This is a crucial month for the fast-growing and increasingly scrutinized cannabis industry. While it marks the one-year anniversary of Canada’s legalization, it also marks the beginning of a second massive round of competition.
Officially, after nearly a year of debate, Canada will legalize derivative and cannabis-infused products like edibles, tinctures, oils, creams and beverages. Now, no one will be able to buy them starting this month. But that’s not what will drive investors as this month progresses.
In accordance with its original legalization legislation, Canada’s regulators are focused on the health and underage prevention side of the booming cannabis industry.
So, later this month, cannabis companies can apply for approval to begin selling these new products no earlier than mid-December – 60 days from their submissions.
A number of guidelines have been set forth in more recent legislation specifically about these non-flower cannabis products… including clear packaging with uniform warnings and precise designs as to not entice under age users to the likes of cannabis gummies and cookies.
This could be a challenge to some, especially with all eyes and heavy regulatory scrutiny on the first round of approved products. But depending on each individual company’s size and partnerships – developed over the last two years of heavy investor interest – some should use this new market to distance themselves from competition.
Now, before we get into the winners and losers with this new window of products, we have to take a look at where the market stands today.
The last six months or so have been rough. The giants like Canopy, Aurora, Tilray, Cronos and others have seen their share prices drop in a big way:
Here, we have the Alternative Harvest ETF (MJ), which holds all of these major players. Producers, which top the list, have suffered the greatest in this period.
You’ll recall, the likes of Canopy, Aurora and CannTrust have had additional individual corporate problems like management shakeups, regulatory failures and investor revolts.
So, in short, cannabis is entering a crucial period. But if history repeats, this is still the time to get in.
You see, the last round of legalization led to a record-breaking rally for all of these names. The summer of 2018 leading up to the October legalization in Canada saw monstrous gains from these producers.
Here’s that same ETF one year ago:
Those stocks were on fire just prior to legal sales opening up. However, from that legalization mid-October until the end of the year, all of those gains were erased.
We could see a similar pattern result from this second legalization of edibles, oils, etc. However, since these products won’t actually hit stores until the very end of the year, we still have a chance to take advantage of the buildup.
Of course, after coming off such a terrible summer this year, the chance to profit is even higher. Many of these stocks have suffered huge devaluations. Canopy, for instance, lost more than half of its market cap in just the last couple of months.
But therein lies our opportunity. Finding which ones, however, that will solicit the most interest from their edibles and derivative product lines is the challenge.
Fortunately, there are two clear winners from this. Both off significantly from their early 2019 highs… and both with partnerships to excel in this specific regulatory environment.
Pot Stock of the Month No. 1: HEXO Corp. (NYSE:HEXO)
Being the youngest brother in a group of boys isn’t the cakewalk eldest children make it out to be. Just as often as you get away with more… you get punished even if you didn’t do anything wrong. The same principle goes for smaller companies in an industry with adolescent large caps constantly in the news.
This is especially true in the cannabis field, with all major players only a few years old and the market only recently open for sales. And HEXO is the poster child for younger brother syndrome.
HEXO is a cannabis producer north of the border, with sizable capacity, lucrative partnerships and fast-growing, recognizable brands. Yet, when the big brothers – Canopy, Aurora and Tilray – started hitting the skids this year, HEXO fell alongside:
As you can see, HEXO has fallen all the way from more than $8 per share to below $4, its end-of-2018 lows. However, it has faced fewer problems than Canopy and its other bigger brothers.
Yes, it did have a management shake up recently, going on right now actually. Its CFO, Michael Monahan is resigning, a loss to be sure. Monahan has significant CFO experience elsewhere that was invaluable to HEXO’s growth strategy. However, Monahan is leaving because of the company’s growth. His travel to oversee its rapid capacity expansion took him away from family for too long.
This is drastically different from others in the industry seeing their own share of management issues. Canopy got rid of its – and the cannabis industry’s – chief spokesman and CEO Bruce Linton earlier this year. Linton was straight up fired by his company’s large investor Constellation Brands for not delivering a path to profits quick enough (more on this later).
HEXO’s situation is different. It has its own major beer brand backing it. The company is in a joint venture partnership with Molson Coors. But Molson’s management hasn’t stepped on HEXO’s growth prospects at all. In fact, it seems the company is pleased by HEXO’s brand and capacity building.
Yet, the company has been punished as if it had the issues the larger companies have had. A more than 50% decline in share price, despite only positives for the company is alarming. But as noted, this month is when those tides turn.
And no company is better positioned to take advantage.
You see, HEXO set out from the beginning to be different than its competitors. Its goals to create strategic partnerships in various offshoot industries has clearly already started paying off. While the company has had to bide its time on the sales front more than competitors, it is better positioned to take advantage of this second round of legalization.
Its deal with Molson is the prime example. From the very beginning the two were partnered to eventually produce cannabis-infused products – specifically beverages. But even if THC-infused alcohol takes a bit longer to come to market than pot gummies, the game is the same.
HEXO has been building its own edibles brands, perfecting its production setup for this eventual legalization and strategizing how to rapidly expand margins once sales become legal.
