Analysts at Stifel said in a note to clients Monday that the underperformance of the cannabis sector was well-founded with the category’s risks on full display in 2022.
In its latest monthly review of the sector, the broker pointed out that in the year to date the average cannabis stock is down 62%, adding this reflected oversupply, limited differentiation, uneven enforcement against the illicit market, regulatory risk, and outsized exposure to lower-income consumers.
For the three months ending September 2022, it estimated the North American regulated cannabis market declined 1% with growth from the Canadian adult use market (+13%) offsetting a decline from the US state-licensed market (-2%).
READ: Biden to pardon all prior federal offenses for simple marijuana possession, sending cannabis stocks soaring
Green Thumb Industries Inc. (CSE:GTII, OTCQX:GTBIF) remains the broker’s top MSO pick, it said, with strong cash flow and a robust balance sheet with GTII uniquely positioned to capitalize on every recreational catalyst.
While the latest data show some positive signs for the hydroponics category, conditions remain difficult pointing to still significant oversupply, the broker said, adding it does not believe the category will return to growth until calendar 2Q23.
WM Technology’s key end markets continue to be under pressure with declining store productivity (revenue-per-store -17% y/y) underscoring the challenges for operators, Stifel commented, adding headset data outlines an uneven performance for Canadian producers while continuing to highlight an irrational, increasingly competitive market.
The broker kept its sell rating for Canopy Growth Corporation (TSX:WEED, NYSE:CGC), noting significant ongoing cash needs and balance sheet risk.
While President Biden’s cannabis announcement drove significant advances for the sector, Stifel said it believed the strength was the consequence of inefficient flows colliding with overwhelming negative investor sentiment.
Stifel said it felt Biden’s pardon for simple marijuana possession was a token gesture given an overwhelming majority of simple marijuana possessions arrests occur at the state local level. And it noted the pardon does not explicitly include expungement.
But it accepted that Democrats who have espoused progressive rhetoric around cannabis reform may use this as a cover to accept the SAFE Act although Republican Senate support is still in question.
Stifel also noted that with continued headlines likely, taking an overwhelmingly negative approach on the sector carries heightened risk especially as the short case for some names is compelling, but requires economic reality to take its full toll.
Contact the author at jeremy@proactiveinvestors.com