Four cannabis stocks with room to grow

Significant investments, improved distribution and refined marketing strategies mean these cannabis stocks are only just starting to sprout

Vikram Barhat 9 July, 2019 | 1:41PM

Cannabis plants

Note: This article is part of Morningstar Canada's Cannabis Week Special Report

The legalization of recreational marijuana in Canada last year not only made it legal to consume but also rendered it a legitimate investment option for investors smelling profit.

As the mainstreaming of marijuana gathers momentum, a growing number of countries are expected to make consuming cannabis legal, including the U.S. where currently 11 states and Washington DC have legalized the use of recreational marijuana and 35 states have legalized its medical use. Federally, the U.S. is expected to follow in Canada’s footsteps to make cannabis legal nationwide by 2023. 

As a result of widening legalization, the cannabis industry is projected to grow nine times by 2030, creating a long runway of growth for growers and cultivators. The global medical marijuana market alone is projected to skyrocket from about US$12 billion in 2017 to around US$40 billion by 2024, growing 19% annually. Recreational cannabis sales are forecast to grow at 25% in the U.S. and 20% in Canada, annually through 2030, according to a Morningstar report.

Long-term investors wishing to get in on the green rush may find attractive options in the following cannabis companies that are at the forefront of cultivation and innovation, and stand to benefit the most from the explosive demand growth for medical and recreational marijuana.

Canopy Growth Corp

 

Ticker

WEED

 

Current yield   

-

 

Forward P/E

357.14

 

Price

$50.49

 

Fair value

$71

 

Value

27% discount

 

Moat

None

 

Moat Trend

Stable

 

Star rating

****

Data as of July 09, 2019

Canadian grower, Canopy Growth (WEED) cultivates and sells medicinal and recreational cannabis, and hemp, primarily in Canada (90% of gross sales), but has a footprint in more than a dozen countries, including the U.S.

The company has pivoted from medical cannabis to recreational sales since legalization in 2018. “Recreational cannabis now accounts for roughly 70% of gross sales,” says a Morningstar equity report, which forecasts 20% average annual growth for the entire Canadian recreational market through 2030, driven by legalization.

As well, Canopy’s global exports are on the upswing, with Germany being its current largest market. “The global market looks lucrative, given higher realized prices and growing acceptance of cannabis’ medical benefits,” says Morningstar sector director, Kristoffer Inton, who pegs the stock’s fair value at $71, and projects 25% average annual volume growth for Canopy’s international medical business amid widening legalization.

While the U.S. market is murky, with some states legalizing recreational or medical cannabis while it remains illegal federally, Canopy has been taking strategic steps to ensure a strong U.S. presence in anticipation of inevitable federal legalization. “We expect that federal law will be changed to recognize states’ choices on legality within their borders,” says Inton, who forecasts nearly 25% average annual growth for the U.S. recreational market and nearly 15% for the medical market through 2030.

Curaleaf Holdings Inc

 

Ticker

CURA

 

Current yield   

-

 

Forward P/E

-

 

Price

$8.97

 

Fair value

$14

 

Value

35% discount

 

Moat

None

 

Moat Trend

Stable

 

Star rating

****

Data as of July 09, 2019

U.S.-based Curaleaf (CURA) cultivates and sells medicinal and recreational cannabis in 15 states. Unlike its Canadian peers, the company does not currently export into the global market.

Curaleaf is much more vertically integrated with 12 cultivation sites, 19 processing sites, and 44 dispensaries, which “gives investors full exposure to the U.S. cannabis market, the fastest growing and largest potential market,” says a Morningstar equity report.

The cannabis cultivator has operations in states with large populations and limited licenses, typically on the east coast. Primarily focused on the medical cannabis market, Curaleaf has made a big pushing into the recreational space through the acquisition this year of Cura Partners, which also expands the former’s footprint to the West Coast.

The U.S. market, despite its opaque regulatory environment, has the highest potential for growth relative to any other market. In the future not so distant, the U.S. federal law is expected to be “changed to allow states to choose cannabis’ legality within their borders,” says Inton, who estimates the stock to be worth $14.

Curaleaf’s lack of international exposure, however, puts it at a disadvantage. “Curaleaf would need to open cultivation internationally if it wants to compete in the global medical cannabis market,” argues Inton, who projects annual growth of 28% for Curaleaf’s recreational sales and 17% for its medical sale.

Aurora Cannabis Inc

 

Ticker

ACB

 

Current yield   

-

 

Forward P/E

526

 

Price

$9.59

 

Fair value

$13

 

Value

25% discount

 

Moat

None

 

Moat Trend

Stable

 

Star rating

****

Data as of July 09, 2019

Another leading Canadian pot producer, Aurora (ACB) has benefited from the legalization of recreational cannabis in the country. Historically focused on medical cannabis, recreational now accounts for roughly 50% of its gross sales and has been rising.

Capitalizing on the growing acceptance of cannabis’ medical usage, “Aurora has expanded its global medical exports, currently shipping to more than 20 countries,” says a Morningstar equity report, pointing out that exporters must pass strict regulations to enter markets, which stacks the deck heavily in favour of early entrants like Aurora.

Unlike its Canadian counterparts, Aurora hasn’t sought to expand operations south of the border through CBD (cannabidiol, the non-intoxicating component of the cannabis) products or acquisitions, choosing instead to focus on becoming a low-cost producer. As a result, Aurora would not benefit from any favourable change in the U.S. regulatory environment “as it has no exposure to the U.S., a market estimated to be more than five times larger than the Canadian market,” says Inton, who appraises the stock’s fair value to be $13.

Aurora’s international medical business is forecasted by Inton to grow 24% annually fuelled by wider legalization and distribution. The company’s recreational volume, on the other hand, are projected to rise about 23% per year on average from 2019 through 2028 amid consumers shift driven by the recent legalization.

Tilray Inc

 

Ticker

TLRY

 

Current yield   

-

 

Forward P/E

1111.11

 

Price

US$45.29

 

Fair value

US$40

 

Value

14% premium

 

Moat

None

 

Moat Trend

Stable

 

Star rating

***

Data as of July 09, 2019

Tilray (TLRY) is a Canadian cannabis grower that sells medical and recreational cannabis through a range of brands. While the bulk of Tilray’s sales are in Canada, the company also sells CBD products in the U.S. through a local partnership with Authentic Brands Group and exports medical cannabis globally from its production facilities in Canada and Portugal. Tilray also has a partnership with leading beverage firm AB InBev to develop cannabis-infused drinks.

As have its Canadian peers, Tilray too has shifted its focus from medical cannabis to recreational cannabis after Canada legalized it. For the reason, the share of sales generated from medical cannabis has fallen from 90% to about a third of total sales.

In order to offset high production costs at home, Tilray recently expanded production in Portugal where it has built cultivation facilities that will allow the company to supply European medical demand with cheaper production, says a Morningstar equity report.

Strategic partnership with pharmaceutical and consumer companies can unlock potential for organic growth through exposure to new geographies and product categories. “Tilray established partnerships with AB InBev to develop cannabis-infused drinks and has an agreement with Authentic Brands Group for CBD products, giving Tilray some limited U.S. exposure,” says Inton, who puts the stock’s fair value at US$40, and projects the firm’s total cannabis sales to grow nearly 24% per year from 2018 to 2028.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Aurora Cannabis Inc5.02 USD-2.71
Canopy Growth Corp33.60 CAD-3.78
Curaleaf Holdings Inc10.63 CAD1.33
Tilray Inc29.00 USD-3.20

About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a freelance writer.