Author: Colin Tang, B.Com

Below is the performance of the Horizons Marijuana Life Sciences Index ETF (TSX: HMMJ / “HMMJ”) as a proxy for sentiment of the cannabis market.

Horizons Marijuana Life Sciences Index ETF

Horizons Marijuana Life Sciences Index ETF

Source: Google

Horizons Marijuana Life Sciences Index ETF

Source: Google

The HMMJ is currently trading at $8.76, a week-over-week increase of 5.68%. Over a one-year period, the HMMJ has lost 53% in value. Currently, the HMMJ is trading 8.15% above its 52-week low of $8.10. Today, cannabis stocks witnessed a bounce in their share price due to what we believe to be an anticipation for Aphria’s earnings report (due January 14, 2020 pre-market), and the further support for cannabis legalization in numerous U.S. states.  First, we discuss expectations on Aphria’s upcoming earnings report and then touch on cannabis legalization in the United States.

Aphria Inc.

Aphria is expected to release its fiscal Q2-2019 on January 14, 2020. Over the past two earnings reports by Aphria, the company delivered relatively strong financial results. In fact, in 2019, Aphria was the first Canadian cannabis company to report a net profit. In a cannabis market that currently has overwhelmingly poor market sentiment, companies that are able to show profitability stand a cut above the rest.

Come this fiscal Q2-2019 earnings result by Aphria, Zacks consensus estimates call for a quarterly loss of $0.02 per share. In addition, Aphria is expected to post revenue of $130.3 million for fiscal Q2-2019 – a 3.3% quarter-over-quarter (“QoQ”) increase. Given that dried cannabis flower sales in Canada over the past couple of months have not shown significant growth, we do not expect to see strong upside in sales from Aphria. We stress the importance of this earnings report by Aphria, as it would provide further insight into pricing pressure in the Canadian cannabis market. In addition, this earnings result is expected to provide preliminary insight into the attractiveness of dried cannabis flower in Europe. Given that Aphria operates in Germany through CC Pharma GmbH, it would be of great interest to see how demand is fairing in Europe. Our research has pointed to Europe as being the largest market for cannabis over the long-term. As we have mentioned, Aphria is expected to report their financial results before markets open on January 14, 2020 – we urge readers to tune in. We will provide a discussion on their financial results in our next Analyst Ideas of the Week (“AIW”).

Legalization of Cannabis in the United States

According to Marijuana Business Daily (“MBD”), up to a dozen states could legalize adult-use or medical cannabis in 2020. As we have previously mentioned, a domino effect in the United States is expected to result in a myriad of states legalizing cannabis in the medium-term. The following are key states to watch in 2020.

These states include:

Dozen states could legalize adult-use or medical cannabis in 2020

The states above are expected to comprise 17% of the U.S. population (of 330 million), representing a notable target market. As more states establish an adult-use cannabis market, we expect this to help form a baseline of growth for cannabis companies.

To illustrate how the legalization of adult-use cannabis in U.S. states may improve cannabis market sentiment, we turn to the state of Illinois. At the start of the year, the state of Illinois legalized adult-use cannabis. According to the Chicago Sun Times, the first five days of recreational cannabis legalization resulted in over US$10.8 million ($14.10 million) worth of cannabis products sales. This can be compared to Canada, which sold $43 million in the first two weeks after legalization (Source: Global News) of dried cannabis flower. Readers should note that the population of Illinois (of 12.70 million) is a third of Canada (of 37.59 million). Although the cannabis usage rate is expected to differ in different states, we reiterate our view that demand for cannabis in the U.S. is expected to be strong.

In significant U.S. cannabis legalization news, Andrew Cuomo (governor of New York) recently highlighted the legalization of adult-use cannabis as one of his 2020 priorities (Source: CNN). Given that the state of New York has a population of roughly 19.49 million, we believe the legalization of cannabis in New York for adult-use would open a huge addressable target market for cannabis companies. With that said, there is strong opposition regarding the legalization of cannabis in New York. The main concern regarding the legalization of cannabis in New York, we believe, are related to weed-fueled drugged driving and youth marijuana use (Source: Evening Tribune). Currently, of the top five states by population in the U.S., only one state has legalized cannabis for recreational purposes (California).

