Funny how niche markets can turn from hero to villain almost overnight. The cannabis sector was like crypto, a growth sector that could do no wrong. And then it all went a bit, Pete Tong. That doesn’t mean it’s gone away entirely and I note that HANetf has just announced that they are launching a UK listed index tracker for this space – one which presumably evades all the issues connected with the Proceeds of Crime Act.
Anyway, the more the sector falls out of favor, the more I find myself taking an interest.
On that basis, it is worth taking a closer look at the research coming out of Canada by Canaccord Genuity. Their excellent analyst is Matt Bottomley and he’s just released his year in review – for both Canada and the US. He’s also included some stocks to watch.
Over to Matt….
” In a year that saw a full 12 months of legalized recreational sales in Canada, 2019 was not without its challenges with our Canaccord Genuity Cannabis Index (CGCI) down (46%) YoY with many cannabis names off more than 70% from their annual highs to end the year.
Although we believe the industry tracked in the right direction (albeit at a very slow pace) towards growing Canada’s domestic market to what we believe could one day be a ~C$10B opportunity – 2019 saw no shortage of headwinds in the space, including: (1) lumpy financial results (and in many cases declining sales) due to bottlenecks in provincial distribution channels, slower than anticipated retail openings and limited product breadths/offerings; (2) overinflated provincial revenue budgets, which came down across the board throughout the year; (3) health concerns surrounding vaping and restrictive stances on certain product classifications (namely edibles in Quebec); (4) significant turnover in C-Suite management (e.g. Bruce Linton at Canopy), which will likely be a net-positive over the long term as the industry continues to mature; (5) a material non-compliance issue at CannTrust; and (6) longer pathways to profitability while a number of LPs reduced or eliminated 2020 guidance altogether.
Looking ahead in 2020. Although we expect more bumps in the road given the still relatively nascent state of the industry, we believe 2020 will be a more catalyst-rich year with additional product forms (edibles, vape pens, concentrates) now in the early stages of implementation and with significant expected increases in brick-and-mortar retail throughout the year. Although oversupplied wholesale channels may continue to weigh on LP results in the near term, we note that end user sales for the most recent three months of data indicate that Canada was operating at a C$1.5B run-rate entering Q4/19 in advance of Cannabis 2.0 and expanded retail. With excess industry capacity for dried bud, we believe pivoting successfully into Canada’s new derivative market and securing consumer mindshare will be critical for success as the industry transitions away from agriculture and becomes more CPG in nature.
” In yet another banner year, the US saw significant progress throughout 2019 (both at the regulatory and specific company level) as markets continued to regulate and implement legal cannabis platforms throughout the country. Unfortunately, much of this progress did not translate in public market valuations, with many US cannabis operators down 25% to 50%+, with the boarder group down by >10% on average for the year (lifted by >20% YoY increases for both CURA and TRUL).
However, unlike the Canadian domestic market, we believe the US generally saw positive news flow and developments during 2019, highlighted by: (1) the implementation of CBD platforms after the passage of the Farm Bill in late 2018 (although we still await further clarification from the FDA); (2) significant M&A as MSOs combined to create portfolio of assets that could contribute to billion dollar top lines in 2020; (3) the clearance of HSR review hurdles (initially an overhang); (4) the legalization (and subsequent implementation) of adult-use sales in Illinois; (5) relatively positive quarterly earnings with many MSOs inflecting into adj. EBITDA positive territory and are likely a few quarters away from positive cash flow from ops; and (6) the passage of the SAFE Banking Act in Congress. Although on its fundamentals 2019 was an overall positive year (in our view), we believe the primary factors holding investors back include the anticipated need for additional capital injections in order to meet forecasts and continued delays/uncertainty in the closing dates of announced sector M&A.
