Cannabis stocks won’t recover until the fourth quarter of 2020: Raymond James

It’s the burning question on everyone’s mind: will cannabis stocks recover?

Like it or not, cannabis is here to stay in Canada and while 2019 proved to be a year of reckoning for weed stocks across the board, 2020 should bring some light at the end of the tunnel.

So says Raymond James analyst Rahul Sarugaser, who on Monday delivered a report to clients on dynamics likely to impact cannabis in 2020.

Sarugaser says that for a number of smaller operations, the year will mean bankruptcy while for others, it won’t be until later months of the year that stocks will start picking up again.

While maybe inevitable, the bursting of the pot bubble in 2019 was certainly a notable feature of the Canadian marketplace, where many high-performing names such as Canopy Growth (Canopy Growth Stock Quote, Chart, News TSX:WEED), Aurora Cannabis (Aurora Cannabis Stock Quote, Chart, News TSX:ACB), Cronos Group (Cronos Group Stock Quote, Chart, News TSX:CRON) and Tilray (Tilray Stock Quote, Chart, News NASDAQ:TLRY) experienced huge losses, some seeing their share prices cut in half or more over the second half of the year.

Some of the blame has been placed on the hype machine surrounding pot’s emergence as a legit industry but the comedown also relates to a slower-than-expected rollout of retail cannabis stores across the country, particularly in Ontario, home to 40 per cent of the population but where only a handful of stores have so far been opened. By the numbers, Alberta has about 11,500 people per cannabis retail outlet, California has about 61,500 but Ontario at the end of the year had as much as 540,000 people per store.

Sarugaser says the Ontario government’s more recent move to opening up the field across the province will do a lot to help companies struggling with too much supply which has driven down the average price of wholesale cannabis. The analyst points to one bellwether company, Village Farms (Village Farms Stock Quote, Chart, News TSX:VFF), whose Pure Sunfarms 50-per-cent owned business has seen its wholesale prices drop from about $4 per gram in Q1 of 2019 to about $2.00 per gram by Q3 and, anecdotally, according to Sarugaser, has even gone as low as $1.00 per gram in the fourth quarter.

The supply bottleneck will eventually get relieved but the results won’t feature positively in the respective top lines of Canadian licensed producers until the second half of 2020 and most likely during the fourth quarter, says Sarugaser, by which time some of the smaller and less well-funded companies will have bit the dust.

Cannabis stocks will diverge into winners and losers in 2020…

“By 4Q20, we anticipate much of the bloodletting—and resulting attrition of poorer operators —will have run its course. At the very least, we expect a wide, clear divergence to emerge between well-run, well-capitalized, strategically adept operators, and those that are doomed to fail,” Sarugaser wrote.

“For those strong operators, we anticipate Cannabis 2.0 revenues will start to make a material contribution to their net revenues in 4Q20. For some players, we expect this boost in net revenue will be further accelerated by extra-Canadian income (derived from U.S. CBD first, international medical cannabis next). We anticipate this succession of destructive and constructive dynamics giving rise to a material rebound among a small sub-set of strong operators in the sector during 4Q20.,” Sarugaser said.

For the lucky few, Sarugaser says a few key features will be needed in order to find success in cannabis, including, having a strong balance sheet with at least 18 to 24 months of runway (the analyst points to Cronos as doing well in this regard); being asset-light with respect to cultivation and thus leaving a company to take advantage of the currently cheap wholesale market (again, Cronos gets the nod here); growing adult-use sales into provincial distributors (Sarugaser points to Village Farms in this respect); strong medical sales and category-leading products and brands to leverage innovative technologies (here, the analyst points out Cronos and Organigram (Organigram Stock Quote, Chart, News TSX:OGI).

Sarugaser also sees an active international presence, particularly in the US, where both Canopy Growth and Cronos have already launched brands.