2019 has been a tough year for the Canadian cannabis industry and this is a trend that we continue to closely monitor.
In the near future, we are going to see new products come to market that fall under the cannabis derivative category and this emerging opportunity is commonly being referred to as Cannabis 2.0. Canadian Licensed Producers (LPs) have been preparing for this opportunity and many are well positioned to capitalize on it once the market officially opens.
We are favorable on the Cannabis 2.0 opportunity due to the types of products that can be sold and the expected impact on Canada’s black market. When Canada’s recreational market opened, companies could only sell a few types of cannabis products (i.e. flower, pre-rolls, gel capsules) and the limited nature of the market allowed the black market to thrive.
In 2020, we expect to see a major transition in Canada as it relates to the types of products that can be sold and the kinds of consumers who will be purchasing them. We believe that the recent weakness with Canadian LPs is overdone and want to highlight 5 companies that we are closely following.
Aleafia Health (ALEF.TO) (ALEAF)
Aleafia Health was one of the first Canadian cannabis producers to focus on the outdoor cultivation opportunity and we have been bullish on this aspect of the business. We expect the outdoor operation to play an important role in the way that the company capitalizes on Cannabis 2.0 in Canada and believe that the market has not assigned much value to this vertical of the business.
Last week, Aleafia Health announced a major milestone and entered into a definitive cannabis material purchase agreement with a Canadian LP. Under the agreement, the company will sell 2,840 kg of dried cannabis flower at $2.50 per gram. The agreement will generate more than $7 million of revenue and will leave Aleafia Health with more than 10,000 kilograms of dried cannabis from the outdoor operation in its inventory.
If Aleafia Health was to sell the remaining 10,000+ kilograms for the same price, it would generate more than $32 million of revenue from the initial harvest. This is much greater than what the market was expecting the company to generate, and we expect the outdoor opportunity to become a more significant aspect of the business in 2020 and beyond.
A few months ago, Aleafia Health acquired farmland directly adjacent to its Port Perry facility. The acquisition adds an additional 2.6 million sq. ft. of cultivation area (total of 3.7 million sq. ft.). Based on the 2019 results, Aleafia Health estimates that it can produce 1,200 kg per acre for a total of 102,000 kg of dried flower in 2020 (at full capacity). If the company is able to operates at full capacity, it could generate more than $250 million of revenue per harvest (based on the pricing of the first sale) and this represents a major opportunity for the business.
We are bullish on the growth prospects associated with the outdoor opportunity and expect the cannabis that is not sold to other Canadian LPs to be used to support the development of cannabis derivative products. In 2020 and beyond, we expect Aleafia Health to be a beneficiary of the cannabis 2.0 opportunity and expect the outdoor operation to play an important role.
At current levels, we believe that Aleafia Health has an attractive risk-reward profile and this is an opportunity to put on your radar. The company is trading at a considerable discount to its peers and has substantial potential catalysts for growth. In 2020, we expect Aleafia Health to record incremental revenue growth and believe that Cannabis 2.0 serve a significant role.
Canopy Growth Corporation (WEED.TO) (CGC)
2019 has been a bumpy year for Canopy Growth and the period was highlighted by the firing of Bruce Linton as CEO and Executive Chairman. This move came after a few quarters of slower-than-expected growth and the company has yet to appoint a new CEO. Although we expected the Canadian cannabis producer to put up better numbers this year, the lack of distribution in Canada from a retail store standpoint has been a bottleneck for the entire industry.
Looking into 2020, we believe that Canopy Growth has substantial growth prospects and is well positioned to benefit from Cannabis 2.0 in Canada. When cannabis derivative products are allowed to be sold, we expect to see the company release a comprehensive line of products and we are bullish on the growth prospects associated with this.
From a distribution standpoint, Canopy Growth is well positioned and owns cannabis retail stores through Tokyo Smoke (as part of the Hiku acquisition) and we find this to be significant. We believe that this aspect of the story will play an important role in the company’s ability to capitalize on the Cannabis 2.0 opportunity and this is something to be aware of.
