Is Emerald Health Therapeutics Inc a Buy?

There's good news and there's bad news for Emerald Health Therapeutics Inc (NASDAQOTH: EMHTF) shareholders. The good news is that the marijuana stock jumped close to 50% higher in August. The bad news is that Emerald Health's share price is still down nearly 20% year to date.

The more important news for investors, though, is that none of this matters when it comes to what might happen next for Emerald Health. What's really important is how well the company is positioned to grow. Is Emerald Health Therapeutics a buy? Here's what you need to know.

Great opportunities

Pretty much every Canadian marijuana grower hopes to capitalize on two tremendous opportunities. The first opportunity is the country's recreational cannabis market, which is scheduled to open for business on Oct. 17, 2018. The second opportunity is the rapidly expanding global medical cannabis market.

Emerald Health appears to be on track with one major prerequisite for succeeding in the Canadian recreational market -- building production capacity. The company stated in June that it was on schedule with retrofitting the 1.1-million-square-foot facility that Village Farms (NASDAQOTH: VFFIF) contributed to the two companies' joint venture, Pure Sunfarms. This joint venture received a cannabis sales license from Health Canada on July 27, 2018. The entire facility is expected to be operational next year.

There's mixed news, however, on securing supply agreements with provinces and territories for the recreational cannabis market. Emerald Health signed a memorandum of understanding (MOU) with the British Columbia Liquor Distribution Branch in July. This MOU is only for 1,086 kilograms of cannabis, but Emerald CEO Chris Wagner stated that the company is allocated around 13,000 kilograms over the next year and a half for the British Columbia recreational market.

Unfortunately, that's the only supply agreement that Emerald has signed so far. The company didn't make the cut for the Ontario Cannabis Store, which is Ontario's only legal online retailer for recreational cannabis. (Ontario is Canada's heaviest-populated province.)

What about the global opportunity? There hasn't been a lot of progress on that front for Emerald. The biggest development is that the company completed its acquisition of Northern Vines in July. Because Northern Vines is a licensed dealer (which Emerald isn't), the deal opens the door for exporting cannabis oils to other countries. So far, though, international cannabis markets remain an untapped opportunity for Emerald Health.

Major risks

I think there are three big risks for Emerald Health. The first risk is that the recreational cannabis market takes off in a huge way but the company gets left behind for the most part. Emerald's exclusion from Ontario's online retailer and limited success in securing supply agreements make this risk a real possibility.

The second risk that I see is that the Canadian recreational market demand doesn't meet expectations. It seems that nearly everyone is assuming that demand will shoot through the roof with the floodgates opening wide in October. If that doesn't happen, most -- if not all -- Canadian marijuana stocks will take a major hit. I expect Emerald will be one of the losers if this scenario plays out.

The third risk is also one that could apply to quite a few marijuana growers and not just Emerald Health. Canada's cannabis market is headed for a serious supply glut within a few years. Practically every marijuana grower in the country is scrambling to add capacity. But when you add up all of their capacity projections, the number is way higher than even the most optimistic demand projections.

This won't be a problem right out of the gate. It will take a while for expansion efforts to be completed. Some planned construction could fall by the wayside. Still, sooner or later supply will exceed demand. When that happens, cannabis prices will fall.

Marijuana growers will turn to international markets to absorb their excess capacity. Unless Emerald can establish international operations quickly, this might not be a viable option for the company.

Weighing the pros and cons

Will Emerald Health enjoy strong revenue growth? Probably so -- at least over the next couple of years. But that's not the question that investors need to answer. Strong revenue growth doesn't mean that a stock is a smart pick to buy. Emerald's market cap of around $470 million already factors in a lot of anticipated growth.

I think that investors should look at the long-term prospects for Emerald. In my view, the company's long-term prospects are iffy. I'm concerned that the company could be in trouble when the supply glut inevitably comes. In my view, Emerald Health isn't a buy right now. There are simply too many other stocks that investors can buy with better growth prospects and less risk.

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