Raymond James: Fundamentals Improving Across Canadian Cannabis Sector

Last week Raymond James said in a note to investors, “Canadian Cannabis Stock Selloff Overdone | Fundamentals Driving Divergence Between Strong & Weak Operators.” Rahul Sarugaser, Raymond James’ analyst, calls the bottom in the Canadian Cannabis sector as he explains, “fundamentals are improving across the Canadian cannabis sector.”

The analyst believes that there will be a “rapid downward spiral of these poor operators, causing them to finally relinquish their lingering grip on market share, leaving a significant vacuum for the quality operators to fill.” This is expected to then allow quality operators to come in and gain market share.

In the note, he summarizes the well-know issues that “hobbled the Canadian cannabis sector from the earliest days of its history as a legal adult-use market.” He says the number one issue was the undersupply, high product return rate, and a limited variety of products as flowers and oil were the only products allowed at the start of legalization. The second issue was how slow the retail rollout was, specifically in Ontario, representing 40% of Canada’s population. Ontario used a “sluggish, flawed lottery system that further delayed the deployment of brick and mortar retail.”

The third reason is that there was and still is a substantial illicit market with a ~75% market share in Ontario in the first quarter of 2020, with the fourth issue being “far too many cannabis licensed producers.”

Sarugaser says that “even with a steady conversion of Canada’s illicit market, there are currently too many operators supplying the sector. 490 licenses have been issued to supply a market of 35 million people.” Sarugaser also adds, “We anticipate the implosion of several large, inefficient, tenuously financed Canadian operators during the next handful of quarters.”

Rahul suggests that the turnaround is currently happening after two years of legal cannabis. He gave a few points to support this idea. The first point he provides is that the capacity issues have been resolved. The second point is now Cannabis 2.0 products have entered and are now allowed to be marketed in Canada.

The last two points he gives go hand in hand. Rahul says that more retail licenses are being issued and are beginning to open stores, especially in the most critical provinces such as Ontario and Quebec. These store openings have yielded “material boosts in nationwide revenue—and the quality and variety of products in every category seems to be improving”. Sarugaser suggests that because of this, Canada is seeing that sector-wide revenues are beginning to grow ” to levels comparable to original market expectations.”

Information for this briefing was found via Sedar and Refinitiv. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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