Market Insights & Analysis from Kramer Capital Research

Cannabis 3.0: The Party All Investors Can Enjoy

Big Cannabis stocks like Tilray Inc. (NASDAQ:TLRY) and Aurora Cannabis Inc. (NYSE:ACB) never really recovered from last year’s broad market correction. Whether they will ever recover their loftiest levels isn’t really my concern.

Those companies were born in a vision of a long-prohibited industry finally running free after generations of being legislated out of existence. Now, however, these are multi-billion-dollar stocks trading at dizzying multiples.

The party, in other words, has already peaked. It was fun early on, but now that the market is in a risk averse mood, future upside is going to get harder to achieve.

That’s why I keep searching off the main cannabis map for real opportunities to capture more than a fleeting thrill. If you look past the buzz about “Big Cannabis” stocks, you will find that other opportunities exist, quietly executing viable business plans.

Last year, I unveiled a list of these companies that I called Cannabis 2.0. Unlike Tilray, a healthy 87 percent of them have kept the rally alive and the group as a whole has soared 45 percent year to date (YTD).

It has been fun, to say the least. But now it’s time to start thinking about the next wave of “green” stocks beyond that list. That’s why I’ve been filling my trading screen with companies that participate in what I like to call Cannabis 3.0.

Seeking the Truly Limitless Opportunity

If Cannabis 1.0 revolved around the mostly Canadian cultivators who supply legal dispensaries and the 2.0 stocks were the pioneers who built services and value-added products around that crop, the third generation is all about industrial applications.

After all, the mood-altering side of the cannabis plant will hit a natural commercial limit once everyone has legal recreational access. To put it in the simplest possible terms, Cannabis 1.0 will top out the minute the entire map turns green and all the people can get as high as they want.

Of course, that’s years away but the glide path is already baked into 1.0 stocks. Tilray, for example, commands a $39 share price because people extended its sales growth curve from $43 million last year to at least $1 billion by 2022.

Aurora and other big cultivators are built around a similar investment path. People who think that these companies will ever be profitable are counting on aggregate demand for their crops to soar by 3,400 percent in the next few years.

I love a parabolic growth story as much as anyone, but that dot-com-style narrative misses the progress that cannabis activists already have made. There simply isn’t room in the North American population to extend the curve that far.

After all, 70 million people in the United States and all Canadians already have recreational access. For them, the revolution is over. All they need to do is visit the dispensary and hand over the cash.

Thus, 30 percent of the population in those two countries already has legal access to cannabis. And it means that the so-called Big Cannabis stocks need to either get aggressive about promoting themselves here at home or expand overseas or move up from commodity agriculture to more refined products in a hurry.

If they don’t, they’re looking at only tripling their current revenue footprints if and when the map turns completely green. That’s not even going to meet anyone’s revenue targets for the current year, much less turn into a sustainable profit for most of these companies.

Maybe Aphria Inc. (NASDAQ:APHA) can do it. The rest are going to face all of the competition and price pressure that comes with operating in a commodity business crowded with too many players and a finite pool of demand.

And in the meantime, they’re using their stocks as ATMs. Tilray, Aurora and Aphria have doubled their floats in the last year. So has Canopy Growth Corp. (NYSE: CGC). Until U.S. banks open up, that’s the way they are choosing to fund their cash-negative expansion.

When a party like that stops, it hits a hard wall. That’s why I’ve been mostly ignoring Big Cannabis growers, except as an occasional momentum trade separate from any long-term investment strategy.

Instead, I’ve been focusing on the value-added businesses around the plant itself. If you’ve subscribed to any of my portfolios in the last few years or attended last year’s Cannabis Summit, you’ve seen a few of them.

These are the 2.0 companies that have given shareholders 45 percent YTD, triple what the Big Cannabis stocks I’ve already mentioned have collectively delivered.

The 2.0 companies are the banks that have found a way to work with the cultivators, the dispensaries, the insurance carriers willing to write policies and the beverage companies and drug developers who are looking to unlock the compounds hidden in the plant.

Those 2.0 companies have done well. They’re relatively sustainable businesses and are a long way from the literal one-penny companies that are too small and too speculative to trade on formal exchanges. Each one is unique.

If they have one problem, it’s that they aren’t pure plays on the cannabis boom. Their business models have a cannabis edge, but it’s only a little sizzle around the fundamentals.

Looking Beyond the Crowd

Furthermore, companies in the 2.0 group are forming a crowd of competitors. My most recent proprietary deep dive into the Securities and Exchange Commission database came back with close to 700 hits. While a lot of them were false positives, there now are too many “me too” players in the field.

It is time to flip the screen again and focus on the investment themes of the Cannabis 3.0 companies. Those that can combine the sustainable business and larger addressable markets of 2.0 companies with the primal buzz of the Big Cannabis stocks will achieve great success.

There is room for endless innovation and added value in the cannabis marketplace. And the Cannabis 3.0 stocks don’t reflect that proposition yet.

What stocks am I talking about? While only my Turbo Trader advisory service subscribers will get the full list, I’ll be giving you some hints in my column in the coming weeks.

One hint: it’s not about using the once-banned plant for a weekend thrill or even as the raw precursor of new medicines. Think industrial.

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Legendary Wall St. trader Hilary Kramer

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