The cannabis sector faces headwinds but watch these two stocks: Echelon

Tightening capital markets mean both risks and opportunities for publicly listed cannabis companies, says Echelon Capital Markets analyst Andrew Semple.

In a research report to clients March 16, Semple characterized the space as one with significant challenges -and some opportunities.

“Q422 earnings season is roughly halfway complete for our coverage names, and results have been generally muted,” the analyst noted. “Significant cannabis price declines in the US, which appear to have been accelerated in the latter half of Q422, have weighed on the expected pace of growth and management teams’ outlooks for 2023. Forward estimates continued to decline as these pricing pressures have been carried forward to 2023, and competition is expected to remain stiff. We expect smaller privately held businesses to gradually exit the market, allowing larger and better-capitalized companies to win back some market share (in the absence of federal reform).

Semple says a consolidation has begun and there are green shoots that are becoming evident.

This process is already well underway in Canada but will take some time to be apparent in the US. Encouragingly, for the first time in months, US management teams are beginning to speak of early signs of cannabis price stability in key markets, as operators turn their focus toward optimizing existing facilities rather than adding new production capacity. We believe this indicates better opportunities for financial performance to exceed expectations in quarters ahead, especially as we move past the seasonally slow Q1 period.”

The Echelon analyst says he is keeping an eye, in particular on two names in the sector that he considers top picks.

“We highlight our two Q123 Top Picks – Verano Holdings (VRNO-CSE, $4.20, Buy, PT $17.00) and High Tide (HITI-TSXV, $1.44, Speculative Buy, PT $10.00) – as two companies warranting extra investor attention due to their solid operating track records, bolstered balance sheets, and attractive valuations,” Semple wrote. “Verano offers an attractive unlevered FCF yield of 10.4% in 2023, including at an annualized rate of 16.5% in H223. High Tide will continue to amass market share in the Canadian retail vertical, driven by its successful discount club model, new store openings, and likely further acquisitions. Both companies report financial results this month, with High Tide reporting after market close on March 17 and Verano issuing Q422 results on March 30.”