CIBC: Cannabis Drinks Facing Challenges, Will Stay Niche for Now

Analysts at CIBC Capital Markets are intrigued by the development of cannabis beverages in Canada, while keeping an eye on the US legal landscape.

In a new note evaluating the Q2 time period for the cannabis sector, John Zamparo, cannabis analyst at the firm, said cannabis-derived beverages are poised to “capture a meaningful amount of new consumers, while margins are attractive, and above that of dried flower for most producers.”

However, in order for this projection to come true, distribution needs to significantly expand.

The promise of cannabis beverages has gone through highs and lows, and the drinks have been hailed by some as a promising new arena for the legalized cannabis industry.

But in his note, Zamparo indicates that these drinks will need distribution points such as “liquor stores or even on-premise consumption at bars or restaurants.” Until then, he sees beverages remaining a niche product for Canadian consumers, stuck at just a 5 percent share of retail sales.

Based on an independent survey of cannabis retailers, the analyst found that beverage offerings from Canopy Growth (NYSE:CGC,TSX:WEED) dominate both in availability and in terms of sales by way of the conpany’s Houseplant Grapefruit drink.

In terms of its actual ratings, CIBC continues to favor Canopy Rivers (TSX:RIV,OTC Pink:CNPOF) and Cronos Group (NASDAQ:CRON,TSX:CRON) as outperformers.

Aphria (NYSE:APHA,TSX:APHA), Aurora Cannabis (NYSE:ACB,TSX:ACB), Canopy Growth and Organigram Holdings (NASDAQ:OGI,TSX:OGI) all received neutral ratings, while Sundial Growers (NASDAQ:SNDL) and HEXO (NYSE:HEXO,TSX:HEXO) are seen as underperformers at the moment.

US update from a Canadian perspective

When it comes to US federal cannabis legalization or reform of some kind, Zamparo seems encouraged by projections for a Joe Biden presidency alongside a Democrat-led Senate.

If any significant policy moves ahead in the wake of a potential Biden victory, Zamparo believes Aphria, Canopy Growth, Canopy Rivers and Cronos Group have the best outlooks for an entry into the US.

“Most importantly, all four have strong balance sheets with capital to invest, while also communicating that, under the right legal conditions, America would be a target for their M&A prospects,” he said.

Zamparo also said the economic effects of the novel coronavirus in the US could have an unexpected positive side effect for the cannabis industry.

The analyst now expects to see a shift in legalization policy from state governors who feel the need to create revenue for their jurisdictions amid the pandemic.

“We suspect that several states that are legal for medical-use, such as Pennsylvania, New Jersey and Arizona, could be the next jurisdictions to move towards adult-use,” Zamparo wrote.

Parting shot highlights future deals

In the note, Zamparo also highlights the status of Canopy Growth’s acquisition deal for US multi-state operator (MSO) Acreage Holdings (CSE:ACRG.U,OTCQX:ACRGF).

The two firms are evaluating new terms for the agreement, and in the eyes of CIBC these favor Canopy Growth and its holders entirely.

The analyst called these changes in the transaction an “unambiguous win for Canopy.” They include: a lower purchase price, a percentage ownership mandate reduction from 100 to 70 percent, an extended deadline to 2030 and increased hemp operation capabilities in the US market.

“We believe ACRG has little to no leverage, and so we expect the proposed amendments to pass,” Zamparo wrote.

Things have changed drastically from the unveiling of the union in April 2019. At the time, Canopy Growth and Acreage confirmed an acquisition plan in which the Canadian giant would incorporate the MSO as its US partner; additionally, Acreage would get access to brand research from Canopy.

The CIBC report also notes that investors should keep a close eye on EBITDA developments seen in the space, as smaller players like Delta 9 Cannabis (TSX:DN,OTCQX:VRNDF) and Aleafia Health (TSX:AH,OTCQX:ALEAF) have reached EBITDA profitability.

“We deem it extremely unlikely that the industry’s producers will meet consolidated consensus EBITDA estimates next year, but we expect a greater number of EBITDA-positive business a year from now,” the report states.

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Securities Disclosure: I, Bryan Mc Govern, hold no direct investment interest in any company mentioned in this article.