They may be under the radar, but certainly for your consideration

by Sean Williams

Last year was supposed to be when marijuana stocks proved their worth, transcending from speculative investments to worthwhile long-term holds. However, this didn’t even come close to happening.

Following a first quarter that saw more than a dozen pot stocks gallop higher by at least 70%, the industry entered a precipitous decline for the remaining nine months of the year. When the curtain closed, the vast majority of cannabis stocks ended the year lower by a double-digit percentage.

In a year when a lot could have gone right, the reality is that very little did. Canada continues to struggle mightily with supply issues caused by an inadequate number of open marijuana dispensaries in Ontario. Additionally, regulatory agency Health Canada’s inability to review and process licensing applications in a timely manner has led to significant delays in bringing product to market. Meanwhile, select U.S. states with recreationally legal pot have been taxing the daylights out of cannabis consumers. The collective end result being that black market marijuana thrived in North America, while most marijuana investments seemed to go up in smoke.

While many of these issues won’t be resolved overnight, the expectation is that a more cost-focused cannabis industry will take the necessary steps forward in 2020, leading to a much better year.

But there are a handful of marijuana stocks that I don’t believe will simply tread water or be part of the status quo in 2020. Rather, I see the following companies as the best pot stocks investors can buy in 2020. They’re far from being brand-name companies, but they have the differentiating factors needed to stand out in what should still be a high-growth industry over the long run.

OrganiGram Holdings

Canadian growers were certainly given the opportunity to be industry leaders, but a combination of regulatory issues and overzealous spending has made that nothing more than a pipe dream…except when discussing OrganiGram Holdings (NASDAQ:OGI).

OrganiGram is unique in a number of ways relative to its peers. For one, it’s the only major grower (i.e., a cultivator that has peak production potential of at least 100,000 kilos per year) located in an Atlantic province. Being based in New Brunswick, OrganiGram has the natural ability to gobble up market share in Canada’s eastern provinces. While less populated, these regions are known for cannabis-use rates that are higher than the national average. It’s also worth mentioning that OrganiGram is one of five growers that have forged supply deals with every Canadian province, so it’s certainly not stuck just servicing these less-populated markets.

Another factor that really stands out with OrganiGram is the company’s production efficiency. According to its management team, it is capable of 113,000 kilos of peak yearly output, yet is working with less than 500,000 square feet of cultivating space. The secret is that it uses a three-tiered growing system in its licensed rooms, thereby pushing its projected yield per square foot to around 230 grams. Comparatively, this yield is about double that of its peers, and it should mean substantially higher margins.

But perhaps the most important thing to remember about OrganiGram is that it’s the only Canadian grower to have produced a no-nonsense profit. In the fiscal third quarter, net sales of cannabis outpaced costs of goods and operating expenses by 1.17 million Canadian dollars ($895,000). Sure, it wasn’t a huge operating profit, but it’s the first real operating profit we’ve seen in the industry, without the aid of fair-value adjustments or other one-time benefits. This is a well-run company with the tools to outperform in 2020 as derivative sales pick up.

Innovative Industrial Properties

It may not be a household name, but cannabis real estate investment trust (REIT) Innovative Industrial Properties (NYSE:IIPR) was one of the few bright spots for the marijuana investment world in 2019. That’s a trend I’d expect to continue in 2020.

The basis for IIP’s business model is pretty simple. The company acquires assets for growing and processing medical marijuana, then leases these properties out for an extended period of time (often 10 to 20 years), thereby reaping the rewards of rental income. Furthermore, it passes along annual rental increases to its tenants, allowing it to stay ahead of the inflationary curve, and charges a 1.5% property management fee that’s based on the current rental rate. In other words, although IIP primarily grows by making acquisitions (the hallmark of most REITs), it does have a modest organic growth factor built in.

