It's too easy to lump all cannabis-related stocks into the moniker "marijuana." Like many other sectors, there are differentiators underneath the same way we see in semiconductors or retail or even energy.
As you go down the marijuana rabbit hole, you're going to find it splits in many different directions: medical marijuana, recreational marijuana, CBD (non-THC oils for the most part), and hemp. These are going to be the main four categories, in my view. A fifth here will be synthetic CBD or specific CBD created in labs.
Recreational marijuana is getting all the headline buzz thanks to the forthcoming legalization in Canada. Don't get me wrong, this will be a huge business. Recreational marijuana sales should be at least twice as large as medical sales. We've already seen this in areas where both medical and recreational use are legal. Furthermore, in areas where only medical marijuana is legal, we can expect medical sales to significantly slow once recreational usage becomes legal.
But make no mistake, this is a commodity. The base producers likely offer a very limited upside. Even on the medical side, if we are simply checking out a company supplying to a pharmaceutical firm, I'd argue the upside is very limited.
I expect we'll see a bit of sell-the-news on the legalization go date in Canada. That could be quickly remedied if midterm elections skew in favor of federal legalization in the United States; however, the big money will likely lie outside of the "commodity."
A name like GW Pharmaceuticals (GWPH) with an FDA approved cannabis-based treatment and IP come to mind. What they have can't be easily replicated any time soon, if ever.
On the recreational side, companies with strong brands should benefit over the near term. The legalization in Canada will likely come with strict regulation on advertising; therefore, brand recognition will be huge. This actually creates a barrier to entry not often discussed. Growing will be easy. Selling might be difficult.
A big move is being made into synthetics. There are non-THC parts of the cannabis plant that offer potential health benefits. We've heard a lot about cannabinoids (CBD - the active components of cannabis). There's a lot of science behind this, more than we can cover here, but what's important here is there are many different active components of cannabis, each with their own potential benefit or use. But these do not come in equal quantities in the plant. Think of it like rare-Earth elements. I believe at some point we'll see discussion of rare-plant CBDs or something like that.
Where will these come from? Labs.
Expect science to meet this need rather than farmers. While a few names have issued press releases about moving into this space, until we actually see it done, I'm in no hurry to chase those names. That being said: I believe this is a space to watch where big money will be made.
CBD-infused beverages have caught fire the past few weeks but this screams spirits and alcoholic beverage producers. If these gain steam in the short-run, the small names can flourish; however, don't expect it to remain that way. There's hesitation from big names like Molson Coors Brewing (TAP) or Anheuser-Busch InBev (BUD) to move into the space until we get more clarity from the federal government. The current headline names have run too far, too fast based on nothing but product ideas and headlines. Great to trade, but terrible to own.
Hemp is the least talked about portion of the marijuana sector and this usually translates to opportunity. Unfortunately, I haven't looked far into this space, so I have some homework to do.
My focus has been on building positions in companies that offer some diversification or unique feature. These are five I could consider:
-- GW Pharma. See above.
-- Canopy Growth (CGC) . I like CGC as a core holding. With a ton of cash on the books along with the backing of Constellation Brands (STZ) , it feels like the "must own." Actually, both of them should be owned.
-- KushCo Holdings (KSHB) . This company is the core packager for most of the branded cannabis companies.
-- Pyxus International (PYX) . The name is reinventing itself from its legacy base from tobacco/agriculture to focus on industrial hemp, e-liquids (CBD) and legal cannabis.
-- CannaRoyalty (CNNRF) . This Canadian firm is a very diverse cannabis play. Rather than focusing on a single company, CNNRF owns little pieces of a lot of Canadian cannabis-related businesses. So, owning this stock is all about spreading risk.
This commentary originally appeared on Real Money Pro on Oct. 4. Click here to learn about this dynamic market information service for active traders.
KushCo Holdings is a holding in TheStreet's Stocks Under $10 portfolio. Click here to learn more about this portfolio and market information service co-manged by Chris Versace and Stephen "Sarge" Guilfoyle.