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Inside the Market’s roundup of some of today’s key analyst actions

In a research report titled “The States Are High,” Industrial Alliance Securities analyst Nav Malik introduced coverage of the U.S. cannabis industry on Monday, expecting continued expansion of the legalized adult-use market.

"Public support for cannabis legalization is gaining momentum with a majority of both Republicans and Democrats in favour," he said. "We expect additional states will legalize adult-use sales (New York, Arizona, and New Jersey are likely over the next 24 months). Federally, two key initiatives – the SAFE Banking Act, and the STATES Act – would have a positive impact on the industry and on U.S. cannabis valuations."

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“Legal U.S. cannabis sales are currently around $11-billion. However, we estimate the total size of the industry (i.e., legal and black market) to be upwards of $75-100-billion. As such, we believe legal cannabis sales will demonstrate extremely strong growth over the next few years as more states move to allow medical and recreational adult-use, and the legal market gains share over the black market. In addition, cannabis products have the potential to disrupt large, established industries including the $250-billion beer, wine, and spirits market; the $120-billion tobacco market; and the $330-billion prescription drugs industry.”

Mr. Malik initiated coverage of both Harvest Harvest Health & Recreation Inc. (HARV-CN) and MedMen Enterprises Inc. (MMEN-CN) with “buy” ratings, noting valuation multiples across the U.S. cannabis sector have the potential for expansion as additional regulator reforms are made at both the state and federal level.

“U.S. MSOs [multi-state operators] trade at a significant discount to Canadian cannabis companies,” he said. “On an EV/Sales (2020 estimated) basis, U.S. MSOs are trading at 3.7 times, a 62-per-cent discount compared with Canadian large cap cannabis companies trading at 9.8 times. In terms of EV/EBITDA (2020E), U.S. MSOs are trading at 12.0 times, a 57-per-cent discount to Canadian cannabis companies trading at 28.0 times. The discount likely reflects the difference in the federal legal status between the two countries, and therefore the perception of an elevated risk profile for U.S. cannabis companies. The valuation gap will likely narrow as additional states move to legalize cannabis, and if key federal initiatives in the U.S. are enacted.”

Mr. Malik expects Tempe, Ariz.-based Harvest Health to see "strong" growth as it utilizes existing licenses and expands its cultivation capacity. He's forecasting the company to increase its retail locations from 36 currently to 94 by the end of 2019 and 140 by the end of 2020. He's projecting 181-per-cent revenue growth from 2019 to 2020 (US$326-million to US$914-million).

“Harvest is one of the largest MSOs in the US and holds licenses in a number of attractive markets,” he said. “We are forecasting strong growth as the Company operationalizes existing licenses, establishing one of the largest vertically integrated footprints of any MSO. Upcoming sales of CBD products provide additional growth potential.”

He set a target for Harvest Health shares of $19. The average target on the Street is $19.42, according to Thomson Reuters Eikon data.

Mr. Malik thinks Culver City, Cal.-based MedMen has established one of the "strongest" brands in the cannabis industry, and expects strong growth to continue. He's projecting an increase in its retail stores across 12 states to 85 by the end of 2021 from 37 currently.

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“MedMen has developed one of the most recognized brands in the cannabis industry by delivering a premium retail experience and through impactful marketing. The Company has established a network of high profile retail locations and we are forecasting strong growth as it continues to deepen its presence in key markets. In addition, MedMen is driving margins by expanding its cultivation capacity and increasing sales of products produced in-house.”

Mr. Malik set a target price of $6, which falls short of the $8.46 average.

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Citing both margin pressure and regulatory risk, CIBC World Markets analyst John Zamparo cut Hexo Corp. (HEXO-T) to “neutral” from “outperformer.”

“HEXO’s track record has been among the most impressive of all the producers in this industry, but we believe the company’s $400-million revenue guidance for fiscal 2020 will be challenging to achieve,” he said. "The dearth of brick & mortar stores is a major reason for this, but in our view, the bigger question mark is the launch of derivative products. We do not doubt their popularity and eventual success, but we believe there is ample reason to suspect that ‘Legalization 2.0’ will mimic the experience of October 2018, when supply chain insufficiencies, product supply shortages, and the time required to abide by regulations made for a tumultuous launch (note that Health Canada will provide an update on regulations on June 14).

“Another reason for concern is the margin compression already being witnessed in the Quebec market. HEXO expects its GM% to decline towards 40 per cent (vs. 49.5 per cent in FQ3) over the next 24 months, partly as a result of mix shift, but more importantly, additional competitors. Price reductions and margin compression were always expected at some point, but this is occurring earlier than we had previously contemplated, and this is a notable decline from our forecasts over F20 and F21, which previously assumed 54 per cent and 55 per cent, respectively.”

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Also expressing concern about sentiment surrounding the Gatineau, Que.-based company, Mr. Zamparo lowered his target for Hexo shares to $8.50 from $9.50. The average is $10.53.

“HEXO has been vocal about its goal of adding Fortune 500 partners to complete its hub-and-spoke model," he said. “We support this strategy, but believe sentiment risk exists if no partner is signed by year-end. We do not question the level of interest from outside parties, but the terms available in any relationship may not be attractive to HEXO.”

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Desjardins Securities analyst John Chu is expecting “muted” fourth-quarter results from Canopy Growth Corp. (WEED-T) and is seeking additional growth insights from its management team.

