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Cannabis MSO survival period ‘could separate the Colas from the Popcorns,’ analysts say

Published: 11:42 08 Feb 2023 EST

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Cannabis multi-state operators (MSOs) in the US continue to face challenges after Congress failed to pass the Secure and Fair Enforcement (SAFE) Banking Act in 2022, which would protect banks and financial institutions providing services to legitimate cannabis businesses from penalties, with investor enthusiasm at an “all-time low,” according to analysts at Stifel GMP.

However, analysts believe this survival period could strengthen some operators by triggering strategic decisions to streamline businesses and better cash flows.

In a note to clients, the analysts wrote that they have seen operators exit cash-burning business segments and restructure margin dilutive operations to bolster their cash generation.

READ: Cannabis MSOs tumble as marijuana banking reform is excluded from defense bill

“This year, we expect most of our coverage could generate positive free cash flow with greater clarity likely on 4Q/22 results, an impressive feat for companies that pay 60% to 200%-plus effective tax rates,” they wrote.

“The lower CAPEX could translate to a better supply-demand balance into 2024 which may also coincide with the next potential federal catalyst; the culmination of President Biden's schedule review where we believe cannabis may be moved into Schedule II or III, the latter we estimate could improve company 2023e cash flows by 1/3rd to over 2.5x.”

They concluded: “Ultimately, we expect growth catalysts will come to fruition with those companies that have built enduring businesses able to fully capitalize on the opportunity, widening the gap between peers.”

Revised 2023 cannabis market forecasts

The analysts wrote that they were making conservative revisions to their market forecasts for 2023, reducing their total market forecast by roughly 3% to $30 billion by 2024, up an 8.6% two-year compound annual growth rate (CAGR).

They also made smaller downward revisions for core MSO markets of 2% to $11.8 billion in 2023 and 1% to $13.5 billion in 2024, which they noted represented a stronger CAGR of about 10.4% for 2022 to 2024.

“The focus of our revisions stem from worse conditions on the West Coast matched with a delay in the growth ramp of New Jersey and Illinois, more weighted in 2H/23 as new stores are slow to open currently,” they wrote.

“We reiterate our forecasts exclude any contribution from states that have yet to begin recreational sales for MSOs including New York, Maryland and Virginia which could unlock $12 billion to $17 billion of additional total addressable market combined.”

Stifel’s analysts noted that its forecasts reflected the recession risk facing the cannabis sector. 

Highlighting that legal cannabis has never seen a prolonged recession, they wrote that the 2020 COVID recession and lockdowns suggest that cannabis behaves as a staple like alcohol.

“Alcohol sales increase overall during a recession, [this] provides upside potential to market forecasts,” they wrote.

Top cannabis stock picks for 2023 

The analysts highlighted Green Thumb Industries Inc. (CSE:GTII, OTCQX:GTBIF) (GTII) as its top cannabis stock pick given its return on invested capital focus and conservative balance sheet.

“We believe GTII has upside to beat 4Q/22 expectations from maintaining market share in New Jersey and perhaps gaining share in Ohio after doubling production in 2Q/22,” they wrote.

They added that Trulieve Cannabis Corp. (CSE:TRUL) (TRUL) was “underappreciated.”

“We believe TRUL could showcase its prowess with a return to meaningful operating cash flow as the Harvest Health & Recreation Inc. (CSE:HARV) (HARV) integration is substantially complete and its Florida indoor superfacility gradually increases contribution in 2023 to lower production costs,” they wrote.

Contact the author at emily.jarvie@proactiveinvestors.com

Follow her on Twitter @emilyjjarvie

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