Stifel analysts W. Andrew Carter, Christopher Growe, and Matthew Smith issued a huge report September 2021 report updating investors on their outlook for the cannabis industry. The group lowered estimates and price targets on several companies. The group also noted they have a negative outlook on the Canadian cannabis industry and Canopy Growth in particular. With regards to the U.S. market, the analysts don’t believe the current administration will change the legality of the industry but believe this is actually a positive thing.
Don’t Expect U.S. Legalization
While the election of a Democratic President in the U.S. had many believing that federal reform was around the corner, Stifel doesn’t think so. The analysts said that they don’t believe this is achievable with this Congress and there is limited potential for modest reform. They wrote, “We believe federal inaction provides the leading U.S. MSO’s (multi-state operators) and our four ancillary cannabis names an extended window for value creation.” The group went on to say, “While this has reduced interest in the sector, we remain enthusiastic about the category’s prospects while federal inaction extends the window for value creation for GrowGeneration, Hydrofarm, Scotts MiracleGro, and WM Technology.”
While Stifel doesn’t think Federal legalization is happening anytime soon, the report was mostly positive for U.S. cannabis companies. The analysts wrote, “Year-to-date, we estimate the North American regulated category grew 45%. The U.S. state-licensed market should benefit from a number of new state systems coming online over the next few years: Connecticut, Montana, New Jersey, New Mexico, New York, South Dakota, and Virginia. Once all of these systems are implemented, the percentage of the U.S. population living in a state with an adult use cannabis commercial system will increase to 44.8%, up from 31% today. We estimate the U.S. state-licensed market will grow to nearly $35 billion in 2023 sales, suggesting 21% CAGR aided by robust underlying growth and new systems coming online.”
Stifel noted that in 2018, Canadian cannabis companies drove investor enthusiasm as the first fully legal developed market. Unfortunately, the market has not met the expectations and competition has been stronger than anticipated. For example, there has been a 100% increase in active licenses since 2020. Some areas in Canada have hit saturation, while others have no access at all. The report wrote, “Expanding legal access is likely to be difficult, with 30% of the addressable market in areas where the Provinces own and operate all retail stores, while municipal restrictions prohibit stores in some areas (most notably Mississauga, Ontario, with over 700,000 residents). For the retail operators, the Canadian market is extremely competitive in some areas, with the average Ontario retailer facing 20 stores within a two-mile radius.”
With regards to the U.S. listed Canadian producers, Stifel said that it thinks the costs of capturing category growth are increasing. To be fair, sales continue to grow with Canadian adult-use sales expected to reach $7 billion by 2023. Recovery from pandemic closures and a continuation to pull consumers out of the illicit market all bode well for the industry. However, Stifel tempered the positive comments with issues regarding regulatory changes and underserved markets.
“We caution that the difficult Canadian market will likely serve as a headwind for profitably participating in the market’s growth as there is a long lead time before increased consumption will be able to drive shipments higher,” wrote the analysts. “Retailer inventories continued their decline from 1Q21, but they remain elevated, with Alberta, Ontario, and Saskatchewan all ahead of levels at the end of 4Q20.” Three companies now own essentially 35% of the Canadian market – Canopy Growth, Tilray, and Hexo.
Stifel had some tough love for Canopy Growth. The analysts wrote, “We believe Canopy is actively eroding its position within an inflexible commitment to Canadian market leadership despite the significant resources needed to achieve this endeavor with no consistent evidence validating the ability to achieve market leadership.” Stifel is keeping its Sell rating for Canopy and lowering the price target to C$15, which was lately trading at C$17.70 while the U.S. stock was lately selling at $13. The analysts also pointed out that since the company fired its founder Bruce Linton, results have been underwhelming. They think a personnel change is needed.
Stifel has a Hold rating on Hexo and lowered its price target to C$2.85 even though revenue is growing. The company cited a complex capital structure for Hexo that could weigh on investor interest. Stifel thinks Tilray is best positioned for market leadership, but lowered the price target to C$11.50 from C$14 and maintained the Hold rating.
The analysts said they were taking a cautious approach towards the hydroponic category, which they cited for slowing growth due to oversupply issues. However, weather, fire, and construction delays could solve that problem. The report said, “Hydroponics benefits from the irrational deployment of capital toward plant touching opportunities with a myriad of funded “CocaCola of cannabis” pitches. But the hydroponics subsector has been largely insulated from this dynamic. Fresh category skepticism is likely to keep this insulation intact, and we believe each company should sport a stronger position for executing additional M&A. Of the three, we favor GrowGeneration with the dramatic underperformance relative to peers in the face of better positioning to contend with and capitalize on more challenging category dynamics.”
The analysts made the following changes:
“We are lowering our near-term estimates for Aurora Cannabis (ACB.CN), Canopy Growth (WEED.CN), Cronos Group, Hydrofarm (HYFM), the Scotts Miracle-Gro Company (SMG), and Tilray (TLRY). Our revisions stem from our more cautious approach to hydroponics category growth (HYFM, SMG) and uninspiring Canadian POS trends (ACB, WEED, TLRY). We are
increasing our estimate slightly for GrowGeneration (GRWG) for the latest acquisitions (two stores), and we are updating our HEXO estimates for the addition of Redecan and 48North. Our ratings remain intact, but we are lowering our target prices for Aurora Cannabis, Canopy Growth, Cronos Group, HEXO, Hydrofarm, ScottsMiracle-Gro, and Tilray. We recently initiated coverage of WM Technology (MAPS) with a Buy rating and $19 target price. While our WM Technology outlook remains intact, we approach our F4Q21 estimates with incremental caution, given slowing category growth, particularly in California, which represents over 60% of the company’s sales.”