Exclusive Interview with Jason Zandberg of PI Financial
With Canada’s Liberal Party prepared to table legislation to legalize cannabis for adult use next week, we checked in with Jason Zandberg, CFA, an analyst covering the sector for Vancouver-based PI Financial, which has participated in capital raises for the sector in excess of $200mm. Zandberg, who focuses on special situations and has been covering the industry for over a year, believes that the cannabis opportunity is “unlike any other sector he has ever looked at” because the demand is already well known. The complete audio interview is included beneath the summary that follows.
Zandberg characterizes the potential market as C$7-10 billion but expects it initially to not fully convert away from the black market, predicting 2019 sales of $4.6 billion but likely exceeding $10 billion over time. One area of concern is that advertising could be highly restricted, and this may be addressed in the legislation, which he expects to mirror the Task Force report from last year. He envisions distribution to vary greatly across the provinces, with dispensaries perhaps in BC and Ontario likely to adopt a model similar to how alcohol is distributed there.
One major positive he projects is that LPs will be able to directly distribute via mail-order at the onset of legalization. As of now, medical cannabis is sold only as dried flower or diluted extracts, and Zandberg expects a much wider range of products, including concentrates, though he isn’t sure if these details will be available when the legislation is introduced.
When trying to distinguish between the companies operating in the industry, Zandberg looks at capacity as a key factor. He seeks companies that are able to scale and generate high yields as measured by grams per sq. ft. of production, noting that the current range is quite wide, with some as low as 50 and the leader at 300. Zandberg thinks that the large producers, including Aphria (TSX: APH) (OTC: APHQF), Canopy Growth (TSX: WEED) (OTC: TWMJF), OrganiGram (TSXV: OGI) (OTC: OGRMF) and privately-held MedReleaf will continue to dominate the market in terms of share, taking advantage of what has been a first-mover advantage. He expects the number of licences, currently at 41, to increase by 20-30 over the next two years, and he also sees further consolidation.
Zandberg believes that the market will be substantially undersupplied due to lack of capacity on July 1, 2018, suggesting that it could be as much as 200mm grams short. While a lot of capacity has been funded and is in the process of being constructed, he cautions that there could be challenges to scaling. Over the long-term, he expects the limited number of suppliers will prevent significant excess capacity.
International opportunities, especially Germany, will create substantial exports, with over $1 billion volume possibly in 2019. He notes that medical cannabis is being adopted increasingly across the globe. Germany, with insurance coverage and pharmacy distribution, should be a substantial market.
Zandberg discussed his coverage list, which includes Aphria, Canopy Growth and Organigram as well as Cronos Group (TSXV: MJN) (OTC: PRMCF) and Emblem (TSXV: EMC) (OTC: EMMBF). He expects Aphria to continue to be a low-cost producer that will be creating large volumes as the feedstock for concentrates. He also expects other LPs to follow the company’s lead into the U.S. over time. Aphria has invested in both Arizona and Florida to date.
Canopy Growth is the market leader, according to Zandberg, and it has been the only real consolidator in the sector. He believes that the Tweed brand stands out in terms of recognition by consumers, and he thinks that it stands to gain the most if advertising rules are somewhat liberal.
Zandberg characterizes Cronos Group as well managed, with the unique position of having facilities on both sides of the country. He also pointed out their joint venture with a First Nations group and their export capabilities as evidence of strong management.
Emblem’s John Stewart has perhaps the best medical background in the industry, and Zandberg expects the company to excel in the medical market. He also believes the company’s high-end focus on the recreational market will help differentiate it from peers.
As far as Organigram, Zandberg sees the recent challenges related to the recall as creating a potentially attractive entry. He also pointed to the company benefitting from its Maritimes location in terms of gaining market share in Eastern Canada.
Zandberg believes that the recent ETF offering by Horizons, the Horizons Medical Marijuana Life Sciences ETF (TSX: HMMJ), adds legitimacy to the market and also opened the door to more participation by retail investors. He concluded by suggesting that investors realize that a lot of companies have benefitted from the rising tide and to make sure to evaluate them on their own merit.
PI Financial has been paid advisory or investment banking fees from Aphria, Canopy Growth, Cronos Group, Emblem and Organigram.