Cannabis company Canopy has a decade-long tailwind

Shares of Canopy growth (CGC) are trading 30% lower since its latest quarterly results last week. However one analyst sees shares as undervalued for the Canadian cannabis company, which has shifted from medical to more recreational sales when that market was legalized in Canada almost two years ago.

“Although we expect the medical market to shrink because of recreational legalization, we forecast more than 10% average annual growth for the entire Canadian market through 2030, driven by the conversion of black-market consumers into the legal market and new cannabis consumers,” Morningstar analyst Kristoffer Inton wrote in a note to investors.

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As for the U.S. market, Inton expects federal legislation will be changed to recognize states’ choices on legality. Canopy will be in a good position when this happens since it reached a deal to acquire Acreage Holdings (ACRGF), a U.S. cannabis company, immediately upon federal legalization.

”Based on our state-by-state analysis, we forecast nearly 20% average annual growth for the U.S. recreational market and nearly 10% for the medical market through 2030,” wrote the analyst.

Additionally, Constellation Brands’ (STZ) 38.6% investment in Canopy, with the option to own up to 55.8% of the company, is another tailwind for the company.

“We see the investment as supportive of Canopy’s focus on developing branded cannabis consumer products while also providing funding backstop,” wrote Inton.

The analyst also notes Canopy Growth exports medical cannabis globally, a market which looks lucrative given higher realized prices, and the growing acceptance of medical marihuana benefits.

“Exporters must pass strict regulations to enter markets, protecting early entrants like Canopy,” said Inton.

Additionally, the company is partially offsetting the threat of cheaper labor costs by moving production into other countries.

“Canopy’s efforts to expand production into countries like Colombia and Lesotho should offset its cost-disadvantaged Canadian production.We forecast around 15% average annual growth through 2030,” wrote Inton.

(AP Photo/Richard Vogel)

Inton goes on to mention the advantage of holding government licenses to operate in a highly regulated industry.

“Companies with licenses could be protected from outside competition, helping establish pricing power,” said Inton.

“This could prove particularly true if holding an existing license provided an advantage for when new licenses are issued. History suggests this could be possible, as Illinois’ early plans for recreational legalization would hand an advantage to companies with medical cultivation and dispensary licenses,” he added.

Inton went on to caution that even if this were the case, “We see sustained positive economic profits for cannabis companies as unlikely over the next 10 years.”

In its latest quarterly performance, the Canopy Growth announced a net loss of 1.3 billion Canadian dollars, weaker than expected revenue, and higher operating expenses.

The company also detailed a strategic plan to focus on key markets and a path to profitability.

Inton’s team predicts it will take the company roughly four years to reach adjusted EBITDA profitability.

“We’re lowering our fair value estimates to $30 and CAD 41 per share from $45 and CAD 60 to reflect our outlook that it will take longer to reach profitability than we previously anticipated,” wrote Inton.

“We maintain Canopy’s no-moat rating and very high uncertainty rating, reflecting the early state of the cannabis industry,” he added.

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