Predictably, July was terrible for cannabis stocks. Right at the beginning of the month, everything started falling apart at once.
Bruce Linton, the face of the industry and head of Canopy Growth, was forced out of the company by his overlords – Constellation Brands. You’ll recall, they made that first and largest outside investment into the industry of $4 billion last year. They weren’t happy that they weren’t getting anything for that money just yet.
Then, CannTrust – one of the up and coming Canadian growers – was raided by regulatory authorities. More than half of its production was seized due to growing it without permits. This just proved the point so many have worried about for cannabis stocks all along… some weren’t above the board on all of their business dealings.
These two events – along with a number of less than stellar earnings results throughout the month – were enough to turn the rising tide cannabis stocks enjoyed in the first half of the year into a tsunami of losses:
Some have been warning this day would come, noting that speculators had too firm of a control over these hot stocks. The first sign of trouble, you see, those short-term speculators fled.
But it gets worse. According to S3 Analytics, short sellers added $169.7 million in new short positions during the month of July.
To put that in perspective, the short position in Canopy Growth – the industry leader – grew by nearly 90% year over year mostly coming just this month.
All is not lost, however. In fact, this turn of events could turn to investors’ benefits.
You see, as the speculators flee cannabis stocks, longer-term, steadier investors find entry points. According to Jason Wilson, a partner in charge of the Alternative Harvest ETF (MJ), July saw his fund actually grow… not in share price but in net assets.
Now, finding which companies will thrive in this new environment is more of a challenge. No longer will rising tides lift all boats. Cannabis sales continue to climb. But these new investors want to see rising earnings too. That’s not something all pot stocks have been successful at just yet.
The real test will come this current month. During August, most of the bigger names in the industry – including post-Linton Canopy – will report their most recent quarterly numbers. That company, and a few others set to report, aren’t necessarily likely to show a profit. But a path to profit will be the name of the game for this month.
The companies most likely to see this new investment capital hit their share prices will be ones that are making significant progress on widening margins and building profitable businesses.
Already, we’ve seen a few do this, to this new investment class’ enjoyment. The way they’ve done this – grow into profitable operations – however, isn’t straightforward.
A perfect example is Aphria. The company announced its earnings at the start of the month. It turned its first profit. But it didn’t necessarily come from growing its core business.
The profitable portion of its company came from a recent acquisition of a German medical marijuana distributor, CC Pharma.
Another company – while not yet profitable, is clearly on its way and a hit with investors – The Green Organic Dutchman Holdings. It too has been pursuing profits through expansion in Europe.
GW Pharmaceuticals – a US drug maker with the only FDA approved cannabis-related drug – has explained to investors that it too is seeking European help to grow. It is looking for approval of its successful CBD-based Epidiolex to sell in Europe, hopefully by October.
In short, the day of the Canadian monopoly on cannabis may be nearing its end. Europe is but one destination to find more profitable streams of income. But it isn’t the only one. Today, we feature two pot stocks that are looking to get a piece of that new investor capital… and grow it through overseas expansion.
Pot Stock of the Month No. 1: HEXO Corp. (NYSE:HEXO)
Not the largest company in the industry, but one of the fastest growing, HEXO Corp. (NYSE:HEXO) is a Canadian grower with lucrative distribution contracts with government approval in British Columbia, Ontario and Quebec… among others.
It has been rapidly growing its capacity since legalization. But HEXO’s story dates back many years prior. Before recreational marijuana became legal last year, HEXO was a provider of medical marijuana to drug developers and health care companies.
Today, it stands as one of the most mature pot companies in the country. But as noted above, that’s not what makes HEXO an appealing cannabis stock to own right now.
It is aggressively seeking entrance into foreign markets. Late last year, it partnered with Molson Coors. It expects as the partnership develops to leverage Molson’s international distribution channels for its cannabis supply.
The partnership is also one of the first that could traverse the beverage industry for cannabis-infused drinks. This is all part of its strategy.
You see, the company thinks of its path to profits as spokes on a wheel:
On the beverage side, we can already see how this strategy is supposed to play out. HEXO has raised tons of capital to grow its capacity. From there, it is already on the forefront of patenting its strains, products and ingredients. With these in hand, it can partner quickly with major companies already leaders in their fields: Molson Coors in beverages, possibly Philip Morris in vapes and so on.
The idea is to leverage these already-enormous businesses’ distribution networks to market new cannabis-based products.
With so many uses for the plant – both CBD and THC types – the potential product portfolio is endless. Think Procter & Gamble or Johnson & Johnson. These kinds of companies have thousands of products. HEXO, if not the sole manufacturer of these endless products, could be the chief supplier of the cannabis side of them.
It hopes to reach Europe and the U.S. especially. It has a joint partnership with a company in Greece to begin cultivating cannabis over there. That gives it a solid starting place within the European Union for further deals – both for distribution and supply.
