BMO Capital Archives - Green Market Report

Debra BorchardtOctober 28, 2021


A new report from BMO Capital Markets outlines the state of the Canadian and U.S. cannabis markets and specifically calls out the increasing competition for American companies. The report also suggests that the Canadian LPs (licensed producers) are likely to fall behind as they lack the profitability of the neighbors to the South. Even though Canada was the first to legalize adult-use sales, the country has instituted punishing regulations and taxes and has an unlimited license regime (i.e., the federal government can issue an unlimited number of production licenses) that has caused the number of dispensaries to soar in Alberta and Ontario. In addition to that, BMO noted that miscalculations around what cannabis consumers want, and overspending in the wrong areas by many companies, have led to sizable P&L losses and dismal stock performances among the LPs. Green Market Report had a chance to review the report and will specifically focus on the analyst’s outlook for the U.S. companies.

Limits In Limited Licenses

One of the things that MSOs (multi-state operators)  in the U.S. have desired is access to a limited license state. This creates an advantage for the first movers to those states. However, analyst Tamy Chen believes that the competition is increasing in these states. She wrote, ” In Pennsylvania, Cresco Labs (OTC: CRLBF) and Trulieve (OTC: TCNNF) are investing in more premium flower production and Green Thumb Industries is doubling its capacity (GTII does not disclose its facilities’ sq. ft. but the company is already a leading operator in the state, so a doubling of capacity would presumably be notable). There are also several operators acquiring retail stores at relatively premium prices to reach the 18-store cap in the state. In Florida, there has been some aggressive price discounting by multiple operators. MSOs such as Columbia Care, CL and GTII have publicly indicated plans to deploy more capex into FL. Massachusetts is another state where we are observing several MSOs invest more capital to increase capacity. ”

Chen notes that some of the pioneers or first-movers in these limited license states are now facing the next wave of settlers or second-movers. Several of the cannabis companies that have a presence in one to two states are now spending big money to expand into these limited license states. They argue that they will be more successful than the pioneers because they can buy strategically and get top locations, whereas the first-movers took whatever location they could get. Chen, though points out that many cities are beginning to let first-mover MSO’s change store locations and so that point may not hold water. The report also says that the second-movers claim their cultivation facilities are better, although that comparison is difficult to make as the pioneers are growing as fast as they can due to undersupply issues. In the medical-only states, this expansion has proven to be a little harder than the second movers thought. Patients seem to be more loyal than recreational consumers.

First – Buy A Store

The BMO report described the approach by the second movers for these expansions. First, the MSO typically buys a bunch of retail stores. Chen wrote, “In fast-growing limited license states, stores could be generating upward of $10-15 million in annual revenues (sometimes even more). There are several strategic reasons to acquiring retail stores first. On a relative basis, it requires less capital and is a shorter lead time to revenues than building a production facility. It should be accretive as the stores should already be profitable, providing the acquiring operator with some time to identify a backward integration opportunity without a drag on cash. In some states, particularly those with a lower store cap, many first-mover MSOs have already reached the cap. As a result, valuations for independent retailers are not as elevated as a state like PA which has an 18-store cap. And finally, by acquiring retail stores, the MSO is acquiring a guaranteed distribution channel for its future production capacity. Once the operator integrates backwards, it can reallocate some of its stores’ shelf space to its own brands.”

Chasing these situations is driving up the valuations of these stores to the consternation of investors. With several states poised to switch from medical-only to adult use, the race to get established in these states is heating up. Chen wrote that operators in the new states say they plan to ramp up production and open the most stores possible. The MSO’s that are left out claim that they are just being patient and waiting for the move to be cost-effective. They think prices are too high and the states will eventually begin issuing more licenses.

Flower Power

In these early days for limited license states, producers can hardly keep up with demand. BMO thinks that once these markets settle down and supply issues wane, the importance of premium flower will emerge. Chen wrote that price competition in maturing cannabis markets typically concentrates in the mass and value segments, which has been experienced in CA, OR and Canada. “Even though CA and OR have many acres of outdoor cannabis cultivation, we consistently hear from industry participants that cannabis consumers continue to pay a premium for high-quality indoor flower. The higher the THC potency, the greater the retail price that flower product can command.”

The report pointed out that most of the flower grown on the east coast is grown indoors, which is more expensive. Plus, as MSOs scale up, the quality of the flower is compromised due to automation techniques. Chen wrote, “We believe successful businesses will be one of the following: a low-cost producer with scale or a premium producer that sells less volumes but
generates higher gross margin. We believe the fundamental reason driving the underperformance of several large Canadian LPs is a mismatch between the capabilities of their production asset(s) and the pricing strategy they are pursuing. Right now, the MSO group as a whole is executing well in favorable limited license environments where demand still somewhat exceeds supply. When this imbalance eventually disappears, it would not surprise us to see some U.S. operators recalibrate their pricing strategies to better suit the capabilities of their production assets.” The BMO report suggests that once these “new” markets mature, the first movers will learn that any old flower may not be accepted by seasoned consumers. She thinks the first-movers will lose their advantage as the race to the bottom pricing takes hold.

