5 Best Cannabis Stocks to Buy in 2022
On October 17, 2018, Canada legalized cannabis for adult use. Since the debate leading to this legalization started, cannabis stocks have been all the rage. An entirely new market is emerging, and investors want to get involved early.
Investors have been so excited about cannabis stocks that we saw a bubble in the sector leading up to the rise of adult-use marijuana in Canada. Since then, the bubble has popped and stock values have come back to reality. Now there’s a strong argument that the marijuana market is poised for a rebound.
In particular, there’s a strong argument that with Joe Biden as president and the Democratic Party controlling both the Senate and the House, cannabis could soon be legal for adult use in the United States as well. In anticipation of this possibility, investors are eyeing the top cannabis stocks yet again.
With the cannabis sector in its infancy, there’s no doubt the companies that worked hard to take control early on will become the leaders of the industry in the future. Getting in on these early cannabis market leaders offers a substantial opportunity for long-term stock market gains.
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5 Best Cannabis Stocks to Buy
When investing in emerging sectors, including investments in both recreational and medical marijuana stocks, it’s as important as ever to make the right moves in the market. Any company with a remote similarity to companies within the sector will try to get involved. Due to market uncertainty and capital issues, many of the penny stocks in the marijuana industry will fail.
Nonetheless, where there’s risk, there’s generally reward. Making the right investments in a sector’s infancy can lead to vast long-run profits. If you’re thinking about investing in the cannabis industry and sharing in these potential long-term profits, the pot stocks below are a great place to start your research.
1. GW Pharmaceuticals (NASDAQ: GWPH)
Investing in an emerging sector involves quite a bit of speculation, so it’s best to look for investments that hedge these bets. Due to the regulatory concerns associated with cannabis, pot stocks are higher-risk than investments in other, less regulated industries. GW Pharmaceuticals gives investors an interesting way to get involved in the cannabis market while bypassing the debate over legal recreational-use marijuana.
The company isn’t interested in growing cannabis or catering to the adult-use cannabis sector. Instead, GW Pharmaceuticals uses cannabinoids derived from the cannabis plant as key ingredients in the development of new therapeutic options, bringing medical marijuana to the next level.
GW Pharmaceuticals’ claim to fame is a treatment known as Epidiolex. The treatment is a highly-refined form of cannabidiol, or CBD, that was developed as a treatment for seizures associated with Dravet syndrome and Lennox-Gastaut syndrome in younger patients ages two and older. It is also the product that gives GW Pharmaceuticals the crown as the first biotech company to receive U.S. approval for a cannabis-related drug.
Because Epidiolex has proven to be far more effective than standard-of-care therapies like clobazam and valproic acid while greatly reducing side effects in its target patient population, the treatment has seen incredible adoption rates in the space. The growing sales of the drug are a driving force behind the company’s compelling year-over-year revenue growth, which clocked in at about 69% in 2020.
The company generated $527.2 million in overall revenue in 2020, more than $510 million of which was attributed directly to sales of Epidiolex. Guidance for the full year 2021 suggests that the company will generate more than $3 billion in overall revenue with Epidiolex leading the charge once again.
GW Pharmaceuticals is also a prime beneficiary of the United States Farm Bill passed in December 2018. This bill reclassified CBD products and hemp, separating them from cannabis, which remains a Schedule I substance controlled by the Drug Enforcement Administration in the United States. With CBD being the main ingredient in Epidiolex, GW Pharmaceuticals will benefit from reduced costs and increased accessibility, ultimately assisting the company in margin growth moving forward.
The company is by no means a one-trick pony. GW is currently in the late stages of development of a treatment known as Sativex, another cannabis-based therapeutic option. This treatment centers around the use of cannabis extracts THC and CBD as potential options for patients with multiple sclerosis (MS). Should this treatment be approved, it has a strong chance of becoming yet another blockbuster and major revenue driver for the company.
At the moment, GW Pharmaceuticals is in the midst of late-stage clinical trials to bring Salivex to market.
Beyond Epidiolex and Sativex, the company has two other cannabis-based clinical candidates that are the subject of four clinical development programs. With multiple clinical development programs currently underway, revenue growing at a breakneck speed, and Sativex being on the verge of reaching the market, GWPH is one for the watchlist.
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2. Cronos Group (NASDAQ: CRON)
Cronos Group operates on the opposite end of the cannabis market from GW Pharmaceuticals. The company is focused on recreational cannabis and has quickly become one of the biggest companies in the marijuana market.
A major part of the company’s growth has to do with an investment made by American tobacco company Altria. The maker of Marlboro, Parliament, and Virginia Slims cigarettes saw value in the cannabis industry early and saw Cronos Group as one of the best marijuana stocks on the market.
