MKM Initiates Mixed Coverage Of The Cannabis Sector, Most Bullish On Hexo

The cannabis group received more attention from Wall Street when a top firm initiated coverage on eight cannabis stocks. However, the analyst coverage is mixed, suggesting stock selection is critical for cannabis investors.

The Analyst

MKM Partners analyst Bill Kirk initiated coverage of the following stocks:

• Acreage Holdings Inc ACRGF, Buy rating, $17 target.
• Canopy Growth Corp CGC, Neutral rating, C$33 ($24.85) target.
• Curaleaf Holdings Inc CURLF, Sell rating, C$5 ($3.77) target.
• Constellation Brands, Inc. STZ, Buy rating, $263 target.
• Hexo Corp HEXO, Buy rating, CA$12 ($9.04) target.
• Tilray Inc TLRY, Neutral rating, $34 target.
• Cronos Group Inc CRON, Neutral rating, CA$14 ($10.54) target.
• Aurora Cannabis Inc ACB, Sell rating, CA$5 ($3.77) target.

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The Theses

Here’s a sampling of what Kirk had to say about each name.

Acreage: Kirk said the conditional Canopy buyout implies Acreage shares are currently significantly undervalued.

“A contractual 0.5818 exchange for Canopy shares on 142.6mn Acreage shares implies a ~US$17 value for ACRG, compared to the current Acreage share price of ~$8,” Kirk wrote.

He said there is certainly uncertainty surrounding U.S. legalization, but not enough uncertainty to justify a roughly 50% discount to the buyout price.

Canopy Growth: Kirk said financial support from Constellation is helpful, but Canopy will likely continue to deal with cultivation growing pains.

“Unlike market expectations, we do not expect Canopy to become a profitable organization by FY2022 (on EPS),” Kirk wrote.

However, he said Constellation’s influence could help improve efficiency over time.

Curaleaf: Kirk said there is a storm brewing in Curaleaf’s primary market in Florida, and not the good kind of storm.

“The majority of Curaleaf retail sales are derived from Florida (59% of company dispensaries; ~30% pro-forma recent acquisitions), a state that is showing declining store productivity (mgs THC sold/location) in part due to dispensary growth in excess of patient growth (~200% vs. ~130% y/y, respectively),” Kirk wrote.

He said buyouts of Select and Grassroots will help with geographical diversification, but Curaleaf’s valuation still looks steep given its relatively small number of dispensaries.

Constellation: Kirk said this alcohol producer offers investors a unique play on the cannabis space given its cash flow from its alcohol business and its financial flexibility. Kirk said about 50% of Canopy’s current losses are due to stock-based compensation, a problem Constellation can easily tackle.

“We believe STZ will remedy this compensation discrepancy, losses at Canopy will lessen and investors will punish STZ less,” he wrote.

HEXO: Kirk sad HEXO is the best opportunity today to invest in an early cannabis brand leader.

“We believe HEXO’s approach to be the working component of expert partners’ products has the best chance of creating a defensible brand (‘Powered by HEXO’),” Kirk wrote.

While consensus Wall Street cannabis estimates are typically high across the board, Kirk said HEXO is not getting the benefit of the doubt for its 2020 revenue goal of C$400 million.

Tilray: Kirk said Tilray has a differentiated business model given its U.S. hemp seed food products push, but its’ valuation remains a headwind.

“Valuation is more reasonable (~13x EV/2023 EBITDA) than many peers, but next year’s (FY20) numbers are still too high in our view,” Kirk wrote.

He said Tilray’s deal for Manitoba Harvest opens the door for CBD-infused and potentially THC-infused food products.

Cronos: Kirk said Cronos will benefit from its Altria Group Inc MO partnership down the line, but it has plenty of obstacles in the near-term.

“As we monitor Cronos' supply chain and research progress, we can’t ignore that expectations for Canadian cultivators, including Cronos, are still too high, as more supply comes online,” Kirk wrote.

He said Altria and recent acquisition Redwood give Cronos a U.S. distribution advantage over peers in the event of legalization.

Aurora: Kirk said profitability for cultivators like Aurora will likely get worse in the near-term before it gets better given falling prices and rising production.

“In this light and with recent industry equity declines, we believe Aurora will have more difficulty refinancing some convertible notes coming due (March 2020),” Kirk wrote.

He said cannabis investors should first consider stocks that likely won’t need to raise capital to hit profitability.

See Also: 14 Top Cannabis Stocks Targeted By Short Sellers

Benzinga’s Take

There will continue to be a great deal of uncertainty surrounding the fledgling cannabis market as companies invest heavily in building infrastructure while keeping an eye on regulatory developments. Given the uncertainty, investors should consider taking a diversified approach to cannabis by buying a handful of different stocks rather than putting all their eggs in one basket.

Do you agree with this take? Email feedback@benzinga.com with your thoughts.