In 2019, Innovative Industrial Properties wound up nearly quadrupling its portfolio from 11 assets owned to 42 properties in 13 states. More important, IIP provides updates to its metrics following every acquisition. As of now, the company’s weighted-average remaining lease is 15.5 years, and its average return on invested capital is a healthy 13.6%. Put in another context, Innovative Industrial Properties should see a complete payback on its $431.2 million in invested capital in just over five years, which means plenty of cash flow and cost predictability in an environment where little predictability now exists.

Also, this is the only pure-play cannabis stock that pays investors a dividend — and a fat one at that! Having recently announced a fourth-quarter payout of $1 per share, IIP is now yielding 5.6%. What’s more, the $1 payout is 567% higher than what the company was dishing out to shareholders just nine quarters ago. This fast-growing company is perfect for growth and income seekers alike.

MediPharm Labs

Ancillary companies will continue to play a key role in the long-term development of the pot industry, but many are contending with the same supply or tax issues hurting direct players. That, however, is unlikely to be the case for extraction-service provider MediPharm Labs (OTC:MEDIF).

Extraction companies find themselves at the center of the hottest trend in the industry: the manufacture of derivative products. Derivatives (like edibles, vapes, concentrates, infused beverages, tinctures, and topicals) were launched in Canada about two weeks ago. They’re a considerably higher-margin product than traditional dried cannabis, meaning it’s not a matter of whether growers devote time and effort to creating derivatives, but a question of how much capacity and capital is allotted to make these high-margin products.

This is where MediPharm Labs comes into play. It takes hemp and cannabis biomass and processes it for the resins, distillates, concentrates, and targeted cannabinoids that growers use to make derivatives. MediPharm’s fee-based contracts to perform these services are often 18 months or longer, meaning that, like IIP above, the company can deliver relatively predictable cash flow every single quarter. And with the company working on expanding its processing capacity to 500,000 kilos per year, the ceiling for sales and profitability continues to be raised.

Speaking of profits, MediPharm has delivered two consecutive quarters of no-nonsense operating profits despite the fact that it only began operations in November 2018. Mind you, these profits were achieved before derivatives even hit Canadian shelves. Now that we’re actually seeing these products make their way to market, MediPharm’s business, and its ability to secure processing contracts, should really heat up. This should make it one of the best marijuana stocks to buy in 2020.

Planet 13 Holdings

Last, but not least, I’m a big fan of vertically integrated multistate operator (MSO) Planet 13 Holdings (OTC:PLNHF) in 2020 and feel you should be, too. While there are plenty of other, larger MSOs to choose from, none offers the differentiation of Planet 13.

The company’s flagship store is just west of the Las Vegas Strip. When complete, the SuperStore will span 112,000 square feet (that’s bigger than the average Walmart by 7,000 square feet) and will house a pizzeria, coffee shop, events stage, consumer-facing processing center, and the broadest selection of cannabis products a consumer could find. In essence, Planet 13 not only wants repeat cannabis users, but it’s also quickly becoming a go-to destination for anyone fascinated by cannabis culture.

Having visited the SuperStore, I can say that Planet 13 has done a lot right. It has heavily incorporated technology into the buying experience, with self-pay kiosks interspersed throughout the store, and has the perfect, engaging layout. This is to say that the company’s highest-margin product is nearest the registers and entrance, while the dozens upon dozens of various dried cannabis strains are toward the back of the store. A centrally located immersion station, as well as personal budtenders, also help make the experience unique.

Best of all, you get plenty of transparency with Planet 13. Every month since opening in November 2018, the company has provided customer traffic data, including numbers for visitors, paying customers, average ticket size, and the percentage of sales the SuperStore is doing in relation to all of Nevada. With expansionary spending on the SuperStore nearing an end, and the company focused on opening a second location in Santa Ana, California, in 2020, my expectation is that Planet 13 will push into profitability before year’s end. That makes it one heck of a value in the marijuana space.

Source: Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends Innovative Industrial Properties and OrganiGram Holdings. The Motley Fool has a disclosure policy.