You hear that? That’s the sound of the beginning of a big rebound in marijuana stocks. Year-to-date, the ETFMG Alternative Harvest ETF (NYSEARCA:MJ) is already up almost 10% — and we are less than three weeks into the year. That’s a huge gain in a short amount of time.
The big rebound in pot stocks can be attributed to favorable fundamental developments (multiple cannabis companies have reported strong fourth quarter numbers in early January), favorable legal developments (among other things, Illinois just legalized recreational marijuana), and a whole bunch of investors deciding that with the new year, comes new opportunity.
That’s the good news for cannabis bulls. The better news? This big rebound in marijuana stocks is just getting started.
Over the next several quarters, everything is going to improve for the cannabis sector. Demand trends will re-accelerate thanks to new vapes and edibles products, as well as retail footprint expansion. Supply overhang issues will ease with rebounding demand. International markets will start to take off as governments around the world follow in Canada’s footsteps. Revenue growth trends will improve. Margins will bounce back. Losses will narrow.
All in all, things will just get better for the cannabis sector in 2020, and as they do, depressed and beaten-up pot stocks will rebound.
With that in mind, let’s take a deeper look at four marijuana stocks to buy for the big 2020 rebound.
Canopy Growth (CGC)
The cannabis market’s biggest and most important company, Canopy Growth (NYSE:CGC), has been leading the pot stock rebound in 2020 so far. Year-to-date, CGC stock is up more than 15%.
Canopy will continue to be a leader in this rebound for the rest of 2020 for one very simple reason: this is the best cannabis company out there by a mile.
They have the biggest balance sheet — thanks to a multi-billion dollar investment from Constellation Brands (NYSE:STZ) — with the most resources and firepower to invest in things like product development, international expansion, strategic acquisitions, and production build-out. They also have the biggest sales base, the most production capacity, and the widest global distribution network.
The management team is arguably the best in the business, as Constellation has infused the company with experienced talent. They also have the most visible pathway to dominating the ultra-valuable U.S. market, thanks to a planned acquisition of U.S. cannabis company Acreage.
All in all, Canopy Growth has significantly differentiated itself from the pack in the cannabis world. As the leader, if pot stocks keep rebounding throughout the rest of the year, CGC stock will lead that rebound.
The only other “high quality” cannabis company that has won the multi-billion dollar support of a consumer staples giant is Cronos (NASDAQ:CRON). This unique feature should propel meaningful out-performance in CRON stock in 2020.
Cannabis market trends will rebound in 2020 thanks to new products, retail footprint expansion, favorable legislative progress, and international growth, among other things. As those trends rebound, investors will rush back into the marijuana industry like its early 2019 all over again.
When investors flocked into the space back then, they did most of that flocking into two names — Canopy and Cronos — because those were the smartest and safest investments given their fortified balance sheets, huge investment capability, and tremendous financial support. Of note, Cronos stock outperformed Canopy stock in the first three months of 2019 by a tally of 80% to 60%, mostly thanks to the fact that CRON stock was cheaper than CGC stock (15-times one-year forward sales for CRON, versus 30-times for CGC at the beginning of 2019).
In 2020, the same dynamic will repeat. Investors will rush back into the space amid improving fundamentals and trends. They will specifically rush back into the smartest and safest investments in the space, CRON and CGC. And CRON will be the bigger winner, because CRON stock (9-times one-year forward sales) remains way cheaper than CGC stock (14-times one-year forward sales).
Although most pot stocks are up big in early 2020, shares of cannabis producer Aphria (NYSE:APHA) are not, mostly because the company reported second quarter numbers in January that missed across the board. Revenues missed estimates, as did profits. And management dramatically cut its full-year guide.
Consequently, APHA stock is actually down 1% in 2020, while many of its marijuana peers are up 10% or more.
This weakness won’t last. It’s a gross overreaction to a few headline second quarter misses. Underneath those misses, the numbers were actually pretty good. Revenue growth accelerated sequentially, from up 8% quarter-over-quarter in Q1 to up 9% quarter-over-quarter in Q2. Volume growth also accelerated, and by way more, going from 7% growth in Q2, to 18% growth in Q2. Gross margins reversed course, after dropping from 53% in Q4 to 50% in Q1, and shot back up to 57% in Q2. At the same, Aphria reported a huge sequential increase in adjusted EBITDA after a sequential drop in Q1.
In other words, all of the company’s important underlying trends improved meaningfully in the second quarter. Revenue, volume, margin, and profit trends all got better.
And that’s before the launch of new vapes and edibles products. As such, the numbers will only get better in the third and fourth quarters. As they keep improving, investors will push APHA stock way higher, especially considering its relatively depressed valuation base (2-times one-year forward sales).
Last, but not least, on this list of marijuana stocks to buy for the big rebound in 2020 is Aurora (NYSE:ACB).
Aurora has long been the second-biggest player in the Canadian cannabis market, coming in right behind Canopy in terms of sales, volume, and production capacity. But investors have increasingly expressed concerns over the company’s balance sheet and liquidity, as Aurora features one of the worst balance sheets in the cannabis sector and has a major cash burn problem.
Ultimately, these concerns have kept ACB stock depressed. These concerns could ease dramatically in 2020. Aurora will launch of suite of edibles and vapes products over the coming months. They should also be opening a ton of new stores.
This combination will reignite demand trends at Aurora, and revenue growth rates should start improving. As they do, more favorable supply-demand dynamics will push up margins. Bigger revenues plus bigger margins equals smaller losses. Smaller losses mean less cash burn.
As cash burn becomes less of a problem in 2020 (and as the company’s improved revenue growth trajectory illuminates a more visible pathway towards profitability), investors will become less concerned about the company’s balance sheet and liquidity. The more those concerns fade, the more ACB stock will rally.
As of this writing, Luke Lango was long CGC.
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