With marijuana stocks seemingly making new highs on a daily basis, many are questioning whether or not many of them are overvalued. But M Partners analyst Mason Brown says that while it may seem intimidating to step in many cannabis stocks at this juncture, their rally will in fact continue.
In a research report to clients this morning, Brown addressed the issue of valuation in the sector in a piece entitled “Industry Valuation: How High is too High?”. Brown says it is natural that investors are raising questions about valuation, considering the fervor of the runup.
“Canadian LPs’ stock prices, along with other cannabis-related companies’ began to run up in October 2016 as the US presidential election and multiple states that were voting to legalize medical and/or rec cannabis brought about more exposure,” notes the analyst. “Stock prices have increased from the mid-double digits to low/mid-triple digits. Not surprisingly, this appreciation and daily new highs has many investors cautious.”
But Brown says the opportunity of the marijuana sector dwarfs the value of the present rally.
“We expect the rally to continue as the LPs push towards a $7.1-billion market and $32-billion aggregate valuation,” he says. “We estimate the aggregate enterprise value of the industry passes $30B as the Canadian cannabis industry matures, representing a 13.9% CAGR in aggregate industry enterprise value over the next eight years. Although public LPs have experienced significant price appreciation (and private LPs higher financing valuations), we believe the advance is substantiated by the long-term opportunity.”
Brown says he believes many are making the mistake of deriving the potential size of the market by comparing it to U.S states that have legaliazed cannabis. He explained why he feels this is a wrong-headed approach.
“We believe a number of likely outcomes will increase medical cannabis consumption long term and that these drivers will add material upside to our medical market estimates. First, it’s important to understand the methodology underpinning our $1.8B Canadian medical market estimate as well as an analyst’s approach to forecasting and updating estimates. Taking a more cautious approach, analysts tend to forecast and incorporate adjustments once they are ‘defendable’ and can be applied to the company level, and our medical estimate likely underestimates the medical market potential in Canada as it is largely based on data from US States that have medical programs that lack 1) federal support; 2) the backing of large clinical studies; 3) limited insurance coverage; 4) pharmacy participation.”
The analyst says upside will be driven by factors such as clinical research, more affordable pricing, greater accessibility, and the development of pharmaceutical formulations.
Brown singles out two companies in his coverage universe that he feels have the most upside, on a relative basis. The analyst says OrganiGram (TSXV:OGI) and Supreme Pharma (TSXV:SL) are both buys. He has a target of $4.20 on the former, which closed Friday at $2.60, and a target of $2.10 on the latter, which closed Friday at $1.70.