In late 2018, Altria invested $1.8 billion into Cronos stock, bolstering what has become one of the most impressive balance sheets in the cannabis space. This may be surprising, considering that Cronos only generates between $300 and $400 million in revenue per year. So, what did Altria find interesting enough about the company to make a $1.8 billion investment in a comparatively small marijuana company?
Cronos Group is one of the key cannabis growers in Canada, helping to support the country’s booming cannabis business. However, that’s just one part of the company’s work. The company is also actively involved in penetrating other markets around the world. The biggest of these markets is the United States, and tapping into this market has the potential to lead to skyrocketing valuations.
At the moment, there are only six states in the U.S. that have not decriminalized or legalized cannabis in some way. Although marijuana is still illegal on the federal level, the push from state to state to decriminalize or legalize the plant suggests that federal legalization of adult-use cannabis will come down the line sooner rather than later. In fact, a bill is expected to be filed shortly to do just that, according to Marijuana Moment.
Cronos Group is uniquely positioned to capitalize on the potential legalization of cannabis in the U.S. Given the company’s success in the Canadian market, similar success in the United States market would drive far higher revenues on account of the much larger size of the U.S. economy.
All Cronos would need to take the U.S. market by storm is a strong partner that can guide the company through the unique regulatory environment in the region. The Altria investment in Cronos Group turned out to be a match made in heaven.
If and when cannabis becomes legal in the United States, Cronos has the ability to grow enough of the product to meet demand. And, as a big tobacco player in the U.S., Altria group understands marketing, manufacturing, and sales of highly regulated products in the region. Between the two, the potential for complete U.S. marijuana-market dominance is there.
Cronos is a highly speculative play. Much of the value of the investment lies in the United States legalizing cannabis for adult use over the next few years, a promising prospect considering the results of the 2020 election season. Should this take place, the potential for gains is hard to ignore, making Cronos one of the top stocks in the cannabis market and one that’s well worth watching.
3. Innovative Industrial Properties Inc (NYSE: IIPR)
Cannabis has several subsectors. There are growers, dispensaries, health care companies, and companies that support and supply them, all working together to build the cannabis ecosystem. A major part of that ecosystem is physical space.
After all, in order to operate a cannabis growing operation that produces enough of the flower to generate a meaningful profit, or to operate a manufacturer that processes the plant into end products at scale, these companies need room to work. They need real estate.
That’s where Innovative Industrial Properties comes in.
The stock represents a real estate investment trust, or REIT, but it’s like no other REIT on the market today. It’s the first company listed on the New York Stock Exchange that provides real estate capital to the booming U.S. medical marijuana industry.
As a REIT, the company uses investments provided by a large number of investors to acquire income-generating properties. However, the company isn’t buying apartment buildings or strip malls. Instead, it invests in massive real estate specifically designed for use as indoor cannabis grow rooms. These properties are then rented to growers, and the profits from the rent are shared with investors.
The company kicks back at least 90% of its profits to its investors by way of dividends, making it a great option for the income investor looking for exposure to the cannabis sector.
However, the stock doesn’t move like any income stock you’ve ever seen. Over the past year, it’s grown from about $125 per share to more than $225 per share, making it an attractive option for growth investors as well.
No matter how you slice it, IIPR stock is one that’s hard to ignore. The company’s business model is clearly working as it continues to pay investors meaningful dividends, and with the growth in the price of the stock over the past year, there’s not an investor without a smile from ear to ear. All in all, this stock is one to watch closely.
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4. Canopy Growth Corporation (NYSE: CGC)
Canopy Growth Corporation has quickly made a name for itself. The company is among the top three cannabis companies in the world by market cap and has become the largest cannabis producer in the world, according to Zippia. That’s nothing to shake a stick at.
Like Cronos Group, Canopy has also attracted high-dollar investor interest from a U.S. company operating in a heavily regulated market. Constellation Brands, best known for its alcoholic beverage brands like Corona, Modelo, and Casa Noble, made a $4 billion investment in the company in August 2018.
As a result, Canopy Growth Corporation’s balance sheet is at least as impressive as that of Cronos Group, ranking as one of the top two best balance sheets in the cannabis space.
As with much of the sector, Canopy saw widening losses and reductions in overall revenue in its second-quarter fiscal 2021 financial results. However, the company bounced back in the third quarter, producing 23% year-over-year revenue growth, largely driven by a rebound in domestic recreational cannabis demand as well as international medical demand.
There’s a strong argument that while it has begun to recover from weakness relating to coronavirus blues, the stock remains vastly undervalued, leaving further room for growth. Moreover, analysts are expecting a strong recovery, which pairs well with the idea that Canopy Growth is highly undervalued.
