Eight Capital slashed price targets for the majority of Canadian licensed cannabis producers (LPs) that it covers on Monday, as the Canadian market shifts from anticipation to execution and investor attention turns to U.S. multi-state operators.
The analyst report, which accompanied initiating coverage of Cresco Labs Inc., Cannex Capital Holdings Inc. and iAnthus Capital Holdings, cut price targets for Tilray Inc. from $85 to $55, Cronos Group Inc. from $24 to $19, and Emerald Health Therapeutics Inc. from $6 to $4.25.
“We are also lowering our target prices on APHA, CRON, FIRE, TRST, WMD and ZENA by 15%, 21%, 14%, 35%, 33% and 34%, respectively,” wrote analysts Graeme Kreindler, William Haynes and Patrick Sullivan.
Eight Capital’s price targets for Canopy Growth Corp. and Aurora Cannabis Inc. remain unchanged, while Organigram Holdings Inc. was the one Canadian LP to get a price target bump, from $12 to $14, “due to the Company's strong execution to date, including industry-leading gross margins.”
(AltaCorp. also initiated coverage of Organigram on Monday with an Outperform rating and a $13.30 price target.)
Eight Capital’s repricing stems from a shift in methodology, with the analysts focusing solely on 2021E EV/EBITDA; previously they used a blend of 2021E EV/EBITDA and 2020E EV/Sales.
At the heart of the report, titled “Time to Look at the $275 B Arb Opportunity in the US,” was an analysis of the market opportunities in Canada versus the U.S. Here are some key takeaways:
U.S. is primed for growth; Canada, not so much
Despite having a much a larger addressable market and better ability to create brands and vertically integrated supply chains, U.S. MSOs trade at a discount to Canadian LPs. This creates a $275-billion arbitrage opportunity, the analysts wrote.
“There is no doubt that valuations favour US MSOs over the Canadian counterparts (2020E EV/EBITDA average of 10.9x for US MSOs vs. 32.3x for Canadian LPs),” the analysts wrote. “We expect that over time this gap will decrease. What remains uncertain is whether the US multiple will rise to the Canadian level, or whether these multiples will meet somewhere in the middle.”
There’s certainly more room for growth on the U.S. side of the border. The analysts project that the combined market cap for MSOs could increase to as much as US$315 billion in the coming years, 14 times what it is today. By contrast, Canadian LPs, with a combined market cap of around $55 billion, already have most of their growth priced into current valuations.
“As witnessed in Canada, the prospect for incremental value creation stemming from broad scale deregulation is immense. We believe that the US market has yet to experience such a step-like growth in market value.”
Where can LPs still capture value?
Despite the widespread price target trim, Eight Capital still expects some Canadian LPs to find places for growth. Expansion into international medical markets is one path forward— although Mr. Kreindler, Mr. Haynes and Mr. Sullivan warn that “the ability to accurately predict not only which country will be next, but at what time frame, remains a speculative and highly expensive exercise.”
Beyond global medical markets, there are opportunities related to biosynthesis, clinical trials, and intellectual property development. “With respect to these early-stage initiatives, we favour well capitalized Canadian LPs that have significant resources to fund these more speculative initiatives, while also maintaining and growing their core operations in Canada,” the analysts wrote.
Shorter-term, positive catalysts include the legalization of value-added products in Canada, and the opening of more retail stores as more supply comes online. The analysts predict that 350 brick and mortar stores could be open across the country by the end of the year, up from 273 today.
Consolidation is coming
The analysts predict that “the cannabis industry will eventually reach a point where 3- 4 operators control 70%-90% of the market share.” This gives a growth runway for top performing LPs. (Their price target for Canopy is still $100 and their target for Aurora is $15).
The coming consolidation, however, may not bode well for small and midsize LPs. Recent M&A activity in Canada – HEXO’s acquisition of Newstrike and Supreme’s acquisition of BlissCo. – was done with essentially no premium.
“We believe these transactions have negative read-through for smaller and undifferentiated Canadian LPs, as the thesis of an eventual buyer taking the Company out at a higher price than awarded in the market has been weakened based on transaction precedent,” the analysts wrote.
Division in trading
To date, MSO stocks have traded largely in line with their Canadian counterparts. The analysts expect this to change, “due to an increasing appreciation of the unique risks, regulatory regimes and catalysts that underlies each asset class.”
“During a time of Speculation, the prospects of what can be continue to outweigh the reality of what currently is. The fragmented US market creates an interesting dynamic where MSOs can demonstrate execution in more mature markets, while continuing to amass licenses in earlier stage or underserviced states,” the analysts wrote.
“Our belief is that investors should strike the right balance between demonstrated ability to execute in today's conditions with an eye for those operators that are building businesses for long-term success.”
In line with this expectation, Eight Capital began coverage of Cresco, Cannex and iAnthus with Buy ratings.
- Cresco: $20 target price, based on 25x 2020E EBITDA of $210-million.
- Cannex: $3 target price, based on 15x 2021E EBITDA of US$94-million.
- iAnthus: $12 target price, based on 20x 2020E EBITDA of US$96-million.