Pot stocks have taken a beating in 2019. Once upon a time, in mid-2018, pot stocks were flying high on the promise of huge growth in the soon-to-be legal Canadian cannabis market. They were also flying high on hopes that U.S. cannabis legalization would follow suit shortly thereafter…
Fast forward 16 months. Nothing has played out as planned. The Canadian cannabis market has been sluggish, weighed by heavy legal fees, distribution hiccups, and capacity shortages which have kept demand in the black market channel. Meanwhile, U.S. cannabis legislation has progressed at a snail’s pace.
Pot stocks have consequently tumbled from their mid-2018 highs. And when I say tumbled, I mean tumbled. Many pot stocks have lost 60%, 70%, and more of their value since mid-2018.
At this point, buying the dip in pot stocks feels like trying to catch a falling knife. But heading into 2020, there’s reason to be cautiously optimistic on pot stocks.
That is, Canadian cannabis market fundamentals should improve, led by improved distribution networks and larger capacity. U.S. legislation should make more meaningful progress, as the House Judiciary Committee just approved the Marijuana Opportunity Reinvestment and Expungement (MORE) Act, paving the path for legalization in 2020. Importantly, pot stocks are spiraling into the next year at record-low valuation levels, meaning that positive developments in 2020 (like improving sales trends and U.S. market legalization) could cause these stocks to soar.
Broadly, then, I don’t think it’s time to give up on pot stocks. Rather, I think it may be time to start considering these stocks as potentially huge rebound candidates for 2020.
Canopy Growth (CGC)
% Off highs: 67%
At the top of this list of pot stocks to consider in 2020 is the market leader, Canopy Growth (NYSE:CGC).
The bull thesis on CGC stock is simple. This is the best-in-class company in the cannabis space, with market-leading sales volume and production capacity, a deep leadership team, several international distribution deals, a visible pathway into the U.S. market (once its fully legalized), and a strong balance sheet fortified by a multi-billion dollar investment from alcoholic beverage giant Constellation Brands (NYSE:STZ).
Thus, if demand trends in the Canadian cannabis market do improve, that will provide a big tailwind for Canopy, since this company has been hyper-focused on building out supply to match super-charged demand. Also, if weed does become legal in America, that will provide a big tailwind for Canopy, too, since this company is best positioned of all Canadian cannabis producers to capitalize on the U.S. cannabis opportunity.
At the end of the day, then, CGC stock should rebound in a big way in 2020 if: 1) demand trends improve in Canada, and 2) U.S. cannabis legislation meaningfully progresses.
Aurora Cannabis (ACB)
% Off highs: 79%
The other “big” player in the Canadian cannabis market is Aurora Cannabis (NYSE:ACB). Much like CGC stock, ACB is set to soar in 2020 if the cannabis space rebounds.
Aurora has everything that Canopy has — big sales, big capacity, wide international reach, etc. — save the multi-billion dollar investment from Constellation Brands (NYSE:STZ). Yes, that’s a big difference. But, this difference is fully baked into the valuation. ACB stock trades at 8-times forward sales to CGC stock’s 20-times forward sales multiple.
Thus, in the big picture, ACB stock is just a cheaper, less fortified version of CGC stock. That makes the stock riskier, because cash burn is a real issue. But, it also should give the stock extra firepower in the event that cannabis market fundamentals do improve in 2020. That’s because ACB stock is cheaper, so there’s more room for multiple expansion.
Broadly, then, Aurora Cannabis stock could bounce back in a big way in 2020, behind two potential tailwinds: 1) reinvigorated sales growth in Canada through supply growth, and 2) addressable market expansion through U.S. legalization of cannabis.
% Off highs: 75%
Next up on this list of pot stocks to consider in 2020, we have Aphria (NYSE:APHA), best known as the only Canadian cannabis producer to strike a profit (and they’ve done so twice).
I like APHA stock into 2020 because this is a company which hasn’t been hit as hard by demand and margin headwinds as other cannabis producers have in 2019. On the demand front, most other cannabis producers have seen their revenue and volume growth rates slow meaningfully over the past few quarters. Some have even seen sequential growth rates go negative. Not Aphria. Both volumes and revenues are growing at a healthy rate quarter-over-quarter and year-over-year.
Meanwhile, on the margin front, black market pricing pressure has created huge margin headaches for most cannabis producers. Across the industry, gross margins are getting whacked. Expense rates are flying higher, too. Not at Aphria. Gross margins are improving, and expense rates are largely stable.
This combination of sustained revenue growth and healthy margin performance is why Aphria has been able to net a profit in each of the past two quarters. As such, the fundamentals here remain favorable. All APHA stock needs to bounce back, then, is a broader cannabis sector rebound. That rebound could materialize in 2020…
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