Looking ahead in 2020. We believe 2020 will be another banner year for the US cannabis industry as we enter an election year that could see additional states become legal via ballot initiative (e.g. adult use in New Jersey) while previously legalized markets (California, Massachusetts, Illinois) are expected to contribute significantly to industry sales growth through the coming year. On the legislation front, we believe federal Bills such as the SAFE Banking, STATES and MORE Acts, could represent significant positive valuation catalysts as they work their way through congressional and senate channels with the overall optionality for cannabis reforms to become part of the US Presidential election cycle (given >65% public support for legal rec cannabis at the national level). Finally, with the closing of material sector M&A expected in the coming weeks/months, we believe the successful closing and integration of many of these assets could result in a handful of operators achieving adj. EBITDA contribution in the hundreds of millions as portfolios and markets continue to grow. As a result, we expect US cannabis names to begin to trade more on execution with the potential to re-rate vs. their more expensive Canadian peers as the US market continues to de-risk throughout 2020.
Selected and up-and-coming companies in the Canadian and US cannabis space.
Tilray Inc. (TLRY-NASDAQ | Not rated). Tilray Inc. is a BC-based licensed producer and the first EU GMP-certified medical cannabis producer to legally export medical cannabis from North America to Europe. The company currently serves medical patients in 15 countries worldwide, including Australia, New Zealand, Germany, Chile, and most recently, Switzerland and Israel. In December 2018, the company entered a joint venture with Anheuser-Busch InBev to collaborate on the development of non-alcoholic THC and CBD beverages. While the company is based in Canada, Tilray also has a cultivation licence from the Government of Portugal which received EU GMP certification in December 2019. Most recently, Tilray announced that it has exported the first-ever commercial shipment (2.5 tonnes) of medical cannabis into Israel from its facility in Portugal.
WeedMD Inc. (WMD-TSX | Not rated). WeedMD Inc. is the publicly traded parent company of WeedMD Rx Inc., a federally licensed producer of cannabis products for both the medical and adult-use markets. The company owns and operates a 158-acre state-of-the-art greenhouse, outdoor and processing facility located in Strathroy, Ontario.. The company maintains strategic relationships across the seniors’ market and supply agreements with Shoppers Drug Mart as well as six provincial distribution agencies where its adult-use brands Color Cannabis and Saturday are sold.
Green Thumb Industries Inc. (GTI-CSE | Not rated). GTI is a Chicago-based, vertically integrated cultivator, processor and dispensary operator selling products including flower, concentrates, edibles, and topicals. The company owns and operates the RISE-branded national chain of retail cannabis stores. The company expects to end the year with annual revenues >US$200M.
Rubicon Organics Inc. (ROMJ-CSE | Not rated). Rubicon Organics Inc. is a Licensed Producer focused on cultivating and branding super-premium, certified organic cannabis at its flagship 125,000 sq. ft. state-of-the-art hybrid greenhouse located on a 20-acre property in Delta, BC, Canada. The company is one of only four producers to achieve organic certification in Canada and is ramping up to produce approximately 11,000 kg of cannabis in 2020. In the United States, the company owns a 40,000 sq. ft, high-tech hybrid greenhouse in Washington state which is leased to a state-licensed operator applying Rubicon Organics’ proprietary organic cultivation methods. The company also has exclusive licensing rights in Washington for iconic lifestyle and cannabis brand, Cookies. Recently the company launched and secured third-party distribution for its first brand, Simply Bare, and acquired 30 new strains, many of which are considered exotic. With sales expected to start in early January, Rubicon aims to capture a 2-3% domestic market share in 2020.
Radient Technologies (RTI-TSXV | Not rated). Radient is an Edmonton, Alberta-based extraction technology company focused on manufacturing natural ingredients including CBD and THC. The company extracts natural compounds from a range of biological materials using microwave assisted processing (MAP), a patented technology platform. For the quarters ending December 31, 2019, and March 31, 2020, the company is projecting revenues of $10-12M and $12-14M, respectively, before considering wholesale cannabis sales of inventory on hand.
Halo Labs (HALO-NEO | Not rated). Halo Labs is an Oregon-based cannabis extraction company with proprietary oil extraction and concentrate manufacturing technology and techniques.