With current market dynamics and headlines creating "profound shifts" in how cannabis industry participants raise capital and with companies left with "few good options" in order to survive, Seaport analyst Brett Hundley believes a "major shakeout is on the horizon." With that in mind, the analyst recommends cannabis investors double down on "high quality names leveraged to recreational THC in the U.S."
'MAJOR SHAKEOUT' ON THE HORIZON: Noting that KushCo (KSHB) recently announced a secondary equity raise at an implied common share valued that was roughly 50% of its previous day closing price, Seaport's Hundley told investors that in a matter of 15-plus months, the cannabis space has gone from "easily raising dual-class common equity to choking down incremental capital offerings at 50% of market value." The analyst believes that current market dynamics and headlines are creating “profound shifts” in how industry participants raise capital, as U.S. federal rules limit institutional capital markets involvement and as most companies are having to sell assets or issue equity on increasingly onerous terms. The North American cannabis industry has "morphed" from a growth discipline into a value discipline, far earlier than initially anticipated, he contended.
Hundley believes there will be two waves of capital infusion for legal cannabis. The first has already occurred, and the second wave is otherwise likely multiple years away, he argued. The analyst noted that retail investors have been "spooked by macro market/sector specific fluctuations," and while limited amounts of debt have and could become available, he thinks the bulk of these funds will need to wait for improved operating metrics and/or regulatory change. As well, new sources of credit could rotate out of existing equity holdings, exacerbating stock market pressures for the group, he added. In order to survive, Hundley sees cannabis companies left with “few good options" and thinks a "major shakeout is on the horizon." Companies without scale that are unprofitable and unable to move toward cash generation are likely to dissolve in the coming months, he added, noting that acquisitions will likely be scrutinized more heavily, offering challenges for many sellers. However, Hundley believes this will be a good thing for the quality enterprises that remain.
The signal to the industry itself "is clear," namely moving toward profitability and positive cash flow, the analyst said. While such efforts could help crack access to credit markets, Hundley expects large portions of debt and equity capital markets to remain on the sidelines until the U.S. government eases regulatory restrictions on marijuana. Thus, companies will have to increasingly change their mindset from fighting their competitors in consumer markets to fighting them in the financial markets, he contended. The analyst recommends cannabis investors double down on high quality names leveraged to recreational Tetrahydrocannabinol in the U.S. "A noisy background is presenting opportunities within a number of companies," he added.
NAMES TO WATCH: Among the stocks in the cannabis space under his coverage, Hundley has Buy ratings on Canopy Growth (CGC), Medmen Enterprises (MMNFF), iAnthus Capital (ITHUF), Acreage (ACRGF) and Curaleaf (CURLF), and a Neutral rating on Aurora (ACB).
PRICE ACTION: In afternoon trading, shares of Canopy Growth, KushCo, Medmen and Aurora have dropped about 5% each to $22.75, $1.48, $1.44 and $4.39, respectively. Also lower, iAnthus' stock has slipped almost 3% to $1.48, Acreage has plunged about 7.5% to $7.49, and Curaleaf has slid over 6% to $5.48.