BMO Initiates Conservative Price Targets on Canopy Growth Corp, Aphria Inc

Benjamin A. Smith
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For Canopy Growth Corp (TSE:WEED) (NYSE:CGC) (FRA:11L1) and Aphria Inc (TSE:APH) (OTCMKTS:APHQF) (FRA:10E), yesterday was another first. BMO Capital Markets becomes the first “Big Six” Canadian bank to initiate coverage on specific companies in the sector—although it was surely less sanguine than many imagined. We look into BMO’s rather tepid price target for Big Cannabis.

But before we go there, let’s start with the positive.

BMO cannabis analyst Tamy Chen and retailing/consumer analyst Peter Sklar slapped a $45 price target on Canopy Growth (Outperform). The target multiple reflects BMO’s view that Canopy has a relative lead in brand development and international expansion, and could emerge as a leading global-branded company in the long term.

Based on the company’s fiscal year end which ceases at the end of March, the analysts projection imply ↑23.05% upside in Canopy Growth over the next 22-months. Most investors would be pretty satisfied with double-digit annualized returns, presumably. BMO’s opinion should also drive a stake through the heart of the fringe minority who cling to the belief that Canadian marijuana companies are fundamentally overvalued. For anyone who missed Barron’s cannabis hit piece on March 30th, here’s our rebuttal.

So far, so good. Now comes the perplexing part.

While BMO’s report was meticulous and precise, their price target seemingly omits Canopy Growth’s immense growth prospects. Not only does Canopy have absurdly low YoY comps working in its favor, international legalization will unfold in stages, ensuring perpetual growth irons in the fire. Last we checked, Canopy Growth was operating or had partnerships in eight countries abroad. This number does not include the United States, where federal de-scheduling of marijuana seems inevitable at this point.

Canopy Growth controlled or jointly-controlled subsidiaries and affiliate investments internationally

Legal entity Defined as % Ownership Country Of Operation
Spektrum Cannabis GmbH Spektrum Cannabis 100 Germany
Spectrum Chile SpA Spectrum Chile 85 Chile
Grow House JA Limited Tweed JA 49 Jamaica
Spectrum Cannabis Denmark Aps Spectrum Cannabis Denmark 62 Denmark
Annabis Medical s.r.o Annabis Medical Czech Republic
Affiliate Investments
Legal entity Defined as % Ownership Country Of Operation
Bedrocan Brasil S.A. Bedrocan Brasil 39.4 Brazil
Entourage Phytolab S.A Entourage 38.5 Brazil
AusCann Group Holdings Ltd. AusCann 11 Australia
Vapium Incorporated Vapium 12.2 Online Retail

Given this reality, it seems odd that BMO set the bar so low. While the $45 headline number seems palatable given Canopy’s meteoric rise, BMO notes: “Our target price of $45 is based on a projected enterprise value that is about 20x our Base Case fiscal 2020 EBITDA estimate… This is within the valuation range attributed to Canadian consumer discretionary stocks, with Dollarama at the high end.”

Say what? Have future growth expectations declined so far that Canopy Growth should now be considered just your average, run-of-the-mill consumer discretionary stock? One that actually trades at a discount to the Dollarama’s of the world? We understand the stock is trading well ahead of future enterprise value, but robust growth may last longer than people realize.

Sure, Dollarama boasts a 5-Year Avg. Revenue Growth of 12.36%, 5-Year Avg. Profit Growth of 19.09%, and a $0.12 dividend. The stock has delivered tremendous returns in recent years, owing to fantastic business execution at home and abroad. But on the top line, it’s hard to fathom how Canopy Growth doesn’t have superior growth potential—not with untapped markets in Germany, the United States and a superior rec/medical portfolio. The good times have barely started.

Bruce Linton said as much during his recent Midas Letter Live interview:

“Because the rate of growth in this sector relative to pretty much everything else that’s going on is likely to pretty extraordinary. It’ll make the people who were in favor of it look pretty good, I hope.”

Perhaps I’m missing something here. Perhaps Canopy Growth revenue and profit increases will follow a bell curve distribution model earlier than I anticipate. But should Canopy continue to leverage its operational and first-in advantages; and should the German and U.S. markets liberalize in the next 2-3 years, BMO’s price target may appear rather conservative in retrospect.

Did BMO Significantly Underestimate Aphria’s Base Case Production Output?

Like Canopy Growth before it, BMO pegged Aphria with an “Outperform” rating and $17/price target. The  projection assesses enterprise value that is approximately 17x their Base Case fiscal 2020 EBITDA estimate. On percentage terms, BMO affords Canopy Growth a ↑17.64% premium between both companies. However, BMO seems to be using a revenue model which severely underestimates the amount of cannabis Aphria will be producing by that time.

According to BMO, adjusted EBITDA is based on only 144,000 kg of production in fiscal 2020. They further elucidate that “expansion plan of this magnitude is subject to considerable execution risk, and hence our more conservative ramp projections versus management’s expectations.”

The problem is, Aphria CEO Vic Neufeld is singing a different tune.

In his recent Midas Letter interview, Mr. Neufeld seemed quite comfortable that total output would best BMO’s estimates by a considerable margin. Here’s one of the exchanges:

James West: Wow, okay! January/February 2019, what will be the total annual output of Aphria?

Vic Neufeld: Together with Broken Coast our high premium B.C bud, awesome growers they are, we’ll be at 240,000 kilos annually. Give me about four months to get to full crop rotation so by let’s call it May of 2019 we’ll be kicking out 20,000 kilos a month.

With Aphria’s fiscal year end finishing on May 31st, the company would be positioned to smash BMO’s Base Case cannabis output target if Mr. Neufeld prognostications come to pass. As BMO’s price target is predicated on ‘just’ $740 million in revenues, one has to wonder whether BMO hasn’t lowballed their price target here.

Final Thoughts

We’ve finally come full circle where Big Cannabis has gotten large enough to attract the attention of the Big Six banking cartel. It’s an important milestone in the maturation and legitimization of the sector. For the refined investors interested in peer group comps and advanced alphabet soup metrics few comprehend, this is the moment you’ve been waiting for. That works for us as well.

However, we can’t help but wonder whether the bank is peering into its model just a little too deeply. Perhaps they are right; perhaps the conservative targets are by design. Whatever the case, we believe Canopy Growth and Aphria may have more upside than the Big Six give them credit for.

Benjamin A. Smith

Benjamin A. Smith

Ben is a research analyst and capital markets professional with nearly 20 years of experience. His areas of expertise are broad-based, and include extensive knowledge of macro economics, stock/derivative trading, commodity complexes, cryptocurrencies and technical/quant analysis. He also maintains an particular affinity for U.S. politics and the macro-regulatory environment facing...
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