Legal marijuana sales are soaring, and investors are relishing the industry's growth. A quick glance at the roughly one dozen largest marijuana stocks reveals that two-thirds have at least doubled in value over the trailing year.
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The give-and-take of marijuana stocks
In terms of sales figures, cannabis research firm ArcView pegged 2016's legal North American growth at 34% to $6.9 billion. By 2021, ArcView anticipates that North American legal pot sales, inclusive of medical and recreational weed, will approach $22 billion. This 26% compound annual growth rate is a function of state- and country-level expansion, organic growth within already legal states, and the movement of sales from black market to legal channels. Investors would likely struggle to find an industry that has 26% annual growth potential over a five-year stretch, which is why they've clung onto marijuana stocks.
But marijuana stocks have a pretty fatal fundamental flaw: they're losers... as in money losers. The vast majority of pot stocks are still losing money as a result of the high costs and legal maneuvering needed to operate in the cannabis industry.
As a reminder, the U.S. federal government still views marijuana to be entirely illegal, and it lists the drug as having no medical benefits. As such, most financial institutions want next to nothing to do with pot-based businesses for fear of criminal charges or fines from the federal government. This means weed businesses are often stuck only accepting cash, which is a security concern. Likewise, cannabis companies are unable to take normal corporate income-tax deductions since they're selling a federally illegal substance.
Thus, marijuana stocks that are profitable right now could really stand out from their peers and potentially attract more investors.
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These are the only two pot stocks to turn a profit in their most recent quarter
Until recently, both Canopy Growth Corp. (NASDAQOTH: TWMJF) and Aphria (NASDAQOTH: APHQF) were both humming along with one quarterly profit after another. Although both companies did wind up reporting a full-year profit in fiscal 2017, Canopy Growth and Aphria both recorded a fourth-quarter loss. Canopy Growth's loss was a result of acquisition-related expenses, while Aphria's loss correlated with large capital expenditures tied to its capacity expansion. Again, while both were profitable in fiscal 2017, they weren't profitable in their latest quarterly results.
Only two marijuana stocks have reported a profit in their latest quarterly results.
Perhaps the surprise of the Canadian medical marijuana group is Aurora Cannabis (NASDAQOTH: ACBFF), which is now the only medical cannabis company to have recorded a profit in its most recent quarter.
While Aphria knocked out five straight quarterly profits, and Canopy Growth pushed into the black in three of its past four quarters, Aurora hasn't been as quick to move to profitability. The reason? Like Aphria in its latest quarter, Aurora has been spending a lot on its massive Aurora Sky project. When completed, the company believes this 800,000 square foot growing facility will be the most advanced and automated commercial grow farm on the planet. The company has also been actively pursuing acquisition opportunities, meaning it could face acquirer-based costs, much like Canopy Growth did in the fourth quarter. And, of course, financing costs have been on the rise.
However, as reported in May in its third-quarter results, Aurora Cannabis saw a year-over-year increase of 1,158% in the number of active registered medical weed patients, leading to a 2,049% increase in the amount of grams sold compared to Q3 2016, and a 107% sequential quarterly increase in gross profit from the second quarter. Despite this rapid growth, administrative and marketing costs also soared, which led to a negligible Q3 profit of close to $0.1 million.
Investors are going to need to see a lot more than a hairline profit from Aurora before it can be trusted over the long-term. However, investors' focus should more importantly be on the debate in Canada over whether or not recreational marijuana will be legalized. A green light would be great news for Aurora and its peers, while another failure could be devastating considering its estimated $110 million in capital costs for the Aurora Sky project.
The only other profitable pot stock in its most recent quarterly report is Scotts Miralce-Gro (NYSE: SMG).
Scotts is best known as a lawn and garden giant that's helped companies improve crop yield and homeowners improve their landscaping. However, Scotts Miracle-Gro has also actively moved into hydroponics in recent years, which is the act of growing plants in a nutrient water solution as opposed to soil. This push into hydroponics via its Hawthorne Gardening Co. subsidiary, as well as its alternate focus on soil and lighting for the medical cannabis industry, has created a subset within Scotts that's growing by a double-digit percentage. Even though its cannabis-focused subsidiary only accounts for in the neighborhood of 10% of total sales, its double-digit sales growth is helping hedge against a slowdown in its traditional lawn and garden operations.
What's more, CEO Jim Hagedorn believes this growth is sustainable. Organic growth aside, Hagedorn also believes that the addition of smaller family owned businesses into the fold will help sustain a high growth rate. Hagedorn noted in early May that integrating mom-and-pop businesses takes a bit longer than traditional acquisitions, but that the long-term growth outlook for Hawthorne Gardening remains strong.
During the second quarter, the company wound up reporting $1.2 billion in sales, a 3% year-on-year decline, but a still healthy profit per share of $2.78 on an adjusted basis. Again, it should be emphasized that much of this profit is derived from Scott's traditional lawn and garden business. Nevertheless, its fast-growing hydroponics and cannabis-focused operating segment could play a much larger role in the future, especially if more states in the U.S. continue to legalize weed.
If you're looking for a way to get in on the green rush, but don't have the stomach to stand the volatility of traditional marijuana stocks, Scotts Miracle-Gro may be the perfect investment for you.
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