In the U.S., it is already listed on the NYSE and plans to begin leveraging its intellectual properties on CBD products to the now legal CBD market there. If and when marijuana itself becomes legal across the nation, it can then go after further partnerships through its wheel and spoke strategy.
Though it plans to grow through both international markets and through partnerships in various industries, investors haven’t been so kind to HEXO of late. The company’s share price peaked earlier this year at above $8 per share. Today, it trades just over $4.
This is more a product of those speculators getting their hands on a smaller company in the industry than anything else. Now that they have been shaken free, expect that share performance to turn around.
HEXO’s share decline so far in 2019 has led it to become one of the most deeply discounted plays in the industry. This presents a rare opportunity to see it turn around even faster than its competitors as the new breed of institutional and long-term investors continue to buy into this remarkable sector.
Action to take: Buy shares of HEXO Corp. (NYSE:HEXO) to take advantage of one of the most mature, if small, cannabis plays looking to grow internationally.
Pot Stock of the Month No. 2: OrganiGram Holdings Inc. (NASDAQ:OGI)
A nearly identical opportunity exists in OrganiGram Holdings Inc. (NASDAQ:OGI). This play, however, focuses much more heavily on CBD than HEXO.
The company too is Canadian based, but has made major inroads to becoming an international player.
OrganiGram, like HEXO, has distribution agreements and governmental permits to supply all across Canada. It is only one of four companies licensed to sell in all 10 provinces. With CannTrust’s recent production seizure, those licenses become even more valuable in the short term.
But unlike HEXO, it has an even more impressive array of brands and specific plans for future launches. Over the last several months, OrganiGram has been pursuing the two fastest growing areas for cannabis – edibles and vape pens.
It has partnerships with fast-growing brands like PAX Era. By early next year, it plans to launch a new line of cannabis-infused chocolates with Canada’s Smartest Kitchen. It has developed other products and ingredients just waiting for a major partner in beverages, like HEXO’s Molson Coors Deal.
The list goes on. It has its hands in just about everything… and the market presence to profit. And as we said above, that’s the name of the game right now.
It now has four straight quarters of positive EBITDA, making it much more appealing to those newer earnings-focused investors. And it’s been able to do that while shoring up its balance sheet.
In May, the company was able to clean its slate of pending debt and gain a large credit facility for further growth. The cash on hand, and that available through this facility, should be put to good use very soon.
Already, we can see how it uses capital when it has it. Last year, OrganiGram signed a deal with Alpha-cannabis, an established German medical cannabis company. As we’ve seen with Aphria’s recent performance, the German market contains some of the best margins in the world right now. Having a solid partnership there is the best way to break through to net gains quarter in and quarter out.
The deal allows for both growing cannabis in Germany and exporting – legally – from Canada to Europe. This is a huge step up from even industry leaders like Canopy and Aurora.
But that’s not the only coals in the fire for OrganiGram. It has also partnered with a company called Eviana Health, a publicly-traded firm with operations in eastern Europe. This supply deal gives OrganiGram even greater access to end users and potential partners in that area.
Europe is likely to become the largest market for cannabis products very soon, at least until the U.S. legalizes marijuana and regulates CBD. Though, that too isn’t beyond OrganiGram’s reach.
Its focus on edibles and vape pen products, gives it a solid footstep in those markets in the U.S., where certain states have already legalized them. The supply shortage a full legalization or even FDA ruling on CBD would create puts OrganiGram in the perfect position for a short-term boost to both its top and bottom lines.
It is already seeing far too much demand for its own products. That’s one reason it signed on with Eviana, to secure production. But it too has plenty of new in-house capacity coming online. Its operations in eastern Canada are undergoing rapid expansion projects, which will nearly double the company’s production capacity by year end.
While OrganiGram, like HEXO, are unlikely to show a net profit in the next quarter or two as these expansion plans take money to build, it is clearly on a path to profits.
Its international exposure puts it in a field above its pay grade – currently trading with a market capitalization of less than $1 billion.
As you can see, its stock has closely mirrored HEXO this year, with early enthusiasm, but recent weakness. This too stems not from what the company is actually doing… but from speculators washing out of the once-hot sector.
And for that new money now entering on the coattails of those speculators, it’s growing income statement and international expansion should turn things around.
Action to take: Buy shares of OrganiGram Holdings Inc. (NASDAQ:OGI) to take advantage of its European leverage and growth opportunities. Its fast-growing EBITDA should propel it to the front of the line for investors’ renewed interest in cannabis.
That goes for both HEXO and OrganiGram. These two companies – despite their recent share price performance – have been doing everything right for this changing market.
They’ve both been greatly expanding capacity, striking the right kind of partnerships, securing their financial positions, growing their margins and breaking international soil.
It is impossible to say how the overall cannabis industry will do in the month of August, as the industry continues to shake itself up. But for these two plays, they have everything going for them to have a tremendous turnaround this month.
Now’s the time to take advantage, while shares remand remarkably undervalued.