Marijuana: A $166 billion market?

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Marijuana may be "just a plant," but it has Wall Street and investors seeing green and grinning ear to ear at its long-term growth potential.

Long considered a taboo topic, cannabis has forced its way into the mainstream. In the United States, where favorability toward broad-based legalization stood at just 25% in 1995, an all-time record number of people (66%) now want to see marijuana legalized nationally. This growing support is a big reason why there are now 33 states that have given medical cannabis the green light, and 10 of those states have also given the OK to recreational pot.

Global expansion has been just as stellar. Last year, global weed sales hit $12.2 billion, with Arcview Market Research and BDS Analytics calling for $16.9 billion in worldwide sales in 2019, representing growth of 38%. There are also more than 40 countries worldwide to have waved the green flag on medical cannabis.

But the big question is: Just how big could the marijuana industry become?

The global weed industry could be bigger than you realize

For those who may not recall, Owen Bennett, the covering analyst at Jefferies, forecast $50 billion in annual sales by 2029, with a total addressable market of as much as $130 billion a year, albeit with no time frame on that estimate. Until recently, Bennett's projection had been the high-water mark in terms of cannabis optimism. However, one of his peers recently dethroned his projection with an even more aggressive one of his own.

Roughly two weeks ago, Christopher Carey of Bank of America initiated coverage on four pot stocks. In doing so, he also outlined a variety of expectations for the industry, which included its total addressable sales potential. Per Carey, the marijuana industry could one day reach $166 billion in annual sales, all while disrupting industries ranging from alcohol and tobacco to health and wellness, totaling $2.6 trillion in yearly revenue.

Furthermore, Carey foresees the United States accounting for more than a third (34%) of this total addressable market, compared with just 3% for Canada. This would peg peak sales potential at closer to $5 billion a year for Canada and north of $56 billion for the United States. 

Clearly, some things need to happen before the legal weed industry has any shot at $166 billion in yearly sales. This includes addressing the massive black market by legalizing cannabis in the United States and other developed countries, and in the interim consolidating overcrowded aspects of the pot industry, such as licensed producers.

An up-close look at a flowering cannabis plant.

Three smart ways to play a $166 billion market

However, Carey has a pretty good idea of how investors should consider putting their money to work to take advantage of the green rush.

Carey's top pick in the industry is Quebec-based HEXO (NYSEMKT:HEXO), which is an interesting selection given that Jefferies lists HEXO as one of its two pot stocks to sell. HEXO landed the biggest single supply deal in history in April 2018 -- a five-year, 200,000-kilo-in-aggregate deal with Quebec that could be extended for a sixth year. When combined with HEXO's recently announced purchase of Newstrike Brands for $197 million, the company will have the capacity to produce 150,000 kilos at its peak, which should be good enough for sixth-highest in Canada. In short, Carey sees plenty of opportunity for HEXO to secure partnerships beyond Molson Coors Brewing, and believes the company is de-risked due to its Quebec supply deal.

While not top picks, Carey also believes investors can't go wrong with Aurora Cannabis (NYSE:ACB) or Canopy Growth (NYSE:CGC), which were also bestowed with a buy rating.

Aurora Cannabis is easy for most Wall Street firms to like because of its industry-leading production potential and superior global presence. Although Aurora's management team has consistently sandbagged its peak production totals, I believe Aurora will have no trouble topping 700,000 kilos a year, and perhaps even approaching 800,000 kilos annually, at its peak. Assuming Canada contends with dried flower oversupply in much the same way recreationally legal U.S. states have, the 24 countries Aurora Cannabis is currently operating in will prove crucial in helping to offload its industry-leading output.

Meanwhile, the largest marijuana stock in the world by market cap, Canopy Growth, has a massive balance sheet, with $3.7 billion in cash and cash equivalents, as of the end of 2018. This cash, which predominantly came from a $4 billion equity investment, courtesy of Constellation Brands, will allow Canopy to acquire complementary businesses, move into new overseas markets, diversify its product portfolio, and build its brands. Canopy, like Aurora, also has a strong international presence, thereby removing many concerns about future commoditization of dried cannabis flower.

A businessman in a suit putting his hands up as if to say, no thanks.

One pot stock that isn't a smart bet

On the other hand, Carey doesn't believe investors should have anything to do with Cronos Group (NASDAQ:CRON) for the time being. Receiving the equivalent of a sell rating is nothing new for Cronos, as it's been the recipient of four total sell ratings in recent months.

While Carey appreciates the more than $1.8 billion Cronos Group currently has on its balance sheet, he and his firm simply can't overlook the company's recent appreciation. Cronos Group's $5.7 billion market cap really sticks out like a sore thumb when considering that its peak production of 120,000 kilos is only good enough for eighth-largest in Canada, and it has a presence in just four international markets. If and when commoditization does strike in Canada, Cronos is a prime candidate to see its margins deteriorate due to a lack of overseas sales channels.

Although I do agree with Carey's assessment of Cronos Group, I'm not entirely on board with his three buy ratings. I believe there are better values in the cannabis arena, but I'm also not too keen on jumping in with the industry experiencing plenty of teething pains. For the time being, even taking into account Carey's aggressive peak sales estimate for the industry, the sideline is looking like a good place to be.

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