Cannabis should rebound in 2020, according to investment bankers Stifel Canada which on Tuesday released their Top Picks for the year ahead, including a number of Canadian and US cannabis and healthcare companies in the mix.
2019 was a watershed year for cannabis, no doubt, with Canada experiencing its first full year of adult-use legalization and pot stocks both north and south of the border climbing higher over the first stretch of the year only to fall hard in later months.
Canadian licensed producers struggled over the second half of the year with product bottlenecks, dropping wholesale prices and too-few retail outlets open across the country. But 2020 comes with renewed hopes as derivative products like edibles and drinks make their way onto store shelves.
And Stifel analysts Justin Keywood, Robert Fagan and Andrew Partheniou say that this next phase in the pot industry’s development, so-called Cannabis 2.0, will not only potentially double the addressable market but will likely bring with it better pricing and margin profiles. That combined with a better regulatory environment in Ontario should make for clearer skies ahead for Canadian pot companies, says Stifel.
“Canada’s REC market has recently faced logistical challenges and inventory levels across the value chain mismatching demand patterns, impacting LP performance. However, we believe these headwinds are set to diminish alongside the release of 2.0 products and broadening retail networks. Hence, we remain more optimistic for improving fundamentals in 2020 for Canadian LPs,” the Stifel analysts wrote.
As for particular names, the analysts have chosen Edmonton-based cannabis retailer Fire & Flower (Fire & Flower Stock Quote, Chart, News TSX:FAF) as their Top Pick in the cannabis sector, saying that with the Ontario market opening up — the current 25 stores could become 250 by the end of this year and potentially to 800 in total — FAF should be a large beneficiary, as it already has 13 strategic lease locations in high traffic areas in the province (mainly in Toronto). The analysts also mention that FAF has the strategic support of Alimentation Couche-Tard to help with execution.
“We expect FAF to expand its store network from 30 at Q3/F2019 to 45 by Q4/F2019 and 110 by F2021. Our F2021 estimate is slightly more conservative than FAF’s guidance of 135 but still shows substantial operating leverage. Embedded in our forecasts includes FAF achieving profitable EBITDA by Q4/2020. Overall, we see a compelling investment case with the growth profile ahead and strategic support from Couche-Tard,” wrote Keywood.
Keywood thinks that FAF will generate fiscal 2020 revenue and adjusted EBITDA of $163 million and negative $1.3 million, respectively, while his “Buy” rating comes with a $2.25 target price, implying a projected 12-month return of 168 per cent at the time of publication.
As for US-based companies, the analysts see many of the challenges faced in 2019 — risks of Department of Justice intervention in M&A activity, the vaping illness outbreak and funding challenges — starting to fade in 2020, with market growth remaining robust across states such as Florida, Massachusetts, Pennsylvania and Nevada.
For the US market, analysts Fagan and Partheniou put both Curaleaf Holdings (Curaleaf Holdings Stock Quote, Chart, News CSE:CURA) and Green Thumb Industries (CSE:GTII) in their “Best Ideas” category.
On CURA, the analysts contend that the multi-state operator is positioned to lead in the Massachusetts recreational market and should capitalize on the Illinois rec market as well, while being fueled by CURA’s industry-leading cash position to further M&A activity.
“We continue to consider CURA as the most prolific acquirer in the industry, hence we view the company’s fortified balance sheet as a clear competitive advantage to fuel future value creation through M&A given the restrained funding environment facing most smaller operators now,” the analysts wrote.
CURA gets a “Buy” rating and $24.00 target, representing a projected return of 194.8 per cent at the time of publication.
Chicago-based Green Thumb Industries (Green Thumb Industries Stock Quote, Chart, News CSE:GTII) also gets the nod, a stock which outperformed most of its US cannabis peers in 2019 and should continue to do so, according to Fagan and Partheniou, who like the company’s superior operational execution, strong financial performance and a balance sheet positioned to drive value creation either by redeploying cash on existing platforms or by capitalizing on reduced industry valuations through M&A.
The analysts give GTII a “Buy” rating and $32.00 target, implying a 12-month projected return of 168.7 per cent at the time of publication.
Finally, in healthcare, Keywood likes specialty pharma company HLS Therapeutics (HLS Therapeutics Stock Quote, Chart, News TSX:HLS), which last week announced that Health Canada had approved its cardiovascular drug Vascepa. Keywood estimates that the target market for Vascepa in Canada is about two million patients, slightly better than his prior projections and implying that Vascepa could be worth $16 to $75 per share, incremental to HLS’ base business of primarily Clorazil at $10 per share.
Keywood rates HLS a “Buy” with a $32.00 target, implying a 31 per cent return at the time of publication.