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Piper Jaffray initiated coverage of cannabis producers, joining a short — but growing — list of Wall Street brokerages watching the industry.
While admitting "we still have much to learn in the sector," analyst Michael Lavery set overweight ratings for Canadian marijuana companies Tilray and Canopy Growth and told clients to expect attractive growth ahead.
"We do believe the long-term growth opportunities are significant — both from transitioning illicit trade to legal sales, medical sales, and from transitioning sales in health & wellness categories to CBD-infused products," Lavery said in a note Tuesday. "While timing of further changes is difficult to predict, the pace of further legalization appears to be accelerating."
By starting coverage, Piper Jaffray joins a small group of brokerages devoting research to the budding industry. Until now, most cannabis investors — many of whom are individuals — had to rely on reports from Cowen analyst Vivien Azer, one of the first from a major firm to cover the sector. Azer issued her 2019 cannabis outlook on Tuesday and raised her projection for U.S. sales to $80 billion by 2030.
Lavery believes there is currently a $15 billion to $50 billion total addressable market between Canada's medical and recreational market, medical usage in the European Union and CBD-infused products in key U.S. categories. The long-term global cannabis market is likely worth $250 billion to $500 billion, with more than 25 countries already allowing cannabis use in some form, Lavery told clients.
"We expect legal recreational marijuana to source from illicit trade and could attract new users to the category, while THC-infused drinks could source share from alcoholic beverages," Lavery continued. "Medical cannabis can replace a variety of products (e.g. pain relief, sleep aid, opioid replacement). CBD-infused products (with non-psychoactive properties) could gain share from food, beverage, and personal care categories."
But as governments around the world realize the potential therapeutic effects — or tax revenues — from legalizing marijuana, investors and analysts have deemed the area ripe for returns.
In the United States, medical use has been approved in 33 states and recreational use has been legalized in 10 and the District of Columbia; the analyst added that it's possible that the federal government will legalize cannabis within two to five years.
The recent passage of the $867 billion farm bill, which was signed into law by President Donald Trump on Dec. 20, also represents regulatory progress, the analyst said. The law includes a provision for industrial hemp legalization that Senate Majority Leader Mitch McConnell, R-Ky., had introduced. The provision removed industrial hemp from the federal government's list of controlled substances, making it a lawful agricultural commodity.
Sixty-six percent of surveyed American residents now support legalizing marijuana, according to the latest Gallup poll.
"If no federal action happens by 2020, federal legalization could likely be a topic of the upcoming presidential election," Lavery wrote. "Given the apparent popularity with voters, both parties could conceivably co-opt the issue. Once marijuana is federally legal in the US, we expect additional inflows of capital, potentially for acquisitions of existing players."
Piper Jaffray initiated coverage of Tilray with an overweight rating and a $90 price target given its existing relationships in the medical (Novartis) and beverage (AB InBev) sectors.
"Tilray has the ingredients for long-term growth," the analyst wrote. "We believe its medical partner, Novartis, its EU capacity, and clinical trials position it well for global medical growth. We consider its relationship with Privateer (US operator and 77% owner) to be valuable, both for brands like Marley Natural (with inherent consumer equity) and for its US operations, especially if US legalization comes."
Tilray recently expanded its relationship with Sandoz (a subsidiary of Novartis) in an effort to supply nonsmokable, noncombustible medical cannabis products where it is legally allowed. CEO Brendan Kennedy said in a December statement that the "agreement represents a major milestone in the movement to provide access to safe, GMP-certified medical cannabis to patients in need across the world."
It is also developing a growing facility in Portugal, which should help it drive supply to the international medical markets especially in the EU.
"Portugal has a favorable climate, skilled labor, low regulatory costs, and tariff-free access to the EU. Its first harvest was in 3Q18, and its Dutch-style glass house should be completed by 1Q19," Lavery said in a note. "We also consider a medical presence important as a precursor to potential recreational opportunities, as we expect recreational legalization to occur in markets with that already have an established medical marijuana market."
Lavery also initiated coverage of Canopy Growth with an overweight rating, and told clients to expect shares to rise to $40 over the next 12 months, more than 34 percent higher than Tuesday's closing price.
"While it is difficult to predict how Canopy may be positioned long-term, we believe its large size currently (relative to competitors) is likely to help drive near-term momentum that can provide resources to help fuel long-term growth," he wrote.
Canopy announced Wednesday that its Latin American-focused subsidiary would be expanding into Peru as the country looks to introduce new regulations for the use of medical cannabis.
The analyst highlighted Canopy's beverage partnership with Constellation Brands as well as its growing intellectual property portfolio with its recent acquisition of hemp researcher Ebbu. As of September, Canopy had 4.3 million square feet of licensed capacity in Canada, which it is expanding to 5.6 million. That's roughly, 35 percent of industry capacity, according to Lavery.
Still, supply shortages have become a temporary hurdle for the major cannabis producer as it accelerates the rollout of its stock over the next year and awaits the legalization of other cannabis derivative products.
"Canopy believes it can formulate both a THC-infused beverage that can substitute for alcoholic drinks and a CBD-infused sports recovery beverage that will ultimately compete with Gatorade," Lavery wrote. "Canopy's partnership with Constellation Brands gives it a competitive advantage in beverages, and it has already begun construction on a new bottling facility at its headquarters, which it designed with Constellation's expertise."
Canopy CEO Bruce Linton told CNBC last year that the company expects to ultimately enter the U.S. in 2019 with the passage of the U.S. farm bill.