In Closing

It was an exhaustive report and this article doesn’t cover every point. Still, BMO thinks that Canadian LP’s shouldn’t pursue MSO chasing. She thinks that by the time the LPs get their MSO deals consummated, they are unlikely to generate the types of returns the MSOs are enjoying now. Instead, Chen thinks the LPs should focus on a cost advantage, product innovation and/or option agreements with successful West Coast cannabis brands.

“Regarding the potential likelihood of success in the U.S., the “pecking order” of our coverage is Village Farms (VFF), Cronos Group (CRON), Tilray (TLRY), WEED, HEXO, OrganiGram (OGI), Aurora Cannabis (ACB), Sundial Growers (SNDL), and The Green Organic Dutchman (TGOD).”

Video StaffJune 1, 2018


The big news this week was that California cannabis retailer MedMen began trading on the Canadian stock exchange (MMEN) . The company has a billion valuation, which has come under some criticism for being a bit frothy as compared to the current state of revenues. However, the company hasn’t reported any earnings since before the California stores came online so that picture could change quickly once the market sees those sales numbers. The stock has fallen 23% since it began trading and has endured withering comments from a site called equity guru as well as from many of the better-known marijuana stock traders.

There were some earnings out this week.

Golden Leaf Holdings (GLDFF) said first-quarter revenue soared, thanks to its 2017 acquisition of Chalice Farms and highlighted the progress it’s making in expanding its cannabis operations in California. Golden Leaf said its revenue jumped 42 % year-over-year to $3.2 million. It also generated $353,000 in gross profit, up from $238,000 in the year-ago quarter.

Emblem Corp. (EMMBF) reported that its revenues for the first quarter increased 41% to $1,277,000 in Q1 2018 from $903,000 in Q1 2017. Gross profits increased 304% to $182,000 compared to a gross loss of $89,000 for the same time period in the previous year.

Sunniva  (SNNVF) released its financial results with $5.2 million in revenue from its two subsidiaries, Natural Health Service Ltd. and FSD, which contributed $2.7 million and $2.5 million, respectively. Net loss for the period ended March 31, 2018, was $6.3 million as compared to $1.0 million during the period ended March 31, 2017.

Hiku (HIKU) reported revenue for the first quarter and it was relatively small, totaling C$246,143. The vast majority of that revenue was gobbled up by the retail cost of sales, which totaled C$202,431. The company managed to squeak out a gross profit of C$15,554. Overall, Hiku posted a net loss of $9.1 million for a loss per share of eight cents versus last year’s loss per share of one cent.

On The Acquisition Front

Canopy Growth Corporation (CGC) is staking a claim in the African medical cannabis market. On May 30, 2018, the company announced that it has acquired Daddy Cann Lesotho PTY Ltd., which trades under the name Highlands.

And in the research world…..

BMO Capital Markets, a North American financial services provider, has initiated coverage on both Aphria Inc. (APHQF) and Canopy Growth (CGC) with a rating of Outperform.

William SumnerMay 29, 2018


BMO Capital Markets, a North American financial services provider, has initiated coverage on both Aphria Inc. (APHQF) and Canopy Growth (CGC) with a rating of Outperform.

According to the report released on May 28, 2018, both companies stand to benefit from a first mover advantage in initial recreational markets as many cannabis companies in Canada do not have the inventory or production capacity to meaningfully participate in the market while both Aphria and Canopy do.

In the long term, BMO believes that cannabis cultivation will become a commoditized activity and that oversupply will become an issue. Although a majority of cannabis brands hope to counter this through the development of brands or through the expectation that they will become a low-cost producer.

The Aphria Opinion

BMO expects that most cannabis firms will not be able to generate sustainable margins at scale, but they do believe that Aphria will be one of the few that can. The report points to the extensive commercial greenhouse cultivation experience held by the company’s management team and to the inherent infrastructure and greenhouse culture in Leamington, Ontario, where the company is based.

Aphria’s target price is $17 and is based on a projected enterprise value that is 17x BMO’s Base Case Fiscal 2020 EBITDA estimate; which in turn was based on the assumption that Aphria’s facility expansions would only be at 65% of its full production capacity by 2020.

The Canopy Growth Opinion

Canopy, on the other hand, is well positioned to become a global brand leader. In addition to the company’s first-mover advantage, the company also has a head start in the international market; establishing cultivation centers in hub regions like Denmark for the future export of medical cannabis to Germany and possibly the rest of Europe.

Canopy’s target price is $45 and is based on a projected enterprise value that is 20x BMO’s Base Case Fiscal 2020 EBITDA estimate. Like Aphria, this figure is based on the assumption that the company would only be at 65% of its full production capacity by 2020, even though both companies expect to reach 100% by that date.

MedMen Goes Public

In related news, MedMen Enterprises announced today that its stock would begin trading today on the Canadian Securities Exchange at 11 a.m. eastern time under the ticker symbol “MMEN”. The company will raise roughly C$143 million or $110 million from the listing, giving MedMen an enterprise valuation of C$2.14 billion or $1.65 billion.

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