Marijuana Stocks Have Done This 1 Thing Poorly

Look! Up in the sky. Is it a bird? Is it a plane? No, it's just another marijuana stock ascending to the heavens.

In a mere 19 days (on Oct. 17, 2018), Canada will open the curtains on recreational marijuana sales in licensed dispensaries, becoming the first industrialized country in the world to do so. The approximately $5 billion in added annual sales that Wall Street expects this legalization to bring in for the Canadian pot industry is a big reason why marijuana stocks have been virtually unstoppable. Since the beginning of 2016, a number of top-performing cannabis stocks are up well in excess of 1,500%!

Pot stocks have investors seeing green

In many ways, marijuana stocks have done everything expected of them by investors, thus far. To begin with, they've been expanding their production capacity at a breakneck pace. For example, Aurora Cannabis (NASDAQOTH: ACBFF) began the year with the expectation that it would generate a little over 100,000 kilograms annually once at full capacity. Now that estimate might be as high as 700,000 kilograms per year, once all of its operations are fully completed. With demand expected to be strong right out of the gate, growers with a substantial amount of production capacity should succeed.

Investors have also witnessed a push into product differentiation and branding. Although there's little precedence to recreational pot legalization, Colorado, Washington, Oregon, and even California to some extent have shown a precipitous decline in the price per gram of dried cannabis post-legalization. This is because most growers overproduce in an effort to take advantage of high per-gram prices in the early going, as well as drive smaller players that may not be able to sustain lower margins out of business.

As a result, major players like Aphria (NASDAQOTH: APHQF) have turned to alternative cannabis products, such as cannabis oils and extracts, which are less prone to commoditization and have significantly higher margins than dried cannabis. In June, Aphria announced its intent to construct an extraction center that'll yield approximately 25,000 kilograms of cannabis-equivalent concentrates per year, when completed. Keep in mind that while cannabis oils will be legal come Oct. 17, concentrates, vapes, edibles, and infused beverages will not be. These other alternative forms of consumption are widely expected to become legal following a discussion and legalization by Canada's Parliament next year.

The one thing marijuana stocks have done poorly

However, as investors, we also understand that no stock or industry is perfect. While the marijuana industry may look practically flawless since 2016 began, the one thing it's been particularly bad at is acquisitions.

You might be scratching your head a bit, because most pundits would agree that consolidation is sorely needed in this space. And trust me, I agree wholeheartedly with this assessment. What I don't agree with are the premiums that acquiring companies have been willing to pay to boost their production capacity or grow their international infrastructure -- and the two biggest offenders might just be Aurora Cannabis and Aphria.

Aurora Cannabis has made two substantial acquisitions this year, and is in the process of working on a third, with its recently announced $221 million purchase of ICC Labs. Of course, this is a drop in the bucket compared with the $852 million it paid for CanniMed Therapeutics and $2.5 billion for Ontario-based MedReleaf. Both buyouts came with significant premiums attached, especially for CanniMed, which fetched nearly triple what it'd been valued at when the courting began in November 2017.

When Aurora made its first unsolicited bid for CanniMed, it was expected to generate only 30,000 kilograms a year in added dried cannabis, along with 720,000 liters of cannabis oils. That's not a lot of production given the $852 million that Aurora forked over for the Saskatchewan-based grower.

Meanwhile, it handed over $2.5 billion in an all-share deal for MedReleaf in order to acquire 140,000 kilograms of annual production. Mind you, Aurora already owns Larssen, which is a greenhouse consulting and construction company that helps it internalize its organic project expenses. Aurora could just have easily purchased land, built a 1.2-million-square-foot facility to generate roughly the same amount of yield it's acquiring from MedReleaf, and probably had well over $2 billion left over. Are MedReleaf's high-quality brands really worth more than $2 billion? I highly doubt it.

As for Aphria, it went all in with an approximate purchase price of $425 million for Nuuvera earlier this year. The thing is, Nuuvera didn't really add anything to Aphria's production capacity. Instead, Aphria gobbled up Nuuvera for a nosebleed premium in order to gain hold of its international infrastructure in more than a half-dozen countries worldwide. Sure, Aphria has around a dozen countries where it can potentially ship its medical cannabis, but $425 million for access to new markets is a real head-scratcher.

Pot stocks may be booming, but management teams have done a very poor job of assessing acquisition value, thus far.

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Sean Williams 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.