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Melius Research initiates coverage of cannabis sector, says it will 'disrupt the beverage industry'

Analyst Rob Wertheimer has an Overweight rating on Aurora Cannabis stock and an Underweight rating on Tilray shares 'with less clarity on future growth outside of Canada'
Cannabis beverage drink
Highlights from the Melius Research report suggest the cannabis market can grow to US$100 billion in the Americas and Europe even without further progress on legalization

Melius Research initiated coverage of the cannabis sector Monday by saying that marijuana “will affect, and then disrupt the beverage industry.”

The cannabis coverage is headed by top-ranked analyst Rob Wertheimer, who is head of research at Melius. He has earlier been an analyst with both Barclays and Morgan Stanley and started his career covering beverage and retail across Latin America.

“The first thing to note is that the potential is emphatically large,” wrote Wertheimer in a note to clients.

READ: Alcohol companies get a buzz from playing offense in cannabis industry

“It will be disruptive to alcohol, beverages, over-the-counter medicines and branded pharmaceuticals. Shareholders in beverage companies may find themselves owning a multi-billion-dollar investment in cannabis. Or, may find a permanent bend down in the growth path as consumers switch over to cannabis,” he added.

Melius Research launched its coverage with a Neutral view of the overall cannabis industry.

“As with tech stocks in the bubble of 20 years ago, we think a basket approach is best, narrowing as winners are identified. Right now, the space seems to price in positives that only may come true, and we recommend a cautious entry,” wrote Wertheimer.

The report provides ratings on Aurora Cannabis Inc (NYSE:ACB) (TSE:ACB), Canopy Growth Corporation (NYSE:CGC) (TSE:WEED), The Cronos Group Inc (NASDAQ:CRON) (CSE:CRON) and Tilray Inc(NASDAQ:TLRY).

Aurora top cannabis pick

Melius initiated coverage with an Overweight rating on Aurora Cannabis and a C$17 price target. The firm said Aurora was its top pick citing upside from potential alliances, early scale in production and global reach.

"The tactic is bold: as the rush to supply a new and underserved market gathers steam, there will likely be a period of overcapacity coming for the Canadian market. Aurora is playing a large part in that, aiming to get production costs down and capacity in the field to capture market share and to try to hold margin though lower cost," wrote Wertheimer.

Separately, Cowen analyst Vivien Azer also designated Aurora Cannabis the top pick at Cowen noting the company’s large cultivation footprint, capable of producing over 575,000 kg.

Aurora is one of the biggest importers, exporters, and distributors of medical cannabis in the European Union.

In September of last year, Coca-Cola (NYSE:KO) was purportedly in talks with Aurora Cannabis about taking an investment in the company and forming a joint venture for CBD-infused beverages. This has still not panned out, but investors are watching the space.

Neutral rating on Canopy

On the other hand, Melius has a Neutral rating on Canopy Growth Corp, which drew Corona beer maker Constellation Brands to take a $3.8 billion investment stake in Canopy in August last year.

“Canopy's aggressive management, years in the industry, early capacity and distribution, along with a funding lead, all position the company well versus peers, with that position well recognized by investors,” wrote Wertheimer.

Alcohol companies like Constellation Brands, Heineken (NASDAQOTH:HEINY) and Molson Coors Brewing Company (NYSE:TAP)(TSX:TPX) are hedging against slowing growth in their main business by investing heavily in the marijuana industry. Constellation's investment in Canopy Growth is the biggest known deal in the marijuana industry and shows just how far traditional alcohol companies are willing to go to find growth.

"The trend towards legalization is broad and becoming unstoppable. Cannabis will affect, then disrupt the beverage industry,” wrote Wertheimer.

"Most millennials and younger users reported reducing alcohol consumption, and marijuana users report quitting or consuming less tobacco, as well. This is particularly true for younger generations, and a concern for beverage investors as legalization broadens out usage," he added.

Interest from Big Tobacco 

The analyst has a Neutral rating on Cronos but expects the Altria Group Inc (NYSE:MO) investment to kick-start "a web of growth and alliances."

Tobacco behemoth Altria has agreed to make a C$2.4 billion (US$1.8 billion) equity investment in Cronos in a bid to widen its business beyond tobacco. While the tobacco sector is coming under pressure due to diminished demand for cigarettes, interest in cannabis is on the rise, which is the reason behind Altria's move to snap up a stake in Cronos.

Finally, Wertheimer assigns an Underweight rating on Tilray, “with less clarity on future growth outside of Canada.”

READ: Altria makes C$2.4B investment in Canadian cannabis company Cronos Group

On the medical side, applications for cannabis are broad.

“Its wide range of potential medicinal uses holds potential to take share in the over-the-counter and pharmaceutical industries over time,” wrote Wertheimer. “As the industry surges in growth, Canadian cannabis companies have a window, opened by that country's lead in legalization, which they can use to develop product, intellectual property, brand and distribution. Our current view is that early leads are important in an industry that will develop and change quickly.”

The report suggest the cannabis market can grow to US$100 billion in the Americas and Europe without further progress on legalization, which nonetheless remains likely.

That market estimate builds up from consumer surveys, pricing studies in legal and black markets, frequency of medical conditions addressable by cannabis across the US and EU member countries, and state-by-state and country-by-country legal frameworks.

“As legalization progresses, the market opportunity will expand beyond US$200 billion,” said the report.

— Adds details on Aurora Cannabis, cannabis industry rating, outlook —

Contact Uttara Choudhury at [email protected]

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Aurora Cannabis Inc Timeline

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February 20 2019

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