Strong Revenue Outlook Still Supports Cannabis Stocks

Strong Revenue Outlook Still Supports Cannabis Stocks
Richard Cox
Updated:

In the modern trading environment, it is not often you will come across an entirely new industry that is still ripe for investment in its early stages.  But with all of the attention that has been focused on the legalization of marijuana for both medicinal and recreational use, it is clear that we have an important sector that should be on the radar for all growth investors looking for long-term returns.

When we look at the underlying trends in the cannabis industry itself, there is plenty of reason to be optimistic -- even with the potential volatility that generally accompanies small-cap companies in newly developing markets.  Over the last year, we have seen several reports from major financial think tanks suggesting that legal cannabis is now the fastest-growing industry in the United States.  Recent numbers from the ArcView Group show that cannabis markets grew by 74% in 2014, generating $2.7 billion in revenue for the period.  This nearly doubles the $1.5 billion in revenues that was seen just a year earlier.

Here is how the sales numbers break down by state for 2014:

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There are some factors that should be noted when assessing the current state of the market.  First is the fact that recreational usage is still illegal in most of the country.  Even in California -- where most of the revenue is being generated -- recreational usage is still illegal.  This ultimately suggests that the current sales numbers pale in comparison to what will be seen once recreational legislation becomes more widespread.  

Consider the following chart, which plots the revenue forecasts for projected medicinal and recreational revenues through the year 2018:

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Here, we can see that sales revenues from recreational usage will gradually start to exceed what is seen on the medicinal side.  So, as long as legal trends continue to loosen restrictions on cannabis, the potential is massive for growth investors to capitalize through long-term positioning.

Over the next five years, the ArcView Group report suggests that as many as 14 more states could legally approve recreational use, and that another two states could approve medicinal use during the period.  These trends can be seen in the map projections shown below:

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Of course, assessing trends in the legal arena can be more complicated than assessing the potential trends in industry growth that is more relevant for investors.  There is nothing to guarantee that each of these states will continue to move forward on the path to legalization, and any delays here could limit the potential upside for investors looking to position themselves with bullish exposure to the sector.  

But it is still useful to consider the possibilities if the current trends continue.  Some analyst reports suggest that industry revenues could rise as high as $35 billion if marijuana were to be legalized at the federal level.  To gain some relative perspective of what these numbers actually mean, investors should draw some comparisons to other, more firmly-established markets.  

Earlier this year, the National Football League (NFL) posted its highest Super Bowl viewership in history, with nearly 115 million people watching the game.  Annual revenues for the NFL, however, are only $10 billion.  The entire organic food industry generates $32 billion annually, while numbers for the confectionary food industry are slightly higher at $34 billion.  If the projections are accurate, cannabis markets could surpass all of these sectors and generate revenues that are on par with the newspaper publishing industry (which comes in at around $38 billion annually).  Needless to say, these are impressive possibilities and this provides an excellent framework for long-term investors to start buying into the growth engines that will drive bullish trends in the coming years.

Stocks to Watch

Near term, the outlook still looks positive -- even without publicly noted potential for federal legalization of cannabis.  Consensus estimates suggest that the cannabis market will grow by more than 30% in 2015.  This is no small feat given the surge in market attention that has been prompted by the early-stage legalization efforts in both Colorado and Washington.  A growth rate of 30% would put cannabis markets well ahead of other fast-growing industries like green building, digital forensics, and education software.  At this stage, there is very little to suggest that we will see cannabis markets fall short of these near-term growth projections.

For these reasons, it makes a good deal of sense for growth investors to take an assessment of which stocks are most likely to benefit from the prevailing trends we are currently seeing.  So far, one of the most stable performers in the sector has been GW Pharmaceuticals (NASDAQ: GWPH) which is a UK-based company that received a good deal of media attention from people like Jim Cramer in 2014.

Most of this buzz was generated by the companies progress in developing Epidiolex, a drug that is currently in Phase 3 clinical trials and has been receiving positive support from the FDA.   Epidiolex is used to treat seizures in some forms of childhood epilepsy, and most of the encouraging elements stem from the fact that the drug reduces adverse reactions when compared to the common pharmaceutical regimen that is in place now.  Other products include Sativex, which is already being sold on the global market and has been shown to reduce spasticity in patients with multiple sclerosis.  GW Pharmaceuticals hopes to receive FDA approval for use of the drug in treating cancer-related pains in the later stages of the illness.  If this occurs, it will be the first approval of a cannabis-derived drug to be used in these areas.

Terra Tech Corp. (OTCQB: TRTC) is a California-based company that saw its stock values nearly double in 2014.  These moves were propelled as Terra Tech was granted its Nevada medical marijuana licence as this will give the company new markets in which to sell its IVXX cannabis extract products.  Terra Tech is quickly emerging as one of the larger names in the industry and its revenue outlook for 2015 looks highly encouraging.

One potential standout that has received less media attention is the Colorado-based American Cannabis Company, Inc. (OTCQB: AMMJ), which is one of the few companies in the industry that has shown the consistent ability to produce sustainable net income. The American Cannabis Company has a broadly diverse product line that includes consulting services for marijuana cultivators (both in the US and in Canada).  This makes the company an important resource because the licensing process often creates the most significant roadblock for new businesses looking to enter the industry.  The company helps startups design their facilities, offers access to proprietary products, and aids in making operating procedures more efficient.

In addition to this, the American Cannabis Company has a product line that further supports the outlook for the stock.  Their Cultivation Cube is a self-contained, climate-controlled cultivation container that helps growers improve on production times and increase yields.  The containers are stackable and measure 1,000 sq. ft, and the increased efficiency can help startups grow revenues by as much as $250,000 annually.  The company also offers a large variety of consumable products, licensed organic soil, and the Satchel (which is a child-resistant distribution package).  We do not see many industry examples of companies that are as broadly diverse as the American Cannabis Company, so AMMJ is definitely a stock to watch in 2015.  

One example of a stock that has not fared so well is Medbox, Inc. (OTCQB: MDBX), which took a beating in 2014.  The company will likely continue to face challenges this year but Medbox has one of the highest market caps in the industry, and this should be supportive for the long-term outlook.  Medbox has strengthened its management team this year and announced plans to diversify its product line beyond its dispensing boxes and consultation services.  If these plans gain traction, MBDX could be an opportunity for contrarian investors looking to a cheap cannabis stock with the reduced potential for further downside.

Last, we look at CannaVEST Corp. (OTCQB: CANV), which is a Las Vegas-based company that has undergone significant transformation over the last year.  CannaVEST has expanded on its relationship with HempMedsPX to include a larger client base and created its own e-commerce website as a means for generating better revenues in coming quarters.  The product line at CannaVEST focuses on Cannabidiol treatments that are sold over-the-counter products and are derivatives of industrial hemp.  CannaVEST still holds its position as one of the leaders in the industry, and the investment outlook remains strong given its efforts to lower production costs and expand output capacity.  Watch for rallies in CANV if we see easing restrictions in the production of industrial hemp, as this could provide additional outlets for the company to grow its product line.

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