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Capitalizing On Cannabis: Divergence Among The Pot Stocks

t's been about a month since I formalized my coverage of the cannabis sector after having spent six months researching it, sharing my initial review of all of the stocks with market caps in excess of $10mm in late August. (Note: here is a link to all previous articles referenced.) While I continue to harbor reservations about many of the publicly-traded companies that are leveraged to the legalization and expansion of medical and recreational marijuana, the "Green Rush" appears to be one of the most powerful longer-term investment themes today. I am so excited about the opportunities ahead that I have launched a service dedicated to helping my subscribers navigate the rapidly changing landscape, 420 Investor. In this article, I want to update the market information that I shared last month as well as to discuss some sharp divergences in performance among the sector's members.

The following table includes the 16 stocks that have market capitalization in excess of $10mm. Note that my calculation assumes that all convertible preferred stock is converted to common shares. This isn't generally an issue for listed stocks, but many penny stocks employ convertible preferred stock in the capital structure, a topic I wrote about in July because some companies abuse it.

 

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How to Decide Between GWPH and GWPRF

GW Pharma is a UK-based company.  I am in the middle of a more thorough analysis of this biotech but have called it out as being the only listed stock in the cannabis sector.  I included it as a member of my "Focus 4" in a Seeking Alpha article on the sector, suggesting that their management team is quite strong. I will likely have a lot more to say soon regarding my views on the company.

For years, investors who didn't want to buy the stock on the London Stock Exchange had the option to buy it as a pink-sheet, using the symbol GWPRF.  More recently, the company issued a NASDAQ-listed ADS, GWPH.  In our "Toking Tuesday" chat on 9/24, one of our members asked about the differences between the two securities.

 

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Does Medical Marijuana, Inc. (MJNA) own Dixie Elixirs?

One of the biggest misconceptions in the cannabis investing sector is the belief that Medical Marijuana, Inc. (MJNA) acquired the Colorado-based Dixie Elixirs & Edibles in 2012.  Nothing could be further from the truth.  If you already know this, then there is no need to continue.  But, if you have any question about the relationship between MJNA and Dixie, read on.

First, don't blame yourself if you were confused.  I don't want to accuse MJNA of fooling people on purpose, but there were many times when they blew smoke to obfuscate the reality.  I described this earlier this year in a Seeking Alpha post.   So what's the real deal?

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Cannabis Stock Universe

This is evolving, and I know some have expressed a desire for a complete summary of the space with buy prices, etc. on all the names.  I am not there yet, but stick with me and we will get there.

I have spent a lot of time on a limited number of stocks, but I don't yet have a confidence level to fully weigh in on the entire space.  I intend to focus on names with $10mm or more of market cap.  My job is to find opportunities, rule out fakers and update you guys on the rapidly changing landscape and how it impacts these companies.  You saw how quickly I was able to analyze MCIG (and get the overvaluation part right, for sure), and you can count on me to keep up with new companies that will definitely be entering the publicly-traded sector.

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This list is the 16 names that I see that meet the $10mm criteria.  I have divided the list into three categories:  Good, Mixed, Negative.  I have then split it into the left side, where I have done enough work and the right side, where I have a feeling but need to do more work.  These aren't valuation calls - they are an assessment of the likelihood of success as I see it influenced by management, the financials and the business model (my 3 "P"s:  People, Pecuniary, Plan).  So, here is my first cut, and it will change, so keep that in mind:

A New Name in the Cannabis Sector

Earlier this week, I was approached by Paul Rosenberg, CEO of mCig, which recently reverse merged with Lifetech Industries.  He was impressed with my interview of Sterling Scott   CEO of GrowLife (PHOT), and wanted to tell me his story.  This is a huge benefit to being the "Cannabis Financial Analyst" at 420Investor.com! 

His company is about to launch a $10 vaporizer that could become a category killer.  The current symbol is LTCHD, but it will change to MCIG on 9/24.  Having exchanged some emails with Rosenberg, reviewed the corporate website and the company's press releases and having read the three SEC filings, I am impressed with many aspects of the story. With Washington and Colorado getting close to implementing legal marijuana for recreational purposes, this stock could get a lot of attention.  With that said, I think that the current price is too high and expect it to fall.  I am sharing some initial thoughts today and plan to follow up with a more comprehensive interview with Rosenberg.

Company

mCig is based in Bellvue, Washington.  CEO Rosenberg's description from its filings:

 

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Apogee Enterprises: Long-Term Thesis Intact Despite Soft Quarter

After it reported its FY14-Q1 in late June, I recommended Apogee Enterprises (APOG) as a high-quality company led by a new CEO with significant margin expansion potential as well as a potential beneficiary of improved commercial construction, suggesting the stock could appreciate from 24 to 37.50-42 over the next 2-3 years. The company fell short of analyst consensus for both sales and earnings for its Q2, which it reported after the market close on 9/18. Despite the short-fall in sales, which grew only 1% from a year ago, earnings growth was still robust at + 17%, demonstrating the margin expansion that is central to my thesis. After it was hit with some profit-taking early the following morning, the stock recovered almost completely, and, at 29.10, is very close to an all-time high. Despite the disappointing quarter, I believe that the company remains on track to achieve my previously described target that is based on its achieving its stated goals of $1 billion in revenues and a 10% OM for the year ending in February 2016, suggesting 29-44% potential price appreciation over the next 29 months.

