Industrial Alliance In a research report titled The States Are High, Industrial Alliance Securities analyst Nav Malik introduced coverage of the U.S. cannabis industry on Monday, expecting continued expansion of the legalized adult-use market.
"Public support for cannabis legalization is gaining momentum with a majority of both Republicans and Democrats in favour," he said. "We expect additional states will legalize adult-use sales (New York, Arizona, and New Jersey are likely over the next 24 months). Federally, two key initiatives - the SAFE Banking Act, and the STATES Act - would have a positive impact on the industry and on U.S. cannabis valuations."
"Legal U.S. cannabis sales are currently around $11-billion. However, we estimate the total size of the industry (i.e., legal and black market) to be upwards of $75-100-billion. As such, we believe legal cannabis sales will demonstrate extremely strong growth over the next few years as more states move to allow medical and recreational adult-use, and the legal market gains share over the black market. In addition, cannabis products have the potential to disrupt large, established industries including the $250-billion beer, wine, and spirits market; the $120-billion tobacco market; and the $330-billion prescription drugs industry."
Mr. Malik initiated coverage of both Harvest Harvest Health & Recreation Inc. (HARV-CN) and MedMen Enterprises Inc. (MMEN-CN) with "buy" ratings, noting valuation multiples across the U.S. cannabis sector have the potential for expansion as additional regulator reforms are made at both the state and federal level.
"U.S. MSOs [multi-state operators] trade at a significant discount to Canadian cannabis companies," he said. "On an EV/Sales (2020 estimated) basis, U.S. MSOs are trading at 3.7 times, a 62-per-cent discount compared with Canadian large cap cannabis companies trading at 9.8 times. In terms of EV/EBITDA (2020E), U.S. MSOs are trading at 12.0 times, a 57-per-cent discount to Canadian cannabis companies trading at 28.0 times. The discount likely reflects the difference in the federal legal status between the two countries, and therefore the perception of an elevated risk profile for U.S. cannabis companies. The valuation gap will likely narrow as additional states move to legalize cannabis, and if key federal initiatives in the U.S. are enacted."
Mr. Malik expects Tempe, Ariz.-based Harvest Health to see "strong" growth as it utilizes existing licenses and expands its cultivation capacity. He's forecasting the company to increase its retail locations from 36 currently to 94 by the end of 2019 and 140 by the end of 2020. He's projecting 181-per-cent revenue growth from 2019 to 2020 (US$326-million to US$914-million).
"Harvest is one of the largest MSOs in the US and holds licenses in a number of attractive markets," he said. "We are forecasting strong growth as the Company operationalizes existing licenses, establishing one of the largest vertically integrated footprints of any MSO. Upcoming sales of CBD products provide additional growth potential."
He set a target for Harvest Health shares of $19. The average target on the Street is $19.42, according to Thomson Reuters Eikon data.
Mr. Malik thinks Culver City, Cal.-based MedMen has established one of the "strongest" brands in the cannabis industry, and expects strong growth to continue. He's projecting an increase in its retail stores across 12 states to 85 by the end of 2021 from 37 currently.
"MedMen has developed one of the most recognized brands in the cannabis industry by delivering a premium retail experience and through impactful marketing. The Company has established a network of high profile retail locations and we are forecasting strong growth as it continues to deepen its presence in key markets. In addition, MedMen is driving margins by expanding its cultivation capacity and increasing sales of products produced in-house."
Mr. Malik set a target price of $6, which falls short of the $8.46 average.