At one time, mainstream investment houses scoffed at cannabis companies. These were sketchy companies led by even shadier characters. There was no reason to get involved other than to tell their customers to stay away. In a few short years, that has all changed.
The New York Stock Exchange and the Nasdaq both list several Canadian cannabis companies, giving credibility and liquidity to these stocks. In addition to that, there are no cannabis mutual funds and only a small group of ETFs for investors to buy. This has led to more buying of individual stocks and a return of the retail trader. As a result, investment houses are taking a fresh look at the sector -- and the latest development is an initiation of coverage by Seaport Global Securities.
The company officially reviewed and rated several companies in the cannabis industry. Seaport analyst Brett Hundley and Luke Perda said that they expect to see the industry rise from $12 billion in value today to almost $630 billion in due time. They believe the market will separate into a retail model that focuses on adult use and a wellness group that specializes in consumer product and pharmaceutical products in more traditional channels. The analysts issued buy ratings on nine stocks, but noted four top picks out of the group with HEXO Corp. (HEXO) being the number one pick. The other top picks are Aphria (APHA) , Acreage Holdings (ACRGF) and The Green Organic Dutchman (TGODF) .
Seaport initiated coverage of HEXO with a Buy rating and a C$12 price target. The company is now at around C$7.53. Hundley said it likes HEXO for its "long-term strategy as a value-added cannabis ingredient company, the purposeful pursuit of a hub-and-spoke model, an early R&D effort to generate attractive IP and a favorable relative valuation." The price target was based on 30x the FY 2021 adjusted EBITDA estimate.
HEXO has about a 2.4% market share in Canada and none in the U.S., as yet. The hub and spoke model that the analyst referred to meant the joint ventures that HEXO has signed in order to leverage its capacity and create branded consumer products that can appear in a larger marketplace. For example, the company joined forces with Molson Coors Canada to create nonalcoholic infused cannabis drinks.
Hundley also liked that HEXO has "the ability and desire to combine with large pharmaceutical companies" to develop more-traditional style medicines. The company offers an Elixir cannabis product, which is a sublingual spray approved by Health Canada. They believe other pharmaceutical companies will turn to HEXO for partnerships.
The company is known for its low-cost production and access to processing space. It has stayed focused on processing capabilities and R&D, steering clear of over-supply issues that ultimately impact many of its peers. The analyst summed it up, saying, "As cannabis products become more mainstream, we expect branded CPG companies to develop products with the help of science-backed processors, like HEXO."
Coverage of Aphria Inc. was started with a Buy rating and $18 price target. The stock was lately trading at C$12.77. The analysts based this on 30x their FY 2021 EBITDA estimate. Hundley liked the company for "Its positioning as a low-cost Canadian LP, its attractive valuation, and its move to establish broad-based international relationships." Still, he didn't shy away from the controversy surrounding Aphria of late. They characterized it as a "bumpy ride."
Hundley wrote. "In early December, 2018, a pair of investment firms released a short thesis on the company, accusing Aphria of inflating results and/or the nature of operations for announced acquisitions, along with conducting transactions among related insider parties in order to increase personal wealth." One month later, Green Growth announced it wanted to acquire Aphria, but Aphria's board recommended that shareholders reject the offer as being too low. There was actually some whispering that the whole acquisition move was a way to jack up the price -- and if it was, it worked.
APHA shares have risen by 149%. The analysts ultimately said, "We believe that the APHA team is comprised of good people, and we believe that they care about strong internal controls, transparency and culture. Leamington (where the greenhouse is located) is very much a farming community, and we believe that company founders take pride in giving back to the community and its people."
Aphria has a 9.5% share of the Canadian market. The company has "built out the structures for greenhouse capacity that will give it a little over 2.4 million sq. ft. of production space in Canada. Pending various Health Canada approvals, production is expected to come online into 2020. Through its purchase of LATAM Holdings, the company also has cultivation opportunities in Colombia and Jamaica."
There is one U.S.-based company in Seaport's top four list -- Acreage Holdings Inc. The analysts give it a Buy rating and C$42 price target, also based on 30x their 2020 EBITDA estimate. The stock recently traded at C$17.40. Hundley said he liked Acreage for "its market positioning as a U.S. MSO (multi-state operator), its dual strategy of wholesale and retail production, its influential board of directors and the strategic nature of its Form Factory acquisition."
Seaport said that it expects Acreage to end 2018 with 19 stores in operation, rising to 56 stores by the end of 2019, and 79 stores during 2020. The company's retail division is called "The Botanist" and is geared to be used by both medicinal and adult-use cannabis consumers. There are Botanist stores in Maryland, New York, Massachusetts and North Dakota. Botanist Ohio has two locations open and three more planned. Hundley appreciated that Acreage is building a portfolio of brands that touch the beginner and connoisseur, while appealing to value and premium shoppers as well.
In December, Acreage acquired Form Factory for $160 million, giving the company access to processing assets in WA, OR and CA. "Today, Form Factory co-packs many different types of cannabis products for 15-20 brands, with an additional 20-35 brands in the onboarding and negotiation phases. Form Factory also holds key IP on encapsulation technologies, an important developing process that we detail in our Ingredients Guidebook," said Hundley. He added, "We believe that the addition of Form Factory will give Acreage the ability to build its own product brand(s) in many forms, while also helping to build relationships with developing third-party brands that might ultimately find greater success."
The Green Organic Dutchman
The Green Organic Dutchman may not have very much revenue, but that didn't stop Seaport from giving it a Buy rating and $10 price target. It recently traded at C$4.29. The analysts like TGODF's "positioning as an organic cannabis producer, its desire to develop IP around product attributes/delivery methods, and its attractive valuation." They believe that other consumer goods companies will turn to TGODF as a partner for food and beverage products.
While TGODF has been slow to get in the game, that hasn't stopped other cannabis companies like Aurora Cannabis from believing in the organic story. Aurora owns 10% of TGODF, which delivered only C$0.5 million in annual revenue during fiscal year 2018. That is expected to changed quickly -- and the analysts are estimating revenues to reach C$91.1 million in Fiscal Year 2019, C$557.3 million in FY 2020, and C$738.4million in FY 2021. The company is forecast to turn a profit in fiscal year 2020.
TGODF acquired HemPoland as a way into the European market and has a joint venture for its entry into Latin America. However, the real story is its organic cannabis oil and products. The company hopes to be the main supplier of this product to those within the cannabis industry, as well as those on the outside in mainstream industries.
Hundley wrote, "We believe that TGOD will prove to be superior to a number of companies across the entire space, in part due to its growing size, its leadership position in organic cannabis and its work around IP development. Thus, we believe that TGODF deserves a forward multiple of 30.0x against EBITDA, equating to a price target of $10 for the stock."