A pessimistic stock analyst from Veritas Investment Research is initiating his coverage of Canada’s cannabis stocks with four Sell ratings on Canopy Growth (NYSE:CGC), Aphria (OTCMKTS:APHQF), Aurora Cannabis (OTCMKTS:ACBFF) and Cronos Group (NASDAQ:CRON).
In a note dubbed “End of the Rainbow”, Veritas’s Stuart Rolfe write that he believes Canada’s cannabis industry “looks wildly overvalued” even if 60% of the country’s black market converts to legal sales following the country’s legalization of recreational marijuana next week.
Rolfe makes the point that eager investors have already driven stock valuations for the eight-largest publicly-traded Canadian cannabis producers to a combined market cap of $55 billion on trailing twelve months sales of $250 million at a time when “oversupply risks are rampant”.
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“Our analysis suggests that the market still lacks perspective when it comes to the size, shape and sustainability of Canada’s proverbial pot of gold,” argues Rolfe.
Uncertain pricing, the presence of a hyper-competitive black market and inordinately high expectations for profits are just three of the factors leading Rolfe to conclude that Canadian cannabis valuations are “at risk of falling precipitously.”
Canopy Growth has much to lose if markets disappoint
Drilling down to the details, Rolfe views the medical marijuana company Canopy Growth as having an intrinsic value of C$30, per a report in the business news site TheFly. He thinks the Ontario-based company seems to have “the most to lose if market conditions disappoint” as it “bet heavily on brand power and novel formulations”. While Canopy is “well-positioned” for scale and should get its product to customers, Rolfe argues that its branding efforts might draw negative attention from regulators. Canopy’s cost disclosures are also among the “least compelling and perhaps least consistent,” according to Rolfe.
Move onto Aphria and Rolfe takes a more sympathetic view, calling the company a “star unicorn” and praising its useful disclosure on strategies and operations. Rolphe says Aphria’s focus on cost management, cash-flow generation and accounting bodes well for its performance. He also thinks Aphria is “best positioned” to become a takeout candidate if industry consolidation gathers pace. Rolfe sets its price target at C$19.
Aurora suffers from being a 'touch unfocused'
The analyst’s take on Aurora, meanwhile, remains mixed, according to TheFly. Via acquisitions, Aurora has morphed into one of the largest scale bets on cannabis capacity available to investors, but its approach seems to be “a touch unfocused”, according to Rolfe. The company’s loss of momentum has corrected its valuation. But the capacity Aurora has built through a string of acquisitions is “remarkable” and could pose a threat to competitors. Rolfe sets the target at C$13 for Aurora shares.
Lastly, Rolfe adopts a harsher view of Cronos Group, calling it “an undifferentiated grower” with a few “solid” cannabis-related investments. Rolfe stresses that some of Cronos’s investments may be plateauing and not adding growth. Without an “ahead-of-the-game” strategy for its capital deployment, he sees few upside catalysts for the Toronto-based company. While its current capabilities are “overvalued”, Cronos might be able to benefit, however, by pushing further internationally and into the market for medical cannabis. Rolfe sets a price target of $4.50 for Cronos shares.
Cronos shares traded nearly 7% higher at $9.66 in Friday’s afternoon trade while Aphria shares fell 2.5% to $14.72. Aurora Cannabis shares picked up 5.25% to hit $10.22 and Canopy Growth added 4.2% to reach $49.15.
Contact Ellen Kelleher at ellen@proactiveinvestors.com