During the last few months, Canopy Growth has been under heavy pressure and touched lows that it had not seen in two years. We believe that the firing of Bruce Linton played a significant role in the recent decline and we expect the appointment of a new CEO to remove a major headwind. The Cannabis 2.0 opportunity should prove to be a considerable catalyst for the Canadian cannabis producer, and we will continue to closely monitor it.
Aurora Cannabis (ACB.TO) (ACB)
From increasing production capacity to entering new markets, Aurora Cannabis has been laser focused on capitalizing on the Canadian and the global cannabis opportunity. So far this year, the Canadian LP has been under considerable pressure and this is a trend that we continue to monitor. One of the biggest concerns that the market has with Aurora is related to the strength of the balance sheet. Fears have been mounting when it comes to the company’s ability to execute on its global growth strategy and this is something to be aware of.
When it comes to the Cannabis 2.0 opportunity in Canada, Aurora Cannabis is expected to be a major beneficiary and we will monitor how the management team is able to execute on this. During the last year, the company formed agreements with leading US cannabis brands and plans to launch these products in Canada.
We have conducted significant due diligence on the brands that Aurora Cannabis has formed a relationships with and are most excited about its partnerships that it has with Binske. Through this relationship, Aurora Cannabis will be able to sell Binske gummies to recreational consumers and medical patients and these products should gain significant traction. Binske has been nothing short of an execution story in the US and has been selling products in the largest US markets. We believe that the expertise that the companies bring to the relationship will play a key role in the success of the operation and we will continue to monitor this aspect of the story.
2020 is expected to be a banner year for Aurora Cannabis and we want to see how the management team is able to execute on the Cannabis 2.0 opportunity in Canada. In the event the Canadian cannabis producer removes the capital concerns from the story, we expect to see increased interest from the market and will monitor how the Aurora Cannabis story evolves from here.
HEXO (HEXO.TO) (HEXO)
Prior to 2019, many analysts were favorable on HEXO and considered it to be one of the best positioned Canadian LPs as within the cannabis beverage market. The main reason for this assumption was related to HEXO’s relationship with Molson Coors, one of the largest beer companies in the world.
Although this relationship seemed promising, there was not a capital component connected to the partnership (unlike Canopy Growth) and this left us cautious from the start. HEXO seems to have dropped the ball on the cannabis beverage opportunity (as well as many other projects) and the market has not responded well to this.
So far this year, HEXO has been one of the biggest underperformers in the cannabis sector and market sentiment remains negative on the operation. Going forward, we believe that the business faces substantial headwinds and will monitor how the management team is able to weather the storm.
WeedMD (WMD.V) (WDDMF)
During the last month, WeedMD had made a number of significant announcements and we believe that the opportunity is flying under the radar. The Canadian cannabis producer is levered to some of the most exciting verticals within the industry and we are bullish on the growth prospects associated with this.
Earlier this month, the Canadian cannabis producer reported to have produced more than 17,000 kilograms from its outdoor cultivation operation. A few months ago, WeedMD formed CX Industries as a wholly owned subsidiary that is laser focused on the cannabis concentrate opportunity. WeedMD is focused on creating high-margin cannabis derivative products and we are favorable on the amount of value that can be created through CX Industries.
In late November, WeedMD appointed Tricia Symmes as General Manager of CX Industries. Going forward, she will lead CX Industries’ commercial operations and the development of new business channels and product development for both the recreational and medical markets.
As it relates to the cannabis from the outdoor cultivation operation, we expect the cannabis to be sent to CX Industries. Going forward, we expect CX Industries to play an important role in WeedMD’s ability to capitalize on Cannabis 2.0 and we believe that the market underappreciates this aspect of the story.
With regard to distribution, WeedMD has been nothing short of an execution story and has successfully secured multiple distribution channels with agreements with six Canadian provinces. When you combine this with the relationship that the company has with Shoppers Drug Mart, you have a business that is positioned to capitalize on the Cannabis 2.0 opportunity.
At current levels, we find the risk-reward scenario to be attractive and believe that WeedMD has visible catalysts for growth. The 17,000 kilograms from the first outdoor harvest should prove to be a major revenue generator and we believe that this aspect of the story is underappreciated by the street. We expect 2020 to be a banner year for the Canadian cannabis producer and this is an opportunity to put on your radar.
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