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AEO Will Fly, LBO or No

American Eagle Outfitters (AEO) participates in the crowded and beaten-up teen retailing space, one of the three “A” names that also includes Aeropostale (ARO) and Abercrombie & Fitch (ANF) in a group that includes several other public and private companies. Mall-based retailers in general struggled with back-to-school as consumers appear to be making big-ticket purchases rather than buying clothes. This is likely a temporary phenomenon, as the underlying fundamentals are positive (falling unemployment, slow but steady personal income growth). After horrible Q2 results, the stocks were hammered, but they got a spark this week from news that a private investment firm has taken a stake in ARO, suggesting the potential for more mergers and acquisitions in the retail space. I suggest that investors focus on AEO, which has a very strong CEO, steadier results and a low valuation. I estimate that AEO could trade back to 20 even without potential M&A.

 

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Awesome Interview with Sterling Scott of PHOT

One of the "Fab Four" of the cannabis industry according to Bruce Perlowin, CEO of Hemp, Inc. (HEMP.PK), GrowLife (PHOT.OB), which is based in California, stands out from the other three companies in many ways, including the fact that it's fully reporting to the SEC and is substantially smaller in terms of market cap. When I recently reviewed the space, sharing some information on 14 names with market caps in excess of $10mm with the goal of helping investors to understand better the risks and potential rewards, I created my own "Focus Four", but I didn't include GrowLife . I have heard from so many investors and potential investors who think that I perhaps should have called it the "Focus Five" and included GrowLife that I decided to begin to further analyze the company.

I spent about 90 minutes on the phone with CEO Sterling Scott (56) as well as the company's outside I.R. representative, Kurt Divich of Integrity Investor Relations (a great resource for potential investors) last week, and I quickly realized that GrowLife merits further attention.

As of the end of June, based on a fully-diluted share-count (including securities that can be converted to stock) of 752mm shares, PHOT has a market cap of approximately $36mm and debt totaling $2.2mm, which puts it at a tiny fraction of some of the better known peers. I hope to have a formal target price and potential recommendation in the near future, but I wanted to share an exchange I had with CEO Sterling Scott so that my readers might get a better sense of this potentially attractive story.

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Exclusive Interview with Terra Tech CEO Derek Peterson

The "Green Rush" can't be denied. The recent abrupt reversal of CNN's Chief Medical Correspondent Dr. Sanjay Gupta regarding medical marijuana followed shortly by the historic move by the Department of Justice to allow Washington and Colorado some space to establish and implement the recreational marijuana regulatory frameworks in their states has helped reignite investor interest in the marijuana-related stocks. The sector was overheated earlier this year and suffered a significant correction. While almost all of the names are highly speculative and trade on the pink-sheets or the OTC, investors have nonetheless been willing to embrace some of these companies trying to capitalize on the move towards legalized marijuana.

I recently reviewed the space, sharing some information on 14 names with market cap in excess of $10mm, with the goal of helping investors to understand better the risks and potential rewards. One of the companies that I included is Terra Tech (TRTC.OB), which is based in California. As of the end of August, based on a fully-diluted share-count (including potential conversion of preferred stock and convertible notes) of 210mm, TRTC has a market cap of approximately $25mm and debt totaling $1.6mm. 

I am fortunate to have had the opportunity to discuss the company and its prospects with its CEO, Derek Peterson (39). One of the first things that investors will note about this SEC-filing company is that Peterson has a "Wall Street" background. The company has a differentiated and evolving strategy, as Peterson explains, and I think that readers will find his vision of how things might play out over the next few years as the regulatory landscape evolves quite interesting.

 

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And, if you want more, be sure to check us out at www.420Investor.com

Big 5 Sporting Goods Looks Good After Correction

Big 5 Sporting Goods (BGFV) operates a chain of stores in the West. The stock was expensive, extended and overbought going into its last earnings report, but severe profit-taking has dropped the price to the point that my negativity two months ago has been replaced by cautious optimism. The balance sheet is strong, the valuation low, and the chart showing strong support just below the current price. BGFV isn’t on my official watchlist, so I don’t have a price target that I am maintaining, but, as I explain below, I can see the stock performing well over the next year, with perhaps 45-50% upside potential.

Background

BGFV was founded in 1955 as a WWII army surplus store that also sold company-manufactured tents and air mattresses. It was initially known as “Big 5 Stores” due to its operation of 5 stores in California. By 1963, the company decided to focus on sporting goods and adopted its current name. It was owned by Thrifty Drug Stores in the 70s and then by Leonard Green & Partners in the 90s. The company went public in 2002 at $13, so it hasn’t exactly been a great investment, up 27% in 11 years. Today, the company operates 414 stores averaging 11K square feet (smaller than superstores) in 12 contiguous western states.

 

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