How This Marijuana Stock Might Have the Smartest Approach to Acquisitions

Ready or not, the cannabis industry is in bloom. In North America alone, the industry is looking at sales growth estimations of 28% from now through 2021, according to a study between ArcView and BDS Analytics. Should this estimate pan out as expected, legal marijuana sales in North America could be around $25 billion per year in a matter of years.

Canada has led the cannabis industry in progressivism, offering some of the best opportunities for investors looking for marijuana stocks to buy now. 

Leading the charge for cannabis’ progress has been Canada, contrary to what the rest of the world seemed to expect: in other words, the U.S. The United States fell behind Canada, in spite of now having 30 states with marijuana legalized in some form, due to a less progressive federal government. Under the current administration, the U.S. federal government still classifies marijuana as a Schedule I drug – entirely illegal, subject to abuse, not considered to possess medical benefits – with renewed opposition to legislative changes in favor of the drug.

While marijuana stocks in the U.S. make gradual progress on state-levels, Canada appears to be on the final stretch of its road to legalization of adult-use marijuana.

When the Cannabis Act, or C-45, comes back to the Senate for a final vote in June, its passing into law would mean adults over 18 would be able to purchase legal cannabis by August or September. Should this be the case, Canada would become the second country in the world behind Uruguay, and the first developed country, with a legal market for recreational cannabis. Canada could also potentially see an increase in annual sales of $5 billion or more.

Against this backdrop, marijuana stocks in Canada have been competing in a mad scramble for capacity expansion. The line of thinking is that a direct relationship is more likely to form between growers with the greatest production capacity and opportunities for long-term supply agreements, pending legal recreational weed gets the green light.

But a lot more goes into a significant marijuana stock valuation than high annual production; one marijuana stock in Canada stands out from the rest when considering other variables.

In a field that is becoming increasingly packed with contenders, management teams for weed stocks have to think more strategically to outperform the rest. One example of a pot stock that is demonstrating the “work smarter, not harder” mentality is MedReleaf (NASDAQOTH:MEDFF), based in Ontario.

While MedReleaf appears solid on paper, this marijuana stock’s production capacity is nothing compared to the three kingpins of Canadian pot stocks: Canopy Growth Corp.(NASDAQOTH:TWMJF), Aurora Cannabis (NASDAQOTH:ACBFF) and Aphria (NASDAQOTH:APHQF). MedReleaf anticipates an annual production capacity of 140,000 kilograms, fully funded; the top three growers are looking at annual production around 300,000 kg, 283,000 kg and 230,000 kg, respectively. But MedReleaf, as it turns out, has some surprises in store.

MedReleaf came out with an announcement of a cash-and-stock deal on February 26, in which the company reported acquiring 164 acres of land.

Acquisitions themselves have become fairly standard news in the marijuana industry, but this acquisition is slightly different. On the property exists a facility known as Exeter, accounting for 69 of the 164 acres, which will be retrofitted for an indoor cannabis greenhouse.

Acquiring a pre-existing facility and retrofitting it for growth, as opposed to building a brand new greenhouse, will save the company money and time, giving MedReleaf the ability to reap its first harvest by the end of 2018. In addition, MedReleaf now owns 95 acres of property adjacent to the Exeter facility, making future expansion a possibility. As a result of this strategic acquisition, MedReleaf’s projected annual yield quadrupled, increasing to 140,000 kg from 35,000 kg.

MedReleaf marijuana stock has been helped along by its transition from sole reliance on dried cannabis sales, which are highly commoditized, to expanding its portfolio.

The company has begun leaning more heavily on extract sales, higher-margin and higher-profit products, as well as venturing into premium strains of cannabis. Among these premium cannabis strains, MedReleaf just rolled out its new line of product called AltaVie. Offered at a higher price per-gram, AltaVie will attract a niche customer – the kind that is less likely to be affected by economical fluctuations.

Looking at MedReleaf’s broader financial picture, the company reported an extract sales increase nearing 700% year-over-year in its Q3. In Q3 2016, extracts had comprised less than 3% of the company’s sales; by Q3 2017, this number was up to 21%. Again, the higher margin and higher price point of extracts compared to dried cannabis is significant.

Were there a side-by-side comparison of two cannabis companies with equal revenue, the company with a greater percentage of extract sales is likely to be the one with the higher profits due to the product’s better margins. MedReleaf’s management team demonstrated a stroke of genius when it decided to shift its focus to extracts and niche consumers of dried cannabis.

When considering marijuana stocks to invest in, what about the potential cannabis supply glut?

In its favor, MedReleaf joins Aphria as one of only two marijuana companies to report a full-year profit both of the last two years. However, one disregarded variable remains in this discussion of cannabis valuation: supply and demand.

This issue is tricky, largely because there has been no historic precedent set for a legal recreational weed market in a developed country, leaving wide variation in estimates of total demand. The general consensus among estimations of Canada’s annual domestic demand is around 800,000 kilograms.

However, by 2020 the country’s growers could produce nearly 2 million annual kilograms, which could mean Canada’s domestic market would experience a cannabis surplus near or above 1 million kilograms.  

It’s possible that some of this excess supply could be exported to other countries with legal medical marijuana markets, but no one knows how much of this potential surplus could be accounted for via exports. On the home front, however, an oversupply would raise per-gram prices, causing margins to tumble.

The dim ray of light in this unsettling scenario is that these higher-priced extracts and premium cannabis strains aren’t likely to be impacted by the projected supply glut, again, largely because they appeal to a niche consumer. Under pressure to raise prices, MedReleaf may receive some protection and stability from these higher-margin offerings.

(For more information, read Here’s Why Marijuana Stock Investors Shouldn’t Be Worried)