As a long-term play, Canopy may be one of the best cannabis-related stocks on the market today. It may take the company some time to reach profitability following recent revenue declines, but it can afford to wait. The company has multiple billions of dollars in cash and is in the process of using some of this cash to acquire smaller companies and assets, setting the stage for strong revenue growth as COVID-19 comes to an end and further regulatory changes take place around the world.
When a market is in its infancy, companies that work hard to take control of the industry will generally become its long-term leaders. That’s exactly what Canopy Growth Corporation is doing. With such a strong financial position, the company is setting profitability on the back burner and focusing on building up its assets to a point where no other company in the space will be big enough to compete.
This is the same type of play made by Amazon.com early on. The company hemorrhaged money to build infrastructure and create a better user experience. Many wondered if the company would ever turn a profit. Today, Amazon.com is one of the most profitable retailers in the world, and there’s no sign of the company’s growth slowing.
Canopy Growth is in a similar position. It’s got the money to spend, and it plans on doing so in order to build the potential for extreme long-run value. That makes this stock one that’s worth considering diving into.
5. Tilray Inc (NASDAQ: TLRY)
Tilray was already one of the largest Canadian cannabis growers in early 2021 However, thanks to a merger with Aphria that closed in the first half of 2021, the company has become the largest cannabis grower in the world, according to Forbes.
While the stock was an interesting play in the past, the merger with Aphria made it impossible to ignore.
In most cases, when a new market is born, it’s highly fragmented with several small companies that make up the overall emerging sector. As a market matures, consolidation — or the combination of these fragmented pieces into larger, merged companies — is important not just to determine who will be the market leader, but for the strength and survival of the sector as a whole.
Through consolidation, larger players are able to reduce the cost of production of goods, resulting in higher margins for companies and a lower overall cost for consumers.
Tilray has been doing just that for quite some time now. It’s the proud parent company of High Park Holdings, Fresh Hemp Foods, Smith & Sinclair, and several other subsidiaries, but none of these smaller subsidiaries hold a candle to Aphria, which is one of the largest cannabis producers in the world. The combination of these two companies brings the consolidation of a fragmented market to a whole new level.
This is a strong play that happened at an interesting time.
The COVID-19 pandemic has been painful for the marijuana sector as a whole. Lockdowns led to tremendous reductions in revenue and painful declines for many.
The times are changing.
Today, multiple vaccines are on the market, and many expect the COVID-19 pandemic to be behind us relatively soon. Tilray plans to capitalize on the recovery with its scalable operational footprint and diverse portfolio of cannabis products.
By working to consolidate the cannabis market, Tilray has become the largest cannabis producer in the world, and as the world reopens following one of the worst health care crises in modern history, the company is poised for significant growth ahead.
The cannabis sector is an exciting one. Led by speculation that nations like the United States will soon break down regulatory barriers in the industry, investing dollars are being poured into the space.
Before you throw your dollars in the ring, it’s important to do your research and consider the risks. Most companies in the cannabis space are not profitable. If they don’t have a strong enough balance sheet, this could mean that there will be transactions in the company’s near future that aren’t in the best interest of investors.
Furthermore, because much of the value in cannabis stocks is a predetermination banking on the idea that the U.S. will legalize the drug, regulatory headwinds could result in sector-wide losses.
However, if all goes well, the cannabis industry could soon be a booming one with the potential to create tens of billions of dollars in revenue for the companies that take part.
Disclaimer: The author currently has no positions in any stock mentioned herein nor any intention to hold any positions within the next 72 hours. The views expressed are those of the author of the article and not necessarily those of other members of the Money Crashers team or Money Crashers as a whole. This article was written by Joshua Rodriguez, who shared his honest opinion of the companies mentioned. However, this article should not be viewed as a solicitation to purchase shares in any security and should only be used for entertainment and informational purposes. Investors should consult a financial advisor or do their own due diligence before making any investment decision.
Canopy Growth: Not My Top Pick In The Sector – A Look At Financials And Valuation
Canopy Growth (CGC) is the number one cannabis operator in Canada. In this report, I retract my title of “best of breed” as I no longer feel that this title belongs to CGC. I also discuss the margin disappointments, the lofty expectations brought on by the high valuation, and why I think the valuation will compress moving forward. There’s enough hail-mary’s to keep me from shorting the stock – I am neutral on the shares.
(Note: all dollar figures are in Canadian dollars, unless otherwise noted)
Who Is Best of Breed?
Lately, I have been very interested in the cannabis sector. This led me to take another look at CGC, as in January of this year, I labeled it the best of breed in cannabis (while simultaneously issuing a neutral rating). I no longer have that opinion, as I think that title belongs to someone else.
