Better Know a Marijuana Stock: MedReleaf Corp.

With the exception of the internet boom in the late 1990s, you'd struggle to find an industry with long-term growth potential as high as legal weed -- and marijuana stock investors have taken notice.

Depending on your preferred source, the legal weed industry has the potential to grow by an average of 23% to 27% on an annual basis over the next five to 10 years. However, a pretty clear consensus among the various reports estimating growth in the legal pot industry suggest that U.S. sales are poised to triple or quadruple between 2016-2017 and 2021. It's certainly not hard to get excited about an industry with sustainable growth of around 25% per year.

However, investing in marijuana stocks isn't necessarily easy given that there are dozens to choose from. Emotions surround the pot industry are also running high, meaning investors may be buying into marijuana stocks without fully understand the risks involved.

With this in mind, we're going to take the time to examine a new pot stock each week until we've covered all of the larger players with a market cap in excess of $200 million. Here are the marijuana stocks we've discussed so far:

Today, we're going to take a closer look at MedReleaf Corp. (TSX: LEAF)(NASDAQOTH: MEDFF).

What MedReleaf does

MedReleaf is one of less than four dozen licensed producers and retailers of medical cannabis products in Canada. The company was founded just four years ago, and it focuses on supplying dried cannabis, cannabis oils, and cannabis oil capsules to qualified medical patients in Canada. It also sells various accessories, such as vaporizers and grinders. Its chief competitors include Canopy Growth Corp., Aphria, and Aurora Cannabis.

Late last month, MedReleaf priced its initial public offering at roughly $7 per U.S. share, or $9.50 Canadian, and in the process wound up raising about $75 million. Approximately 80% of this was from the issuance of shares from its treasury, while the remaining $15 million or so came from existing shareholders selling a portion of their stake in the company. The pricing of the deal gave MedReleaf the title of largest North American marijuana stock IPO of all time.

Promise and opportunities

For MedReleaf, there are two clear catalysts that could push its valuation higher.

To begin with, the company will benefit if the medical marijuana patient pool in Canada continues to grow by leaps and bounds. According to data from Health Canada, which is the regulatory body that oversees public health for Canada's citizens, the number of eligible medical cannabis patients has been growing by about 10% per month, which is been good news for demand and pricing. In particular, dried cannabis sales have grown by an average of 6% per month, while cannabis oils being have really stood out with average monthly growth of 16%. If Canada's medical weed patient pool keeps growing, MedReleaf will be a happy camper.

Another major catalyst for MedReleaf revolves around the legislation currently working its way through Canada's Parliament. Prime Minister Justin Trudeau recently introduced a bill that would legalize recreational marijuana throughout Canada by as early as July 1, 2018, which would open a pathway for licensed producers to see a massive influx of new consumers. The Canadian government has suggested that legalizing recreational weed could generate $5 billion to $7 billion in added annual revenue, which would be a major opportunity for MedReleaf and its peers.

Another positive is the company's recent IPO, which raised a bunch of cash that MedReleaf can now use to expand grow capacity at its Bradford, Ontario facility. The quicker this expansion takes place, the more market share and repeat customers Canadian producers and retailers are liable to claim. Currently, the Markham facility has 23,500 square feet of dedicated grow space, and its Bradford facility will have 86,000 dedicated feet of grow space when fully online.

Risks and concerns

On the other hand, no marijuana stock is perfect, and MedReleaf comes with plenty of potential flaws.

For instance, what if Canada doesn't move forward with Trudeau's proposed recreational pot bill? Conservative members of parliament have argued that there are two issues with the bill. First, it calls for a home-grow option, which conservatives suggest will give minors much easier access to the currently illicit drug. The other issue is there are no guidelines in place to determine if a driver is impaired or not. Because tetrahydrocannabinol (THC), the psychoactive component of marijuana, sticks around in the bloodstream for a long period of time, it makes deciphering when someone used cannabis, and how impaired they are, difficult. If recreational weed doesn't get the nod in Canada, MedReleaf and its peers could see their market caps hit hard.

Speaking of peers, Health Canada also gave MedReleaf, Canopy Growth, Aphria, and Aurora Cannabis something to worry about in May when it announced that it was making changes to the country's medical marijuana program. Among the changes, new licensed producers are expected to be added beyond the current 44, and producers will be allowed to grow as much as they can safely and securely store in their vault.  In other words, a recipe for greater competition, more supply, and lower margins appears to be on the horizon.

A final notable concern for MedReleaf is that it's facing a sea of expanding competition. Even if the number of licensed producers doesn't increase, its larger peers are growing "like a weed." Canopy Growth is primarily growing inorganically, having recently completed the acquisition of Mettrum Health and the purchase of 472,000 square feet around its corporate headquarters. Peers Aphria and Aurora Cannabis are growing organically, with Aurora Cannabis working on finishing its 800,000 square foot state-of-the-art Aurora Sky project, and Aphria in the midst of completing its $100 million Phase IV project that'll boost capacity to 1 million square feet. These peers aren't going down without a fight, meaning MedReleaf isn't guaranteed to succeed.

Should you buy MedReleaf?

Now for the most important question or all: Should you buy MedReleaf stock?

On one hand, Canadian medical marijuana stocks offer a few things that U.S. marijuana stocks don't offer: the potential for widespread recreational legalization, rapidly growing medical cannabis patient pools, and in some cases profitability. Canopy Growth Corp. is on track to be marginally profitable this year, while Aphria has turned a profit in five consecutive quarters. If patient access keeps expanding and MedReleaf delivers recurring profits, it could fully take advantage of the legal pot industry's rapid growth.

On the other hand, we've seen attempts to legalize the use of marijuana backfire before, and MedReleaf is already valued at a potentially nosebleed price-to-earnings ratio this year. There's also about to be a large influx of competition on the medical side of the equation that could stamp out MedReleaf's chances of gobbling up significant market share through capacity expansion.

For the time being, my suggestion would be to add MedReleaf to your watchlist, but remain on the sidelines until we have a definitive ruling on recreational weed from the Canadian government.

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Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.