Canada markets closed

This Canadian Pot Stock Is Preparing for Exponential Growth

Ryan Vanzo
Marijuana leaves, cannabis on a dark background, beautiful background, indoor cultivation

The pot market continues to grow year after year, at least in terms of consumer demand. Canaccord Genuity Group Inc thinks that Canada’s cannabis industry will hit $3.2 billion in sales this year, up from $1.5 billion in 2019. That’s a jump of more than 100%.

The U.S. market is also growing rapidly. According to Grand View Research, the legal marijuana market in the U.S. should surpass $70 billion by 2027.

Cannabis analysts at Cowen Inc believe federal legalization will occur by the end of the decade, opening the floodgates to a $100 billion market.

While the demand for pot may be on the rise, pot stocks are in a world of pain. In 2019, most companies lost half of their value, which some falling by more than 80%.

Why the disconnect? There’s one factor to blame: commoditization. Fortunately, this same factor offers investors a clear chance to profit from the turmoil.

How to invest

If you don’t understand commoditization, stay far, far away from pot stocks. The name of the game this decade will be avoiding the pressures that come from peddling in commodities.

What is commoditization? It’s the same force that makes apples, corn, and carrots so cheap. There isn’t much differentiation between different producers, meaning they all sell into the open market. Commodities are subject to supply and demand forces, and escaping this pricing dynamic is very hard.

While legal cannabis seemed special at first, the market realized in 2019 that it will be a race to the bottom in pricing. Nearly every producer is planning massive expansions in output. Market demand is rising, but industry supply is rising even faster.

In both Canada and the U.S., cannabis companies have reported lower and lower selling prices. The promise of massive production growth is being met with skepticism over profitability.

If you want to succeed in pot investing, be sure to pick stocks that can resist the deleterious effects of commoditization.

Pick stocks like this

Think of powerful brands like Kraft Heinz Co, Molson Coors Beverage Co, and PepsiCo, Inc. What do they sell? Pure commodities. Well, sort of. All of the constituent ingredients are commodities (corn, soy, sugar, etc), yet the companies are able to sell five cents worth for a dollar.

How so?

The secret is branding. Consumers know and love products like Heinz ketchup, Pepsi cola, and Coors beer. They’ll pay a premium for how these commodities are packaged and presented. You can purchase the ingredients separately, but you won’t know how to turn them into a finished product.

To avoid commoditization, pot stocks need to figure out branding. Companies like Hexo Corp. (TSX:HEXO)(NYSE:HEXO) are miles ahead of the competition.

Hexo is working directly with existing global brands such as Molson Coors to co-create cannabis products. The first Hexo-Molson product, a THC-infused beverage, should hit Canadian shelves this month.

The benefit is clear for both companies. Hexo gets instant brand name recognition, while the partner gets access to cannabis capabilities without building its own infrastructure. This year, Hexo wants to secure more branding deals in categories like sleep aids, edibles, and cosmetics.

Hexo is betting that customers will buy a cannabis product from a brand they already trust, rather than an unknown pot startup. This strategy should help fuel sales growth and protect pricing power.

Revenue is expected to nearly triple over the next 12 months, but long-term, the sales ceiling is much higher.

More reading

The Motley Fool recommends HEXO. and HEXO.

Fool contributor Ryan Vanzo has no position in any stocks mentioned.

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool Canada’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Motley Fool Canada 2020