Here’s a good end of year article from Motley Fool about the Cannabis-infused beverages market. This time next year in Canada and many states in the US people may sitting down to Thanksgiving & Christmas celebrations with a cannabis rather than alcoholic drink sitting in front of them.
“This bud’s for you” is about to take on an entirely new meaning…
Companies have made aggressive moves to get into position for what could be a $600 million market in the U.S. by 2022, according to investment firm Canaccord Genuity, and an even larger market worldwide. What’s this significant new market? Cannabis-infused beverages. And 2019 is poised to be a pivotal year for the cannabis-infused-beverage market.
Investors seeking to profit from the early growth of this new opportunity have plenty of options to choose from. But some stocks have a definite head start over others. Here are the top marijuana beverage stocks to buy in 2019 — and what you need to know about the market that’s in its infancy but could soon take off.
Types of marijuana beverages
Marijuana beverages go well beyond just dropping a marijuana leaf into a drink. To understand the possibilities for marijuana beverages, it’s important to know something about the two key chemical ingredients in the cannabis plant.
Perhaps the best-known chemical ingredient of cannabis is tetrahydrocannabinol. THC is the primary psychoactive component of cannabis. When marijuana users get high, it’s the result of THC’s effects on their brain.
Another cannabis ingredient that’s also attracted a lot of attention is cannabidiol. Unlike THC, CBD isn’t psychoactive. A CBD-based drug that treats epilepsy, Epidiolex, won approval from the U.S. Food and Drug Administration in June 2018, becoming the first drug made from the marijuana plant to receive an FDA green light. CBD could also potentially be effective in treating neurologic indications including anxiety, inflammation, and pain relief.
These two ingredients highlight the two primary types of marijuana beverages. THC-infused drinks are similar to alcoholic beverages. Their purpose is to give the consumer a buzz. CBD-infused drinks, on the other hand, are intended to be therapeutic. For example, some energy drinks contain CBD. Companies also market CBD-infused “wellness beverages” that purport to ease inflammation and pain.
Marijuana beverages overlap with existing beverage categories as well. Flavored water, coffee, tea, beer, and other alcoholic drinks are starting to include THC and/or CBD.
Dynamics of the marijuana beverage industry
The main thing to know about the marijuana beverage industry is that it’s still in a very early stage, primarily because recreational use of marijuana isn’t legal in most of the world. Currently, only two countries have legalized recreational marijuana at the national level — Uruguay and Canada.
But Canada’s legal recreational marijuana market, which opened in October 2018, doesn’t allow marijuana beverages. The country still hasn’t finalized regulations pertaining to cannabis edibles — including beverages — and concentrates. Health Canada, the agency responsible for Canada’s public health, thought more time was needed “for the development of specific regulations to address the unique risks posed by these product classes.” These regulations are expected to be in place in 2019, opening up what could be a significant new market.
While federal laws in the U.S. prohibit all marijuana use, 10 states plus the District of Columbia have legalized recreational marijuana use. However, in key states including California and Colorado, cannabis-infused beverage sales make up barely 1% of the total legal marijuana market.
But 2019 could be a pivotal year for the marijuana beverage industry in the United States. The results of the November 2018 U.S. elections improve the chances that federal laws could be changed to leave marijuana legalization to the individual states.
Also, the U.S. Congress recently passed legislation that will legalize hemp as an agricultural crop. Hemp by definition is cannabis with no more than 0.3% concentration of THC on a dry-weight basis. Hemp — and by extension CBD-infused beverages where the CBD is derived from hemp — will now be legal in the U.S., opening up a market that could reach $22 billion by 2022.
Beverage companies are interested in marijuana because it gives them a chance to introduce an entirely new category of drinks to the consumer market.
Alcoholic beverage companies see marijuana as a potential threat. A study from the University of Connecticut and Georgia State University researchers found that alcohol sales dropped by 15% following the implementation of medical marijuana legalization in U.S. states. Legalization of recreational marijuana could affect alcoholic beverage makers even more, since a larger number of consumers could choose marijuana products in states with legalized recreational marijuana than in states allowing only legal medical marijuana.
For alcoholic beverage makers, launching cannabis-infused beverages is a way to offset potential lost sales from their core products. But these companies, as well as makers of non-alcoholic beverages, also could enjoy increased revenue from non-intoxicating CBD-infused beverages.
What to look for in marijuana beverage stocks
There are two major kinds of marijuana beverage stocks. First, there are marijuana stocks positioned to compete in the cannabis-infused-beverages market. Second, there are beverage stocks that seek to offer cannabis-infused beverages. What to look for before investing in one of these companies is basically the same for both categories, but with a twist for each one.
For pure-play marijuana stocks, one of the most important criteria is capacity. A company can only sell what it’s able to produce. Another key thing to look for with these stocks is its ability to target a large retail consumer market. Partnerships with companies that already have this expertise and that have retail distribution channels are a big plus. So is access to the capital required to compete in large retail markets that require significant advertising and promotional spending.
