EXCLUSIVE: ATB Capital Markets Signals 2024 Hidden Gems In Canadian Cannabis

Deep-Value Opportunities in Overlooked Small-Caps

“We see certain Canadian cannabis small-cap stocks as deep-value opportunities. This is because the sector has been neglected by the market, and too much focus has been put on large names like Canopy Growth Corp CGC or Tilray Brands Inc TLRY,” said Frederico Gomes, director of Institutional Research at ATB Capital Markets.

In an exclusive interview with Benzinga, Gomes provided key insights into the recently released "Focus On Deep Value Small-Caps: Canadian Cannabis 2024 Outlook" report, challenging prevailing negative sentiments surrounding the sector in Canada.

Gomes specifically highlighted micro-caps and small-caps, such as High Tide Inc HITI and Nova Cannabis Inc NVACF as leaders in the industry. These companies are not only generating positive free cash flow but are also trading at remarkably low multiples, presenting an enticing investment proposition.

See Also: How To Invest In Cannabis Stocks?

Resilience Amid Challenges

Despite facing challenges related to excessive regulations and taxes, Gomes noted the sector's attractive double-digit growth rates throughout 2023. He attributed this resilience to companies optimizing operations, cutting costs and becoming more efficient. "Companies have become increasingly more efficient and nimble to reduce cash burns and get closer to profitability," he said.

Fragmentation in the LP Market

“In terms of fragmentation in the Licensed Producer (LP) market, we believe this will continue over the near term. We don't see an appetite for large-scale M&A among the top players in the industry, or bankruptcies occurring among the top 5 LPs,” he added. “The underlying economics remain challenging, with competition happening mainly on price as a result of a lack of brand equity. These conditions will lead to volatile market share, keeping the market fragmented.”

Retailers Rise in a Consolidating Market

Looking ahead to 2024, the report forecasts a fragmented LP market, with retailers expected to outperform LPs in a consolidating market. Gomes explained, “Consolidation is happening among retailers because the economics of the business are more conducive to scale advantages, as large retailers benefit from data licensing agreements, consumer loyalty programs, and private label initiatives.”

Growth Predictions and Top Picks

ATB Capital Markets predicted continued growth in the Canadian cannabis industry, forecasting a 10.9% year-over-year increase in 2024 and a 9.2% compound annual growth rate (CAGR) from 2022 to 2031, reaching $9.9 billion in sales by 2031 from $5.1bn today.

Where Should Investors Look?

Top picks among retailers include High Tide and Nova, with projected 2024 free cash flow yields of approximately 4% and 20%, respectively. Decibel Cannabis Co Inc. DBCCF, identified by Gomes as "among the Top 5 LPs in terms of market share," is favored for its strong position in pre-rolls, growth potential, and attractive valuation.

SNDL Inc SNDL is also mentioned for trading at a discount to net cash and investments.

Challenges And Regulatory Adjustments

As large retailers like High Tide and Nova look to expand their footprint, challenges may arise, including store caps in certain provinces “such as Ontario (75-store cap) and BC (8-store cap).” Gomes says he anticipates regulatory adjustments. "We think regulators in these provinces may soon allow an expansion of those caps, which would extend the runway for growth for retailers.”

Read Next: Cannabis Vape, Pre-Roll Market Soars: Canada Sees Double-Digit Growth in Q3 2023

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