Jefferies is the latest Wall Street firm to initiate coverage in the cannabis space – but unlike many of its more bullish peers, its base-case outlook on the nascent industry is much more subdued.
The investment bank in a note Monday initiated on cannabis with coverage of nine names, including five rated as Buy, two as Hold and two as Underperform. For the industry as a whole, Jefferies’ base-case scenario projects growth to $50 billion by 2029, from $17 billion in 2019. The model includes Canada, the U.S.’s 33-state medical and 17-state recreational markets, Europe’s 12-country medical market, Latin America’s 5-country medical and 2-country recreational market and three other countries in the rest of the world with medical legality.
Jefferies analyst Owen Bennett conceded that the firm’s base case projection is “probably conservative,” adding that a “realistic upside scenario” could see a global cannabis market of as large as $130 billion by 2029.
“This assumes full U.S. federal legalization, full recreational and medical legalization across Europe, full medical and recreational legalization across Lat Am, and cannabis disruption of a number of other industries,” Bennett wrote in a note. “Industries at risk of disruption are pharma, alcohol, health and wellness, pet care and smoking cessation.”
Jefferies is the latest in a small but growing cluster of Wall Street firms adding cannabis to their coverage, acting as an imprimatur to the burgeoning industry amid regulatory hurdles and evolving public perception.
Cowen initiated coverage on the industry in 2016, and now forecasts cannabis sales in the U.S. alone to reach $80 billion by 2030 under the assumption of full federal legalization. Piper Jaffray, which initiated cannabis coverage in January, believes there is currently a $15 billion to $50 billion total addressable market between Canada’s fully legalized market, medical usage in the European Union and patchwork of U.S. legalization. The firm also projected a $250 billion to $500 billion total market “longer-term if cannabis were legal globally.”
But capturing the U.S. market will be pivotal for any company that “wants to claim large-cap or even mega-cap future status,” Bennett said.
“Although all coverage names are not currently allowed U.S. operations while it is federally illegal, they should still be establishing optionality for when/if U.S. regulations change,” he added.
The U.S. is the largest global cannabis market, and a recent report from cannabis research institution BDS Analytics projected that about 70% of the global cannabis spending would derive from the U.S. in the next three years.
Trends to watch
As further legalization allows for further expansion into recreational and medical areas, the two segments will begin to diverge as companies within either – or both – industries adopt different strategies to reach consumers, Bennett said.
“Medical and [recreational] are broadly similar now but will become two distinct segments,” Bennett said. “Rec. will be about creating brands and delivering differentiating experiences, while medical will be about developing unique and specific drug formulations, with exacting pharma ingredients, protected by IP.”
Jefferies currently models a global medical market of $8 billion for 2019, rising to $19 billion by 2029, and a recreational industry of $9 billion in 2019 growing to $31 billion by 2029.
“We expect a pricing ladder to be created in the recreational space, a bit like we see in wine or spirits, with the bottom end characterized by a focus on THC potency, and the top end about capturing the full entourage effect of cannabis, this effect driven by the interaction of hundreds of different compounds and requires the best quality inputs and much more care and time taken over growing and processing,” Bennett said.
The “long-term winners in the medical space,” on the other hand, “will be those that are investing in clinical trials, applying for patents and are backed by a strong medical team with experience,” Bennett added.
Bennett also waved off concerns of price commoditization, an often-used bear argument for the industry that assumes selling prices for cannabis flower will decline as legalization and cultivation become more widespread.
“We have a couple of issues with this,” Bennett said. “Our first issue, for premium flower especially, is you can't assume fungibility like any other commodity. All cannabis is not actually the same with there being over 1,000 strains, each delivering a very unique functional experience.”
Jefferies also does not see a period of oversupply until mid-2021 at the earliest, Bennett added – and even these fears may be overblown.
“What the market fails to factor in when assessing oversupply is that much future use will be in the form of derivatives, which by its nature requires more flower (1kg of flower, for example, will only produce between 150-300g of cannabis oil/extract),” Bennett said.
But though the upside potential of cannabis remains bright, the industry is not without its risks, Bennett caveated. He cited the list of possible short- and long-term effects still being studied today, including decreased motivation, impaired memory or anxiety.
“What the above means is that while at present more favorable legislation is the main driver of cannabis growth, it could also swing the other way and prove a barrier again at any point,” Bennett said.
Here’s a list of Jefferies’ ratings and price targets for each of the cannabis companies included in its coverage:
· Canopy Growth Corporation (Hold, price target C$64.00)
· Aurora (Buy, price target C$12.00)
· Cronos (Underperform, price target C$17.00)
· Hexo (Underperform, price target C$5.60)
· Green Organic Dutchman (Buy, price target C$6.10)
· CannTrust (Buy, price target C$15.00)
· OrganiGram (Buy, price target C$10.00)
· Emerald (Hold, price target C$4.30)
· Flowr (Buy, price target C$5.70)
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Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck
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