Investing Ideas for Extraction and Vape

By Steve Gelsi, The Street

When it comes to cannabis, savvy investors should consider the rising popularity of vaping instead of smoking the product.

So far, however, much of Wall Street's attention has been directed at flower production and larger integrated cannabis names such as Canopy Growth Corp.  (CGC)  (TSE: WEED), Cronos Group  (CRON) , Acreage Holdings (ACRGF) (CSE: ACRG), Aurora Cannabis Inc. (ACB - Get Report) , Curaleaf (CURLF) (CSE: CURA), The Green Organic Dutchman Holdings Ltd. (TGODF) (TSE: TGOD), Tilray Inc. (TLRY) , Aphria Inc.  (APHA)  and others.

More options are emerging, though, to make more targeted investments in refining cannabis to make vape oils, waxes and edibles.

Among these emerging names, Valens GroWorks Corp. (VGWCF) (CSE: VGW) debuted its stock late last year on the OTCQB. The stock recently drew an outperform rating from AltaCorp Capital.

"We view Valens as one of the premier businesses within the cannabis sector, and believe that the company is ideally positioned to benefit from the expected evolution of cannabis consumer consumption patterns, namely, the shift from dried flower towards consumer packaged goods extract products [such as] vape pens, edibles [and] beverages," said analysts at AltaCorp Capital.

Sure, the market around growing, distributing and selling dried cannabis flower for smoking remains the biggest. But it's not growing as quickly as the most popular alternatives including oil-filled vaporizer cartridges, wax or shatter concentrates, and edibles.

study commissioned by the state of Colorado on its cannabis business revealed some compelling data around the non-smoking trend. While marijuana sales increased 51.6% (to $1.5 billion) between 2015 and 2017 in Colorado, concentrated product sales increased by 114% and infused edible sales jumped 67%.

Investors who agree that this trend reflects preferences in the broad cannabis market may consider the potential in a variety of smaller oil extraction and vaping specialists.

These oil and edible specialists should not be confused with ancillary cannabis stocks for businesses that hardly touch the plant, if at all. KushCo. Holdings  (KSHB) , for example, makes cannabis packaging as a closely watched ancillary name.

Matt Karnes, managing partner at GreenWave Advisors, said a number of stocks offer exposure to cannabis oil extraction and equipment growth on the Nasdaq, Canadian Securities Exchange, or the OTC.

Some these names include Origin House (CSE: OH), Neptune Wellness  (NEPT - Get Report)  and extraction equipment maker Quadron (CSE:QCC). Dixie Brands (CSE: DIXI.U) makes edibles.

Meanwhile, one name in the extraction business that deserves a closer look is Valens GroWorks, which, with its proprietary extraction and vast extraction capabilities, specializes in full spectrum crude extraction, oil refinement processing including distillation, cannabinoid isolation, and analytical product testing.

Valens GroWorks operates primarily through two wholly-owned subsidiaries in Kelowna, British Columbia, which is northeast of Vancouver. Valens Agritech holds a license to cultivate cannabis and produce cannabis oil under Canadian law. Under this subsidiary the company conducts an array of extraction services for clients including toll processing, proprietary refinement and creating value-add products for some of the world's largest and most reputable licensed producers. Valens Labs operates a licensed and accredited commercial cannabis testing lab and has partnered with $100 billion market cap testing equipment company Thermo Fisher Scientific Inc.  (TMO - Get Report)  to create a globally recognized "Center of excellence in Plant Based Science". The facility is built to EU GMP standards, providing the opportunity to extract, test and export product on a global scale.

Valens GroWorks holds extraction service deals with several big cannabis growers in Canada including Canopy Growth, privately-held Sundial and Organigram Holdings Inc. (OGRMF) (TSX VENTURE: OGI).

Kayla Mann, the marketing manager for Valens GroWorks, said the company got a head start over others in the industry by obtaining certifications under Canada's narcotics laws to research and extract cannabis, which pre-date the more recent Health Canada cannabis regime.

By the time adult use cannabis became legal last October, the company was more than ready.

"We were able to do product development research and work with a university because we came at it from a science perspective," she said. "We had this beautiful time to test and adjust to the market before we came online from a sales perspective."

Valens GroWorks refined its extraction process just as big producers started to come to the conclusion that it could be better for them to outsource it, she said.

"It's tougher to do than you think, and experience is required," Kayla said. "Vertically integrating the extraction is a massive feat. The plant changes at every phase of its life from cultivation, drying, packaging, shipping. Taking it from flower to unrefined oil -- that's just the first step. After that, you're removing waxes and lipids -- there's methods for that. There's better combinations for a vape pen oil versus an edible with different ways of extracting it."

As a go-to player in the space, Valens GroWorks uses a fee for service revenue model, which means its business is not tied to the cannabis market price, which tends to fluctuate and is expected to go down over time as big growers scale up.

After its stock offering and private placement with AltaCorp Capital and Beacon Securities, Valens GroWorks has about $17 million in cash as it gets ready to start generating revenue this year.

Kayla said cannabis oil consumption continues to rise in markets such as Colorado and California even as flower sales dip.

Currently, the company's products are not available in the U.S., but Valens GroWorks hopes to make more forays south of the Canadian border when regulations here are more favorable.

The future for cannabis-based oil derivatives remains bright in the U.S., Canada and elsewhere, she said.

"We have a whole new marketplace for cannabis for people who don't smoke or who don't like the thought of smoking," she said. "We've only had a couple ways to do it - both with tobacco or cannabis -- you have to roll it and smoke it. That's not efficient, it's something people have to learn how to do, and it's tougher to travel with. Now you're getting a variety of better ways to intake cannabis, for whatever properties you may like them for, and you're bringing in the demographic that don't smoke. With an edible, the onset, duration and potency of your high is extremely unpredictable due to your body's bioavailability which is different for each and every person. This is daunting to the average person who just wants to have the equivalent of say, a couple beers for example. At Valens, we have the technology to eliminate those uncertainties if ingesting is your preferred method through our oil-derived value add methods."

Oils also offer more product refinements such as mixing in more cannabinoids like CBD, the non-psychoactive part of the plant that may help reduce stress.

"We're reintroducing CBD into THC-driven products. It can make it a much more balanced high," Kayla said. "Instead of getting a moonshine, you're getting a nice wine or whatever you want. It's about creating products that are more sustainable for the more moderate consumer. You don't get a super baked high. It's a consumer good that people seeking a more mellow effect can appreciate and enjoy."

Overall, the oil extraction side continues to attract interest from institutional investors looking to back companies before they go public or get sold to conglomerates.

Michael Gruber, managing partner at Salveo Capital, said growing raw flower is expected to become more of a low-cost commodity, with richer potential returns in branded oils and other more refined products.

"Folks further down the supply chain are getting more margin on extraction and on the extraction branded side," Gruber said. "If you can get a distinct brand, it's a way to get higher prices for your products."

Salveo already has several investments in companies involved in non-smoking consumption of cannabis, with exposure to topical lotions, vape pens and cartridges, lozenges and other items.

"We're very active in the space to create more specific products," Gruber said. "We believe in the market. Oil is a critical component in each of them."

Sean Doyle