For beverage stocks, it’s also critical to possess the capability to successfully reach large retail consumer markets. As with pure-play marijuana stocks, that includes being able to fund large-scale marketing campaigns and having solid retail distribution channels. But beverage stocks also need a source for the cannabis ingredients needed for cannabis-infused drinks. That means they need partnerships with marijuana growers.
Investors should also use the criteria they’d use for investing in any kind of stock. Companies’ track records of success in their industry are important. And don’t forget the stock’s valuation — what the market thinks the stock is really worth. While it can be acceptable to pay a premium for a stock, the company’s realistic growth prospects need to justify that premium.
Top marijuana beverage stocks
With these criteria in mind, there are five top marijuana beverage stocks that investors should consider buying in 2019.
Canopy Growth (NYSE:CGC)
Constellation Brands (NYSE:STZ)
DATA SOURCE: YAHOO! FINANCE. MARKET CAPS AS OF DEC. 15, 2018.
Canopy Growth is the world’s largest marijuana grower in terms of market cap — the total value of a company’s outstanding shares. The company boasts more than 4.3 million square feet of licensed growing space, making Canopy one of the two biggest marijuana producers in terms of annual production capacity.
Canopy has been a major supplier for Canada’s medical marijuana market for several years and is now one of the top suppliers for the country’s recreational marijuana market, with supply agreements in place with all of Canada’s provinces and territories. The company also has significant international operations in Europe, Latin America, Australia, and the Caribbean.
In 2017, major alcoholic beverage maker Constellation Brands and Canopy Growth formed a partnership to develop cannabis-infused beverages. As part of this deal, Constellation bought a 9.9% stake in Canopy. In August 2018, Constellation invested another $4 billion in Canopy Growth, increasing its ownership to 38%.
Canopy Growth shares initially traded only on the Toronto Stock Exchange. However, in May 2018 the stock also listed on the New York Stock Exchange, opening up a new opportunity for Canopy to raise capital. But thanks to its partnership with and the big investment from Constellation, Canopy doesn’t have to worry about issuing new shares to fund its planned entry into the marijuana beverage market.
Valuation metrics based on earnings, such as the price-to-earnings (P/E) ratio, can’t be used with Canopy Growth because the company isn’t yet consistently profitable. However, investors use the price-to-sales (P/S) ratio to value companies that aren’t profitable or aren’t consistently profitable.
Canopy’s P/S ratio of 150 is extremely high, however. Most stocks trade at P/S ratios in the low to mid-single digits. But Canopy’s P/S ratio is based on historical sales. The company’s high market cap reflects tremendous expectations of growth for the company as recreational and medical marijuana markets expand around the world.
Constellation Brands is the third-largest beer maker in the U.S., with its best-known products including Corona and Modelo. The company’s sales are growing faster than are those of its peers. Constellation also is the No. 1 high-end beer company and the No. 1 imported-beer company in the U.S., two of the most lucrative segments in the beer industry.
The company decided to move into the cannabis market because it saw a tremendous opportunity to build premium consumer brands similar to what it has done in the beer, wine, and spirits markets. With Canopy Growth, Constellation has a partner that is already a leader in the cannabis industry that has the capacity and scale to compete globally.
Constellation and Canopy plan to introduce a variety of cannabis-infused beverages in Canada when regulations are finalized. And Constellation is definitely preparing to enter the U.S. market as well, as soon as federal laws allow.
Although Constellation used a lot of its cash to fund the Canopy Growth transaction, the company continues to generate strong cash flow — with estimated free cash flow in fiscal 2019 of between $1.2 billion and $1.3 billion. Free cash flow, by the way, is the company’s cash generated from operations minus capital expenditures — money spent on fixed assets such as land, buildings, and equipment. It’s a great metric to use to determine the overall financial strength of a company. Constellation’s debt levels have decreased in recent years, giving it more financial flexibility.
Constellation stock’s valuation appears to be relatively attractive in comparison with most pure-play marijuana stocks. That’s largely because the company has an established track record of success, while marijuana stocks’ valuations are based more on future expectations. However, the company’s success in its core market makes its stock trade at a premium to its major peers in the alcoholic beverage industry.
Hexo, formerly known as Hydropothecary, is a lot smaller than Canopy Growth. But it’s currently the fourth largest Canadian marijuana producer in terms of capacity. Hexo is on track to produce 108,000 kilograms of cannabis annually by the end of 2018.
The company is most dominant in its home province of Quebec. In April, Hexo signed a supply agreement for Quebec’s recreational marijuana market that assures that the company will enjoy a market share of 35%. The deal was the largest forward-supply contract ever in the Canadian cannabis industry. Hexo also has supply channels in four other Canadian provinces.
Other than Canopy Growth, Hexo is the only Canadian marijuana grower to land a partnership with a major alcoholic beverage maker. In August, Molson Coors Brewing (NYSE:TAP) and Hexo announced that they were forming a joint venture to develop and market cannabis-infused beverages in Canada when regulations permit.
