This Stock Could Really "Shine" If Canada Legalizes Recreational Marijuana

Within a matter of months, marijuana history might be made. On June 7, Canada's Senate is set to vote on legislation that would make it only the second country in the world, and the first developed country, to legalize recreational cannabis. If Parliament moves forward with legalization, it could add $5 billion or more in annual sales. However, it should be noted that getting the product in dispensaries will take a good eight to 12 weeks post-legalization, making August or September the earliest point at which adult-use pot would go on sale.

Early signs are certainly pointing toward legalization. Canada's parliament has far more progressive lawmakers than conservatives, and a two-year tax-sharing agreement has been reached with all but one province, Manitoba. This tax-sharing agreement proposes a rough tax of around 10% on recreational weed, which is considerably lower than the tax Canadians pay on alcohol. For at least the first two years, Canada's provinces would receive 75% of tax revenue collected, since they're on the front lines of enforcing the law.

Pot stocks gear up for an expected recreational weed legalization in Canada

In anticipation of this vote and the likely legalization of recreational cannabis, marijuana-related companies have been expanding their operations as quickly as their wallets will allow.

For example, growers are organically and inorganically doubling, tripling, or quadrupling their production capacity. Just two weeks ago, MedReleaf (NASDAQOTH: MEDFF) announced the acquisition of 164 acres of property for $17 million in cash and 225,083 common shares of stock. This acquisition came complete with a 1.1 million-square-foot facility on 69 acres of property, known as the Exeter Facility, that it'll be retrofitting to grow cannabis. This new facility will quadruple MedReleaf's production from 35,000 kilograms of cannabis a year to 140,000 kilograms annually. And trust me, MedReleaf is one of more than a dozen growers that have dramatically increased their production potential of late.

Other aspects of the cannabis industry have been preparing for increased demand, too. Consulting businesses, marijuana breathalyzer developers, and even financing companies are all expected to benefit from pot's ascent in Canada.

However, there's one surprising stock that's on virtually no one's radar at the moment which could really "shine" if Canada legalizes recreational weed: LED lighting and lighting system business, Cree (NASDAQ: CREE).

The advantages and disadvantages of HPS light bulbs

Currently, a majority of indoor cannabis growers turn to high-pressure sodium (HPS) lights to encourage crop growth and maximize yield. HPS lights are traditionally the lowest-cost option available to aid growers, and their results are highly predictable, leading to easily forecastable yields. But even though HPS lights are time-tested and have relatively predictable yields, they also come with pretty notable financial drawbacks.

To begin with, HPS lights generate a lot of heat in an indoor setting. If we're talking about just a few plants being grown, that's not a huge concern. However, stack a few dozen or hundred of these HPS lights in an indoor commercial setting, and you have a potential sauna on your hands. Therefore, electricity costs tied to temperature maintenance (i.e., air conditioner usage) to ensure maximized cannabis plant growth can certainly add up over time.

Secondly, HPS lights require a lot of wattage per square foot to effectively do their job. Ed Rosenthal, author of the Marijuana Grower's Handbook, notes that with two 1,000-watt HPS bulbs for indoor cannabis sativa plants, it takes roughly 66 watts for each square foot of growth. In plainer English, the electricity bill for growers is going to be astronomical because of HPS lights.

How Cree could get its foot in the door

Now Cree, which makes LED lights, offers a solution. LED lights produce far less heat than standard HPS bulbs, which should reduce long-term electricity costs, and they consistently run at a lower wattage than HPS bulbs, which, as noted, come as high as 1,000 watts. Most importantly, LED lights also last significantly longer than HPS bulbs, which can cost more as they age and become less efficient.

The drawbacks? There's an ongoing debate whether LED lights can offer the same yield as traditional HPS lights. Growers know what to expect with HPS lights, but they don't have that same knowledge with LEDs, mainly because LEDs haven't been given the chance to prove themselves.

The other issue is cost. HPS lights can often be purchased for a few hundred dollars. By comparison, LED lights may run north of $1,000 a pop. Essentially, it's a higher upfront cost that'll result in considerably lower long-term electricity costs.

So why the sudden interest if Canada legalizes? Simple: Canadian growers will finally be flush with cash and operating cash flow, and they'll probably realize that pushing toward LED lights will lower their long-term electricity costs and make their greenhouses more cost-effective. A mixture of bought-deal offerings that have raised significant capital, along with revenue generated from cannabis sales, has put capital in the pockets of growers that had otherwise been lacking. Remember, cannabis is still illegal at the federal level in every country but Uruguay, and as a result banks have kept their distance and been mostly unwilling to lend to cannabis companies. With capital on hand, the higher upfront costs of Cree's LED lights would no longer be an obstacle.

For its part, Cree hasn't mentioned cannabis sales as being a business driver, but that could soon change, thanks to Canada. By no means are LEDs guaranteed to thrive in the cannabis industry, given their lack of history and predictability relative to HPS lights, but the table is set for LEDs to have the opportunity to showcase what they can do in high-growth commercial platforms. Marijuana investors and Cree shareholders should definitely be paying attention.

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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.