For the past couple of years, the marijuana industry has been virtually unstoppable. Sure, it's had a few hiccups in 2018, but investors who've had the wherewithal to stick with these companies for the past couple of years have been greatly rewarded.
The big question is, with marijuana now legalized throughout Canada: Can this cannabis rally continue in 2019?
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Recent operating results suggest a bumpy road ahead for weed stocks
The honest answer is that's not a guarantee. With the industry well past its period of promises, Wall Street and investors' attention has now turned to tangible results. In essence, operating results actually matter; and based on what we saw during the most recent round of quarterly reports, things weren't all that pretty. With few exceptions, marijuana stocks lost money on an operating basis, when one-time costs, benefits, and fair-value adjustments are excluded.
For most pot stocks, it's going to take time before they have any shot at being profitable. Many are still in the process of completing capacity expansion projects, marketing and building up their brands, and laying the groundwork to move into new markets. For fundamentally focused investors, it makes most of the direct players not all that appealing.
Then again, it's not as if ancillary pot stocks have performed all that much better. Many of the companies working behind the scenes that don't come into direct contact with the cannabis plant also lost money in the most recent quarter or for their full fiscal year.
Despite these losses, one pot stock finds itself in such a unique position within the ancillary industry that it could be a borderline must-own stock in 2019.
This behind-the-scenes marijuana stock might be a must-own next year
Last week, California-based KushCo Holdings (NASDAQOTH: KSHB) reported its fourth-quarter and year-end results. Full-year sales for the provider of packaging and branding solutions soared 177% to $52.1 million, albeit gross margin for the year fell 11 percentage points to 24.2%. The company blamed a year-end inventory adjustment of $2.8 million on the reduction and suggested that gross margin would have exceeded 30% without it. Ultimately, KushCo recorded a $10.2 million net loss, which reversed a year-ago profit of $69,000.
Generally speaking, a reversal from what were essentially breakeven results in 2017 to a greater than $10 million loss in 2018 would send fundamentally focused investors running in the other direction. But KushCo appears to be so perfectly set to benefit from the proliferation of legal cannabis in Canada, the U.S., and in Europe, that it could be worth turning a blind eye to near-term losses and letting the company's corporate strategy play out in the years to come.
As noted, KushCo is primarily a provider of packaging solutions to the cannabis industry. It produces tamper- and child-resistant packaging that allows growers to remain compliant with federal, state, and local laws. The company has more than 5,000 growers worldwide that it's already servicing, and this number could grow in the years that lie ahead.
Since many locales and states have strict guidelines as to what sort of warnings and branding can be on packaged cannabis products, KushCo is also responsible for working with growers to develop a strategy to build their brands. With Canadian growers pushing beyond the capacity expansion stage and into brand building, this marks the perfect time for KushCo to become a one-stop shop of sorts for packaging and branding solutions.
But wait – there's more
However, KushCo is much more than just a packaging company. Earlier this year, it acquired Summit Innovations and added a completely new element to its business. Summit is a producer of hydrocarbon gases and solvents. These hydrocarbon gases are used in the production of cannabis oils, while solvents are an indispensable part of the process for making cannabis concentrates.
By purchasing Summit Innovations, KushCo placed itself at the center of a high-margin alternative cannabis market. Though there's little precedence to the legalization of recreational weed, what few states have done so in the U.S. have given investors insight on what to expect next in Canada. If Colorado, Washington, and Oregon serve as examples, growers are going to overproduce in Canada and eventually drive down the per-gram price of dried flower, hurting the margins of most direct players. This has cannabis companies eager to turn to higher-margin alternative products, such as oils and concentrates.
Next year, Canada's Parliament is expected to take up discussion on expanding alternative consumption options. While there's no exact timetable on when this'll happen, rumor has it that alternatives like edibles, vapes, cannabis-infused beverages, and concentrates, will be legal by sometime this coming summer. That would be yet another boost to KushCo following its Summit Innovations acquisition.
So, where does that leave KushCo? According to management, the company is angling for $110 million to $120 million in full-year sales in fiscal 2019. At the midpoint, this would represent year-over-year sales growth of 121%. Assuming the company is serious about improving its gross margin to at least 30%, we're talking about gross profits of $33 million, if not higher. Though it could still take a year or two for KushCo to become profitable on a recurring basis, the table is set for this ancillary pot stock to feast.
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