regulatory framework for its recreational marijuana market. Should the state fail to do so, municipalities can create their own set of rules that the state would recognize. Like most other adult-use cannabis measures that've passed in other states, municipalities will also have a say on whether recreational dispensaries are welcome within their boundaries, and, if so, just how many will be allowed. 

A large sign that reads, Marijuana, outside of a licensed dispensary.

Image source: Getty Images.

This marijuana stock now looks like a genius

While legalization in Michigan is potentially good news for the entire cannabis industry -- at least those companies willing to operate in the U.S. -- it's a particularly nice windfall for upscale retailer and grow-farm operator MedMen Enterprises (NASDAQOTH: MMNFF).

Currently, MedMen has stores in three states. Of its 16 existing or planned locations, eight are located in the mammoth market of California, with four in New York and another four in Nevada. It also operates five cultivation facilities across the U.S., since marijuana's Schedule I classification at the federal level means cannabis can't be transported from one state to another. If MedMen has a retail operation within a specific state, it'll have a grow site as well, to internalize its costs and control the quality of the product it's selling.

What makes Michigan's approval so intriguing, and makes MedMen look like a genius in the process, is that MedMen announced a deal to acquire privately held PharamCann for $682 million on Oct. 11. The priciest U.S.-based transaction in history allows MedMen to add 18 new retail locations in eight states, along with eight more cultivation facilities, boosting its total to 13. It also doubles its state presence to 12 from six. 

In particular, PharmaCann already has a presence in Michigan, with a dispensary under contract and a letter of intent in place for a manufacturing site, as of July. With Michigan moving forward with recreational legalization, MedMen has its foot well in the door, as the state will now put the wheels in motion to issue cultivation licenses and sales permits. In other words, it makes the hefty price tag that MedMen paid for PharmaCann considerably more reasonable -- especially if it can snag a good percentage of its estimated $1.4 billion to $1.7 billion in peak weed sales.

A magnifying glass being held over a company's balance sheet.

Image source: Getty Images.

Now, a word of caution

Then again, investors would be wise not to get too carried away by this latest legalization. Even with its foot in the door in Michigan by way of PharmaCann, MedMen is a long way from being a fundamentally sound company.

Despite sporting what might be the most impressive sales per square foot of any retailer, including Apple, MedMen is going to have to spend aggressively to expand its retail network and growing capacity. For the next two or three years, all facets of expenses are likely to soar, leading to significant quarterly losses.

Take the company's fourth-quarter and full-year report from a few weeks ago as a perfect example. Sure, the company's nearly $40 million in annual sales looked great on paper -- almost a 1,400% year-over-year increase -- but it came with a net loss of $112.3 million, not including one-time benefits. General and administrative expenses alone skyrocketed to $98.2 million in fiscal 2018 from $14.1 million in the previous year. As the company ramps up store openings and pays for its pricey acquisition of PharmaCann, these costs aren't going to decline. If anything, MedMen is going to get fundamentally worse before it has any chance to get better.

While not overlooking the niche role MedMen could slide into in the U.S. market, the company doesn't offer much from a fundamental perspective. That makes it a pot stock that's easily worth passing up for the time being.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.