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5 Things Pot Stocks Will Be Focused on in 2019

This article was originally published on Fool.com

The legal cannabis industry has made history at seemingly every turn in 2018. The big news, as you’re probably well aware, is Canada becoming the first industrialized country in the world to legalize recreational marijuana. Beyond this, we’ve also witnessed:

  • The U.S. Food and Drug Administration approving the first-ever cannabis-derived drug on June 25.
  • Vermont giving the OK to adult-use weed in January entirely through the legislative process.
  • Tilray becoming the first Canadian pot stock to IPO on a reputable U.S. exchange.
  • Aurora Cannabis completing the largest and second-largest pot deals in history.
  • Two new states — Utah and Missouri — passing broad-based medical cannabis laws.

In short, the industry is seeing green. But all eyes now turn to what the marijuana industry will be focusing on in 2019. While we don’t know that answer with any certainty, the following five strategies are a good bet to dominate next year.

1. Continued capacity expansion

The first thing you can almost certainly expect marijuana stocks to focus on in the upcoming year is capacity expansion. Even though we’ve witnessed a slowdown in new expansion announcements since the first half of 2018, it’s going to take a couple of years before the announced capacity-expansion projects are up to full speed.

For example, Canada’s projected top five growers by annual output are (in my best estimate):

  • Aurora Cannabis: up to 700,000 kilograms
  • Canopy Growth Corp: around 500,000 kilograms
  • Aphria: 255,000 kilograms
  • Tilray: Around 225,000 kilograms
  • The Green Organic Dutchman: 195,000 kilograms

All told, the top Canadian producers could generate between 1.8 million kilograms and 1.9 million kilograms at their aggregate peak. Right now, they’re only combining for around 125,000 kilograms in annual run-rate production. Aurora Cannabis was at just 45,000 kilograms as of September, while Canopy Growth and Tilray were producing about 40,000 kilograms and 6,000 kilograms on an extrapolated basis (from their latest quarterly report). The Green Organic Dutchman won’t even have its first sale until the first half of next year.

Long story short, capacity expansion is almost certainly on the docket.

2. A focus on product branding and innovation

Next, we should see a concerted focus on developing and marketing cannabis products. This will take on two dynamics.

First, there’s the act of separating one cannabis product from another. In an exceptionally crowded field, marijuana growers will be looking for ways to get their brand-name products in front of as many eyeballs as possible. This means spending on marketing as well as possibly working with a packaging and branding specialist like KushCo Holdings. KushCo is responsible for ensuring that cannabis companies stay compliant with local, state, and/or federal laws while also providing branding that fits a company’s needs.

Second, we’re liable to see pot stocks broadening their line of products beyond just dried cannabis. Though there’s little precedence to recreational legalization, dried cannabis flower has shown a propensity to be commoditized in select U.S. states in recent years. Chances are that oversupply will lead to an eventual decline in per-gram dried flower pricing in the future. In order to avoid this, pot stocks will be focused on developing higher-margin alternative cannabis products, such as oils and perhaps even edibles and infused beverages (assuming the latter two are approved in 2019) in the upcoming year.

3. A push into international markets

An important third strategy will be the move into international markets. Even though domestic weed demand should hit around 1 million kilograms a year, per a report from Health Canada, a majority of sales are expected to occur in overseas markets where medical cannabis is legal. In fact, with Canadian growers potentially peaking at well over 3 million kilograms in aggregate production, more than two-thirds of demand could come from foreign markets.

Aurora Cannabis and Aphria have been particularly aggressive in ensuring that they have a solid presence in overseas markets. For instance, Aphria acquired Nuuvera for 425 million Canadian dollars earlier this year, not for its production potential but for its infrastructure in eight foreign markets. Following closure of the deal, as well as a push into South America, Aphria now has access to a dozen markets.

Meanwhile, projected leading producer Aurora Cannabis has a presence in 18 countries and five continents. It’s organically pushed into new markets but has also found new sales channels via acquisitions and partnerships. Its joint venture with Alfred Pedersen & Son in Denmark to retrofit greenhouses (known as the Aurora Nordic facility) is a good example of the latter. When complete, Aurora Nordic will be a major supplier of medical cannabis to the Scandinavian region.

Look for this push into foreign markets to ramp up in 2019.

4. Profits coming into focus

Fourth, it’s going to be important for marijuana companies to recognize that we’ve moved beyond the promises stage and into a new era in which tangible results matter. Thus, moving forward, we’re liable to see marijuana stocks paying closer attention to their expenses and bottom-line results.

Now, understand that pot stocks are probably going to get the benefit of the doubt from International Financial Reporting Standards (IFRS) as they expand capacity in the early going. IFRS accounting allows agricultural companies like pot growers to regularly adjust the fair value of their biological assets (i.e., cannabis plants). This fair-value adjustment is being taken above the line by pot stocks, meaning it is, in some cases, resulting in a positive cost-of-goods-sold figure rather than a negative number, as we’d expect. In other words, quarterly profits right now should pretty much all have asterisks next to them.

The real challenge in 2019 is whether we’ll see marijuana companies produce enough product to become profitable on an operating basis, without one-time adjustments. And if they do become profitable, will those per-share profits be meaningful enough to move the needle and interest fundamentally focused investors? My personal belief is that investors shouldn’t hold their breath on this last point.

5. Ongoing industry consolidation

Finally, it seems like a good bet to count on consolidation within the marijuana industry in the upcoming year. The pot space is crowded, and consolidation, if done correctly and for the right price, could make for stronger and more cost-efficient companies.

On the “buy” side of the equation, look for Canopy Growth to be aggressive. Remember, it recently closed a $4 billion equity investment from Modelo and Corona beer maker Constellation Brands, meaning it has a war chest full of cash. Although Canopy has been pretty clear that it wants to move into new markets, it’s evident that this cash gives it the unique flexibility to buy complementary businesses.

As for acquisitions, perhaps HEXO Corp will find itself gobbled up next year. HEXO, which made a name for itself this year by forging a joint venture with Molson Coors Brewing Co. to develop cannabis-infused beverages, is for sale for the right price, according to its CEO Sebastien St-Louis. HEXO’s CEO isn’t quite sure whether HEXO will be a dominant force or be consumed in the process, so long as his shareholders benefit along the way. From the sound of things, if HEXO were made an offer with a hefty premium, this potential top-10 producer would accept.

About the only thing for certain is this: 2019 is going to be another exciting year for marijuana stocks.

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Sean Williams has no position in any of the stocks mentioned. The Motley Fool US owns shares of Molson Coors Brewing. The Motley Fool US recommends Constellation Brands, Hexo., and KushCo Holdings. The Motley Fool has a disclosure policy.