“Recall that January and February recreational sales were down 4 per cent month-over-month and 6 per cent month-over-month, respectively, while March sales were up 17 per cent month-over-month. Canopy may thus see flattish quarter-over-quarter sales growth unless it is able to increase market share to an even more dominant position; we estimate Canopy had a 43-per-cent recreational market share in the previous quarter,” said Mr. Chu in a research note ahead of the June 20 release of the release of its quarterly report.

Pointing to "soft" industry sales, he's projecting net sales of $84-million for the quarter, which is essentially flat from the third quarter and below the Street's consensus of $91-million. He's also forecasting an adjusted EBITDA loss of $43.4-million, which is an improvement from the previous quarter ($83-million loss) and better than the consensus ($67-million loss).

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"Items to look for on the call include the following: (1) update on the pre-roll and softgel rollout; (2) additional colour on management expectations that the Canadian operations can be EBITDA-positive in the next 18 months but that Canopy as a whole will likely remain EBITDA-negative for the 'foreseeable future' (as per CFO Mike Lee in a recent BNN Bloomberg interview); (3) US hemp build-out strategy update (ie plans for hemp operations in seven US states within 12 months); (4) updates on edibles legalization and details on its planned advanced-product portfolio; and (5) clinical trial updates," he said.

Mr. Chu maintained a “hold” rating and $74 target for Canopy shares. The average target on the Street is $75.98.

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Alacer Gold Corp.'s (ASR-T) management “has done a commendable job delivering on expectations to date and mitigating risks during the rampup” of its Sulfides project, according to RBC Dominion Securities analyst Mark Mihaljevic.

“While inherent risks remain elevated until steady state results are demonstrated consistently, we believe this creates the potential for further upside if Alacer can maintain its positive momentum,” he said. "Results to-date have been encouraging with steady improvements in utilization, throughput, and recoveries and performance nearing design levels in May.

"In our view, Alacer’s cash generation in Q1 (net debt reduced by $30-million) was impressive, especially this early in a ramp-up. Our analysis of past investment cycles has demonstrated a strong trend of outperformance following an inflection to positive FCF as well as a willingness by investors to pay a premium for companies with strong FCF [free cash flow] margins. We believe the strong FCF positions Alacer to internally de-lever its balance sheet through 2019 and consider returning capital to shareholders in 2020."

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Mr. Mihaljevic said he sees further “low-hanging fruit” to add value to Alacer, noting: “With market focus having been (and still is) directly tied to the Sulfides project, we believe the ongoing operational outperformance of the Oxides and potential mine life extension has been largely overlooked by investors. Along with increasing 2019 production on the back of improved guidance, we have also incorporated the potential 20 Mt leach pad expansion, including assumed developed of Ardich as well as modest ongoing near-pit exploration success. While less impactful to overall value than the sulfides, near-mine oxide success can add real value, generate strong returns, and bolster the medium-term production/cash flow profile.”

Maintaining an “outperform” rating for Alacer stock, he increased his target to $5.50 from $4. The average is $4.64.

“Year-to-date, Alacer’s shares have materially outperformed precious metals peers given successful ramp-up of the Sulfides project,” the analyst said. “While the risk/reward proposition is more balanced than it was in late-2018, we still see the potential for further share price upside as the Sulfides project approaches steady state, Oxide life is extended, and the balance sheet is de-levered.”

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After a recent tour of its Ontario assets, Mr. Mihaljevic thinks Alamos Gold Inc. (AGI-N, AGI-T) is likely to endure a “year in transition” in 2019 that will set the stage for production growth in the second half of 2020 with the completion of a number of key projections.

“This includes completion of the lower mine tie-in at Young-Davidson and construction of the Kirazli project in Turkey and Cerro Pelon project in Mexico which are anticipated to come online by the end of 2020,” said Mr. Mihaljevic. “This is forecast to drive production growth to 600,000 ounces at AISC of $825/oz in 2021 from 495,000 ounces at $945 per ounce in 2019, with the potential for further growth through 2024. As a result, we expect a free cash flow inflection in late-2020, ramping up to $160-million in 2021 versus an average of negative $40-million generated in 2019/20.”

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Though he sees an operating inflection point on the horizon for its Young-Davidson mine in Ontario, he maintained a “sector perform” rating and US$5.50 for Alamos shares. The average is US$6.38.

“With ongoing investor focus on free cash flow generation, we believe Alamos will be challenged to outperform peers until tie-in of the lower mine at Young-Davidson nears completion, the Phase II expansion at Island is executed, and the Kirazli project is successfully ramped-up, which we expect by late-2020," he said.

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In other analyst actions:

Acumen Capital analyst Brian Pow resumed coverage of Alaris Royalty Corp. (AD-T) after a $100-million convertible debenture financing with a “buy” rating and $23.50 target. The average target on the Street is $20.89.

“With an attractive valuation, dividend yield, and potential near-term deployment catalysts, we reiterate our BUY Rating,” said Mr. Pow. “As in the past, AD has the potential to exceed our modest outlook for gross annual deployment which provides further upside to our estimates and the share price.”

JPMorgan upgraded Gibson Energy Inc. (GEI-T) to “overweight” from “neutral” with a $27 target, rising from $26 and above the $25.07 consensus.

National Bank Financial analyst Matt Kornack resumed coverage of BTB Real Estate Investment Trust (BTB-UN-T) with a “sector perform” rating and $4.65 target. The average is $4.55.

Editor’s note: In an earlier version of this article, Acumen's target price for Alaris was incorrect. It has been updated.
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