Quick… how many publicly traded Canadian marijuana companies do you think there are? Ten? Twenty? Fifty?
How about 219.
Because that’s how many I have on my watchlist.
In other words, the competition in legal marijuana has been bruising. And if Sundial’s (NASDAQ:SNDL) -50% revenue decline in Q2 was any indication, Canadian growers are in for more pain.
But much like electric vehicles in 2017… cryptocurrency in 2015… e-commerce in 1994… we know that legal marijuana is coming to the U.S… eventually.
In the meantime, how can investors dig through these 219 companies for gems?
Simple. We can use a modified version of my Golden Rule strategy: pick companies with 1) momentum, 2) value and 3) reasonable underlying business to buy.
U.S. Marijuana Penny Stocks
Back in November, I outlined how the future of companies like Tilray (NASDAQ:TLRY) and Sundial depends entirely on federal cannabis legalization. Without a change at the national level, these Canadian-based firms that list on major U.S. exchanges (i.e., NYSE or NASDAQ) will fizzle out, as these firms are currently banned from doing business in the U.S.
Meanwhile, some small companies have managed to forge ahead. By listing in Canada or OTC and avoiding interstate commerce, these firms have built successful businesses where the big players have failed.
Even better, many of these firms are penny stocks that still have incredible 10x… 50x… 100x potential.
The Golden Rule for Marijuana Penny Stocks
To identify these marijuana Moonshots, I’m going to use a combination of quantitative and qualitative metrics tailored to the cannabis industry:
- Momentum. Only companies with positive YTD returns make the list. Bonus points for those up over the past month while the industry has declined -10%.
- Value. The average weed company has a price-to-sales ratio greater than 100x. We’ll only consider those trading at 10x or below.
- Quality. The company must either have positive operating profits or patented intellectual property. Firms must also have a presence outside California, Oregon or Colorado, three of the most competitive marijuana markets in the U.S.
MedMen (MMNFF, MMEN)
100% YTD returns, a 1.5x price-to-sales ratio and an (ahem) growing presence in six U.S. states make MedMen (OTCMKTS:MMNFF, NEO:MMEN) the top pick of my Golden Rule Strategy. The company’s bottom-line losses are shrinking fast and the business is expanding to boot. Same-state revenues were up 2.8% in Q3 — 8.2% if you include expansion into New York and Arizona.
There are certainly issues with the company. Rapid expansion means that corporate overhead burns cash faster than it’s coming in. And $4 million share-based compensation per quarter is high for a startup that’s still short of everything.
But the longer Congress dithers in legalizing marijuana on a federal level, the better off MedMen will be. That’s because those delays will give MMEN time to grow its store footprint without foreign competition. And when the U.S. finally allows NASDAQ and NYSE-listed firms to work in the U.S., MMEN will suddenly become a takeover target for those looking to jumpstart their U.S. presence.
MMEN is also cheap, thanks to its relatively weak cash flow. At a hair over 30 cents, it won’t take much to propel MMEN to 10x returns.
POSaBIT Systems (POSAF, PBIT)
At first glance, POSaBIT (OCTMKTS:POSAF, CSE:PBIT) might seem like a Reddit joke — it’s a firm using blockchain to handle payments at marijuana stores. But dig deeper, and you’ll soon see why the No. 2 Golden Rule Strategy pick is actually my top Moonshot choice for the entire marijuana industry.
That’s because PBIT operates in the highly non-competitive world of cannabis finance. Traditional U.S. banks and credit card processors like Visa (NYSE:V) are legally banned from working with marijuana sellers, which has created a tangle of workarounds for non-cash payments.
Enter POSaBIT, a company that’s starting to look like Square (NYSE:SQ) for the cannabis industry. Because there are so few strong players in the industry, PBIT has managed >100% growth this year alone. And the payments firm is planning on adding another five U.S. states to the 14 it already serves.
POSaBIT also breaks even on operating margins, an unusual feat for any tech startup. Gross profit margins were up 7% to 26.5% in Q2, and more gains could be on the way as scale builds up.
Finally, there’s a tactical element. POSaBIT will soon start trading on American OTC markets under the ticker POSAF. Doing so will open the floodgates for U.S. investors, rewarding those who already own its Canadian listing.
Clocking in at No. 3 is MariMed (OTCMKTS:MRMD), a former cannabis advisory firm turned licenser and operator. I especially like the company because it has one of the most experienced teams on the East Coast. And this month, the firm added former Sam Adams CMO Robert Hall to its list of advisors.
That matters because it’s harder to find experienced cannabis teams in the east. Many tend to work for established firms like Harborside (OTCMKTS:HBORF) and Vibe Growth (OTCMKTS:VBSCF, CSE:VIBE) out West, where competition means sales have flatlined. MariMed’s East Coast focus, on the other hand, means sales have almost tripled since last year.
MRMD’s franchise system can also turbocharge growth. By helping others set up shop, MariMed can expand far faster than vertically integrated players like Trulieve (OTCMKTS:TCNNF, CSE:TRUL) and Green Thumb (OTCMKTS:GTII). With a reasonable 5x P/S ratio and a share price just over $1, MariMed is a company that could easily run up 5x if it continues to execute well.
Canadian Growers and Brands
My Golden Rule Strategy also works in reverse: finding high-priced, sinking momentum stocks that tend to underperform.
There’s no shortage of these stocks in the branded marijuana segment today.
Consider Planet 13 Holdings (OCTMKTS:PLNHF), the owner of the Trendi, Dreamland Chocolates and Leaf & Vine brands, as well as its eponymous store on Las Vegas boulevard.
If you’ve never heard of any of these names, I don’t blame you. The U.S. Patent Office counts over 10,000 active cannabis trademarks and I couldn’t name 99% of them.
Tilray and Sundial also land squarely in this camp. Their attempts at premium marketing have largely fallen flat. If you don’t believe me, try asking your neighbor to name one Sundial product line.
I wouldn’t suggest shorting these stocks just yet — Congress could still pass surprise legalization rules. But don’t be fooled by Sundial and Tilray’s 40% drops since June. They’re still no bargain for the Moonshot investor.
Just How Oversupplied is the Marijuana Market?
|-30%||Gross margins lost by Sundial Growers in Q2. Canadian marijuana prices have dropped so far that firms are price-dumping to generate cash.|
|2.6%||The size of the Canadian marijuana market relative to that of the U.S. Despite having fully-legal cannabis access, Canadians spend only a quarter of what Americans do on the drug.|
|7.5||Months of inventory held by sellers of Canadian cannabis edibles, according to the most recent data compiled by the Canadian government.|
|1 billion||Grams of inventory represented by the Canadian oversupply. Dried cannabis has a shelf life of 6 to 9 months before having to be destroyed.|
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Brother, Can you Spare a Dime(bag?)
Today, 91% of Americans now favor cannabis legalization. Not only have memories of the 1980s War on Drugs faded. Many also see it tackling issues that feed into racial injustice and wealth inequality.
The picture on Capitol Hill however, is starkly different. Politico has noted that Senate Majority Leader Chuck Schumer wouldn’t have enough Democratic votes to pass cannabis legislation, let alone find ten Republicans to support the cause.
Meanwhile Dhrumil Mehta at political site FiveThirtyEight has theorized that the success of state-level legalization has reduced the sense of urgency in political circles:
“For those who already have access to the drug, it may not matter whether it’s their state government or the federal government making that allowance.”
But no matter the human costs, federal legislators seem stuck in neutral. And until that changes, firms flying under the federal cannabis radar will be the winners of Washington’s unending bickering.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.