Let’s start with the balance sheet. Cash and short-term investments totaled just over $2 billion as of the end of the quarter. As recently as year-end 2018, CGC had nearly $5 billion of cash and short-term investments on its balance sheet. Over the same time period, shares outstanding has grown from 303 million to 364 million. In other words, CGC has managed to burn through $3 billion of cash while diluting shareholders by 20%.
There appear to be several reasons for the poor financial performance. CGC has seen weak gross margins – this past quarter saw gross margins of 6%, down from 20% in the year prior, and much lower than 42% it reported last quarter:
In the chart above we can see that gross margins are all over the place – it appears that it isn’t so easy to grow cannabis. I note that gross margins typically are very stable in other industries.
Moving on to operating expenses, share-based compensation dropped significantly compared to the prior year and totaled just over 30% of revenues (somewhat tolerable). Selling, general, & administrative expenses totaled $135.4 million – $16 million higher than total revenues. It is an understatement to say that CGC has bit off more than it can chew – there’s no excuse for SG&A to be larger than revenues.
I was disappointed that CGC has decided to go the direction of less-clarity, as in this most recent quarter it has decided to stop disclosing kilograms sold and average selling prices:
“Moving on, we are no longer providing our kilogram sold and average selling prices as our business shifts to a more diversified product line from flower. So, let me offer you some color on price and mix impacts during Q1.
Our flower B2B business saw sales decline 20% in Q1 compared to Q4, driven by a volume decline of 5% and an average selling price decline of 15%. The decline in the ASP is mainly driven by geographic mix, as product sales in Alberta were lower and product sales in Ontario were higher, as well as a migration toward higher-sized package offerings. (source: Earnings Call Transcript)”
From the discussion above, the average selling price declined by 15% from 2019 year-end results, and those numbers were already 22% lower than in 2018. Deteriorating gross margins in the absence of revenue growth (revenues grew only 15.5% YOY) suggests problems with the business model. Elevated operating costs relative to revenues suggests problems with operational execution.
Management is optimistic that they can return to 40% gross margins and they cited cultivation efficiencies and potentially higher margins from beverages:
“We’ve already proven that we can deliver 40%-plus gross margins and are confident that we will return to that level as we work toward higher capacity utilization across our facilities. Taking beverages as an example, with the robust demand we’re seeing for our beverages, we are ramping up production and the throughput of our beverage facility has doubled in July from June, and we plan to double again in August. And based on the continuing strong consumer pull we are seeing, our beverage facility could reach capacity much sooner than expected. (Earnings Call Transcript)”
Thing is, even if we assume that gross margins suddenly return to the 40% level (I’m skeptical), then CGC would have seen a maximum $38 million benefit to its bottom line. It still would have burned through $150 million in cash for the quarter and $600 million on an yearly basis.
Valuation Isn’t Pricing In The Risks
As we saw earlier, cash is quickly running out. That’s a problem because the net cash position has typically been the anchor point for a bullish thesis. CGC has approximately $1.5 billion in net cash, after subtracting $500 million in debt. That leaves CGC with a market cap of $6.2 billion and an enterprise value of $4.7 billion. Using an annualized $441 million net revenue run rate, CGC trades just under 11 times enterprise value to sales.
However, considering CGC’s high level of cash burn, I question whether enterprise value should be used in determining the valuation. Instead, I prefer to use market cap, as CGC likely needs to maintain a large cash position to cushion future losses. CGC trades at 14 times forward sales – an egregious multiple considering the current growth rate.
One can argue that the revenue growth rate was impeded by COVID-19, as many of its retail stores were closed for about a month. However, I note that CGC experienced a similar revenue growth rate the prior quarter, even before the onset of the pandemic. Based on the current 15.5% growth rate, the 14 times forward sales multiple appears too rich. Assuming a 20% future net margin (likely optimistic considering the volatile gross margins), and 2.5 times price to earnings growth rate, CGC would need to trade at under 8 times forward sales before it would even begin to look investable. Using the same profitability assumptions above, CGC would need to return to a 40% revenue growth rate with a strong rebound in gross margins before I’d consider buying at current levels.
After more than one year of legalization of adult-use cannabis in Canada, it has become clear that growing and selling cannabis isn’t so easy, at least in Canada. CGC’s volatile gross margins are indicative of business model pressures, while the fact that SG&A outpaces revenues suggests material execution issues. In spite of what appears to be financial underperformance, CGC trades at a generous valuation. I believe that its listing on the U.S. major stock exchanges has a lot to do with that, as cannabis investors who don’t want to invest in over the counter securities might not feel that they have any other options. I am neutral-bearish on the stock, but am avoiding shorting because shares might provide some upside if the management team can fix its expense profile and improve its growth rates.
I’m Buying The Best of Breed Cannabis Stocks
I’m not buying CGC, but I’m buying what I believe to be “best of breed” in the cannabis sector with a price target 300% higher than current levels.
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