Top five states by population in the U.S.

Source: worldpopulationreview.com, FRC

Performance of Select Canadian LPs

The following shows the performance of select Canadian LPs on a year-to-date (“YTD”) 1-month, 6-months, and 1-year basis.

Performance of Select Canadian LPs

Source: Google

The average YTD, 1-month, 6-months and 1-year returns were -0.97%, -0.83%, -55.20% and -61.38%, respectively. The worst performers on a YTD basis were Aurora Cannabis Inc. (“Aurora”) and The Supreme Cannabis Co., Inc. (“Supreme Cannabis Company”).

  • Aurora: There has been growing concerns whether Aurora will be able to satisfy its debt covenants on a $360 million loan that is due August 2021. Recently, Aurora faced a downgrade from Bank of America analyst Christopher Carey due to balance sheet risk.
  • Supreme Cannabis Company: The Chief Executive Officer (“CEO”) of Supreme Cannabis Company, Navdeep Dhaliwal, parted ways with the company on January 6, 2020.

Valuation of Select Canadian LPs

The following shows the average Enterprise Value to Revenue (“EV/R”) that cannabis companies are currently trading at. The companies used in the chart below are outlined further below.

Valuation of Select Canadian LPs

Source: FRC, S&P Capital IQ

Valuation of Select Canadian LPs

Source: FRC, S&P Capital IQ

The average EV/R, as of January 13, 2020, was 11.5x – a decrease from an average EV/R of 12.5x on January 6, 2020. As a number of companies are not EBITDA positive, we have refrained from tracking the average Enterprise Value to EBITDA (“EV/EBITDA”).

In the following, we provide commentary on Canadian retail cannabis pricing.

Canadian Retail Cannabis Pricing

Canadian Retail Cannabis Pricing

Source: Online Provincial Cannabis Store, FRC

Canadian Retail Cannabis Pricing

Source: Online Provincial Cannabis Store, FRC

As expected, the average retail price per gram decreased from $11.63 to $11.57 – a week-over-week decrease of 0.55%. The largest retail price per gram decreases were witnessed in the provinces/territories of Yukon (of -3.08%), British Columbia (of -2.39%) and New Brunswick (of -1.77%). This was slightly offset by a retail price per gram increase in Alberta (of 0.25%). The other provinces/territories witnessed a nominal week-over-week increase/decrease in their retail price per gram. Over the long-term, to combat the black market for cannabis, we expect retail price per gram to continually decline nationwide.

With cannabis edibles and other alternative products hitting shelves across cannabis retail stores in Canada, our research has indicated that many cannabis consumers are complaining about pricing, product accessibility, and quality. Below, we give our brief take.

Although we are not qualified to speak on the quality of cannabis edibles, we acknowledge that pricing and product accessibility are pertinent issues. For example, using the British Columbia (“B.C.”) cannabis store as a proxy for prices of cannabis edibles, pricing for edibles with 10.0 mg of THC ranged from $5.99 to $9.99.

B.C. Cannabis Store

B.C. Cannabis Store

Source: https://www.bccannabisstores.com/collections/all-edibles

Through our research, we have found cannabis edibles on other online cannabis stores (which are technically illegal to purchase from) with a THC content of 100.0 mg sell for $9 – $15. As such, cannabis edibles purchased from the black market have a significantly higher THC content while only being slightly more expensive.  Until the retail price for cannabis edibles greatly diminishes, we fail to see a scenario where legal retailers will be able to compete effectively against the black market for cannabis edibles. We continually expect price-sensitive consumers to purchase cannabis edibles illegally.

In terms of product accessibility, several news outlets have pointed to a lack of available supply for consumers. For example, Lana Paraskevopoulos (general manager of Canvas Cannabis) told reporters of the Toronto Sun that “some products [sell] out within one or two hours.” In addition, as readers can see from the image above, the selection of cannabis edibles seems to be severely limited. At the moment, we believe the roll-out of cannabis edibles, and alternative cannabis products, appears to closely align to the initial roll-out of dried cannabis flower – a disaster.

The below chart shows Canadian retail cannabis pricing since we began price coverage.

FRC, Online Provincial Cannabis Store

Source: FRC, Online Provincial Cannabis Store