Hexo filed a preliminary prospectus in November 2018 to “make offerings of up to $800 million [Canadian] of common shares, warrants, subscription receipts, and units or a combination thereof of the company from time to time.” This move, combined with its partnership with Molson Coors, should enable Hexo to make a big splash in the marijuana beverage market. And if Hexo’s sales increase enough from its Molson Coors partnership, it could drive the stock significantly higher — good news for shareholders.
Like Canopy Growth, Hexo isn’t yet profitable. Although Hexo has a lower market cap than Canopy, its stock trades at an even higher multiple of sales than Canopy does. That’s probably because investors think that as a smaller company, Hexo has more room to grow than Canopy does. Still, its solid position in Quebec and its Molson Coors relationship give Hexo a great shot at being a big winner in the marijuana beverages market.
Heineken is one of the world’s largest beermakers and sells more than 300 international, regional, local, and specialty beers and ciders. In terms of revenue generation, the company ranks second, behind only Anheuser-Busch InBev.
While Constellation Brands is waiting to launch a cannabis-infused beverage, Heineken beat it to the punch, having launched one in California’s, the world’s biggest marijuana market. In June 2018, Heineken subsidiary Lagunitas announced a partnership with cannabis company AbsoluteXtracts to market cannabis-infused sparkling water products under the brand name Hi-Fi Hops. The products became available to consumers in July 2018. One version of Hi-Fi Hops contains 10 mg of THC, while the other contains 5 mg of THC and 5 mg of CBD.
Funding major marketing campaigns isn’t a problem for Heineken at all. The company consistently generates a multibillion-dollar cash flow and has an ample cash stockpile.
Heineken stock is more attractively valued than Constellation Brands based on forward P/E ratios — which measures a stock price by its predicted earnings. This lower valuation is due primarily to Constellation’s stronger financial performance in recent years. Investors pay more for stocks that are perceived to be of a higher quality. With its Hi-Fi Hops products leaping off the shelves, the company reaped the rewards from its first-mover status in the U.S. among major beermakers hoping to cash in on the cannabis beverage market.
Aphria is the fourth largest Canadian marijuana stock by market cap. But the company is the No. 3 producer in terms of annual production capacity and should hold that position for at least a few more years. Aphria is on track to be able to grow 255,000 kilograms of cannabis per year.
Although Aphria doesn’t have a partnership at this point with an alcoholic beverage maker, it does have a close relationship with a key player in the alcoholic beverage industry. Aphria selected Southern Glazer’s, the largest wine and spirits distributor in North America, to distribute its recreational marijuana products in Canada.
Aphria has also been mentioned as a potential candidate for several beverage makers. In August, for example, reports surfaced that Diageo was in the hunt for a cannabis partner. Aphria was widely considered to be near the top of the list, especially considering its chief commercial officer was the president of Diageo Canada before joining Aphria.
In the meantime, Aphria formed a joint venture with retail strategy company Perennial to develop consumer-centric brands for cannabis-infused products, including, but not limited to, cannabis-infused drinks. The initial focus of this joint venture will be on cannabis-infused products for the wellness, medical, and recreational marijuana markets.
Aphria’s valuation is steep based on historical sales. However, the stock looks quite attractive in comparison with its key rivals, especially considering Aphria’s tremendous production capacity.
Risks for marijuana beverage stocks
There are two kinds of risks for marijuana beverage stocks of which investors should be especially aware — regulatory risks and valuation risks.
The main regulatory risk for businesses focused on the Canadian market is that the government won’t finalize regulations as quickly as expected. Delays could hurt stocks such as Canopy Growth, Constellation Brands, Hexo, and Aphria. Every month of delay is an additional month of missed sales, and more time that the capital spent developing these new products doesn’t pay off for shareholders.
In the U.S., there is a risk that the federal government could choose to enforce anti-marijuana laws in states that have legalized marijuana. While that risk appears to be lower than in the past, it’s still a looming possibility.
What are the valuation risks? The current valuations for many marijuana beverage stocks reflect expectations of tremendous growth. If this growth isn’t achieved, these stocks could be hit especially hard.
Investors seeking to reduce valuation risks will probably prefer stocks such as Constellation Brands. Most of the stock’s valuation is pegged to its core alcoholic beverage business, which is easier to project than the marijuana beverage business because there’s a long track record available. If the marijuana beverage play doesn’t pan out, at least you’re invested in a business that does strong alcohol sales.
Think long term
The key to success with investing in marijuana beverage stocks is the key to success in investing in any stock: Think long term. Buy stocks with an eye toward their growth potential over the next 10 years or more. Ideally, you should buy a stock with the idea of holding the stock for at least several years — although major changes to your assumptions that led you to buy the stock can warrant selling sooner.
There will inevitably be volatility over the short run with these stocks. However, the long-term trends definitely appear to be in their favor. As more countries allow cannabis-infused beverages to be sold, the stocks of the companies best positioned to profit from the growth should deliver nice returns to patient investors.