But the missing underlying advantage investors will only now begin to see is what it means to partner with a sinvestment company like Molson. Beer companies – and tobacco, to be fair – have long been under scrutiny on how they market their products. “Drink responsibly” campaigns, package warnings, stiff regulations and more have long been a part of these kinds of companies’ wheelhouse.
Cannabis – especially how Canada is regulating it – needs to be handled the same. The no-room-for-error regulatory environment during this second round of legalization makes HEXO’s Molson partnership even more valuable. And, when beverages eventually go to market in a big way, this venture will have a top position.
Right now, you can get HEXO stock for a huge discount to what it offers as investors switch back into greed mode ahead of this derivatives and infused-products legalization. Now’s the time to take advantage.
Action to take: Buy shares of HEXO, before investors flood back in.
Pot Stocks of the Month No. 2: Canopy Growth Capital (NYSE:CGC)
Now, it might seem strange to see Canopy recommended for this month following the above criticism of the company. But there’s a damn good reason it is set to turn around in the short term. One that actually matches well with its little brother, HEXO.
First of all, its summer drama has finally settled down. While Constellation isn’t enthused with its slower-to-profits outlook as one would hope, its Linton firing has quieted this chief investor enough to take advantage of this next round of legalization.
Of course, it would be impossible to discuss this topic without again pointing out the importance of having a sinvestment – specifically a beer company – in your corner right now. Constellation remains the largest outside investor in this industry, with its shares of Canopy.
It is also an experienced hand at regulation, safety concerns, marketing and licensing of age-restricted products… in multiple countries. In fact, the maker of Corona beer is even larger of a multinational beverage giant than Molson Coors, with more than three times the market size. So, it knows how to prep for this new round of legalization.
And Canopy hasn’t been sitting idle on its own branding and product development to take advantage of this newer market.
This is going to sound strange… but Canopy’s partnership with Martha Stewart is crucial to understanding the short-term value proposition here.
You read that right. Martha Stewart is partnering with Canopy Growth – the largest player in the cannabis industry. Primarily, the two are launching several health and pet care products using CBD – the non psychoactive version of cannabis.
These CBD products include oils and creams, for both customers and their pets. While this particular deal might not be the boost in sales and eventually profits Constellation would like. It does give us the basis for it.
CBD is part of this Canadian derivatives law. But it is also the only form of cannabis legal in the U.S. In the States, there are still regulatory hoops to jump through, which don’t necessarily have a definitive timeline like Canada. But in many states, you can already get CBD health care products, as long as they aren’t labeled as such.
This opens up a huge second market for Canopy, which has spent much of early 2019 diving into CBD production.
But that’s not the only reason Canopy is slavering after this new derivative products market. Back in late June, the company announced a number of initiatives – likely on the back of its then-controversial management decisions. One of which was a huge capacity expansion for its Smith Falls facility.
This Canadian operation will house tens of thousands of new square feet dedicated solely to the production of edibles. Specifically, it will house the production of chocolates – with room to scale up even more.
It also has room at Smith Falls for potential beverage production, with its hot-and-cold partner Constellation. Once it jumps through the regulatory hoops, it will be able to produce more than 5 million cannabis-infused beverages per month.
Equally important to all of this is what this could mean for margins. The company has struggled to turn a profit, or even offer hope of a near-term profit. This is why it is down even more than HEXO over the last few months:
However, as these new products trickle onto the market – this industry leader could see a huge boost to margins. Edibles and beverages are expected to be the highest margin products over the next few years as the cannabis boom moves forward.
That could even lead to additional investment from Constellation and other private equity and institutional investors. Canopy’s recent price fall only makes that a more likely possibility.
Of course, these aren’t the only reasons why you should look into this highly scrutinized industry leader right now.
Yes, you get access to its early dominance in CBD. You get a partnership with Constellation that offers huge undervalued opportunities. You even get the largest chance at a sharp pre-legalization rally. But you also get something else. Actually, it’s what you don’t get that makes it a great deal right now.
Canopy’s chief rival, Aurora Cannabis, is in a terrible spot. Rather than focusing on the kinds of projects Canopy has – CBD, edibles, etc. – Aurora has put its money into vaping pens. It has a large investment in Pax Labs, and has been spending a fortune on its own capacity expansion to service this once-expected major slice of the cannabis market.
But vaping has started to fall seriously out of favor. With more than 800 people sick and 16 potential vape-related deaths, regulators, politicians and customers are turning on this side of the industry. Some states have seen sales drop for vape products. While cannabis is still a tiny portion of the larger vape issue, all of this comes at the worst possible time.
Aurora was counting on its post-secondary-legalization boom to come from this market niche. Now, with less demand just when the market was about to open up for it, Aurora is likely going to lose even more market share to Canopy post legalization.
Now, this is a story for another day. But suffice it to say, in an industry so scrutinized and desperate for investor money, you’d rather be selling chocolate than vape oils or pens.
Canopy, like HEXO, have incredibly important partnerships entering this second round of Canadian legalization. Both know and even control much of the current market share in Canada. And both of been working on their post legalization growth plans for months… even years.
The build up to that mid-December launch of these products could be the best time to get in on a cannabis rebound rally. And these two will lead it.
Action to take: Buy shares of Canopy Growth Capital (NYSE:CGC) ahead of the rest of investors set to swarm in.