By: Rob Wertheimer 

We are launching coverage of the cannabis space, highlighting its growth, potential to become a major category in consumer/specialty pharma, and potential to disrupt growth curves in the same. Cannabis equities themselves trade on revenue potential, with very little current clarity on how margins and revenues will settle out at maturity. As with tech stocks in the bubble of 20 years ago, we think a basket approach is best, narrowing as winners are identified. Right now, the space seems to price in positives that only may come true, and we recommend a cautious entry.

The first thing to note is that the potential is emphatically large. Cannabis will be a multi hundred-billion-dollar market with time and continued legal progress. It will be disruptive to alcohol, beverages, over-the-counter medicines and branded pharmaceuticals. Those are dramatic statements, and we’ll defend them inside. For now, note that the pace of legalization is picking up, globally, and it’s time to start paying attention. Sell-side research coverage is thin thus far. Shareholders in beverage companies may find themselves owning a multi-billion-dollar investment in cannabis. Or, may find a permanent bend down in the growth path as consumers switch over to cannabis.

The product is also a long-term dream for marketers, which is to say, for creating differentiated and defensible consumer and medical brands. It’s not just a commodity plant. Cannabis isn’t one simple molecule; there are a over a hundred interacting cannabinoids (e.g. the commonly known THC and CBD) and other chemicals that, in different balances, produce different effects. Modes of consumption are going to change as the product goes mainstream: less smoking, more of everything else.

On the medical side, applications for cannabis are broader and may be more customizable than for many other plant-derived drugs. Cannabis-derived molecules are similar to ones found naturally in the body, called endocannabinoids, which interact with multiple bodily systems. Potential treatment areas include: nausea, appetite, headache, chronic pain, epilepsy, glaucoma, multiple sclerosis and many others. Research has been restricted and much of the above needs to be proven out, but it’s not invented or improbable.

So, there is a large potential market, and reasons to think branding and product development can support margins. And opportunities for public investors to buy the theme are scarce, supporting valuations.  But lots of things have to happen to unlock potential. Some products, like a cannabis adult beverage, don’t quite exist yet. Supply in Canada is tight but is growing very fast, and the market may well careen between shortage and glut as it grows, with margins not yet protected by strong brands or IP.

We are launching with a Neutral industry view and limited dispersion in ratings.  Our top pick is Aurora Cannabis, with an Overweight rating, with upside from potential alliances, early scale in production and global reach. We are Neutral on Canopy, with upside to our target, Neutral on Cronos, and Underweight on Tilray. Canopy and Aurora are further advanced in creating international scale, and have capacity to take an early lead in Canada, which may prove a good profit pool to lever into expansion.

Report Here