April 17, 2019

AltaCorp Capital Inc Managing Director on HEXO Corp (TSE:HEXO) Coverage and Price Target

Midas Letter
Midas Letter
AltaCorp Capital Inc Managing Director on HEXO Corp (TSE:HEXO) Coverage and Price Target

AltaCorp Capital Inc Managing Director and Senior Equity Research Analyst David M. Kideckel, PhD, MBA explains why AltaCorp is bullish on HEXO Corp (TSE:HEXO) (NYSE:HEXO) (FRA:74H). AltaCorp recently initiated coverage on a number of names, including HEXO, which it gave an outperform rating and a $10.50 share price target. Kideckel emphasizes the importance of branding, beverages, and CPGs to success in the cannabis market and notes that HEXO is partnered with Molson Coors (NYSE:TAP), one of only three companies with an industry-leading partnership. Kideckel suggests the joint venture between the two companies, Truss, has been undervalued by the market and investors. Kideckel indicates that AltaCorp’s HEXO price target is conservative and takes into account the relative newness of the infused beverage space. Kideckel also discusses AltaCorp’s coverage of Cardiol Therapeutics Inc (TSE:CRDL) (OTCMKTS:CRTPF), a player in the biosynthetics space. Kideckel highlights Cardiol’s exclusive partnership with Noramco, the world leader in chemical synthetics as a significant differentiator.


Benjamin A. Smith: Welcome to Midas Letter Live. I’m with David M. Kideckel. He is the Managing Director and Senior Analyst at AltaCorp Capital. David, welcome back to the program.

David M. Kideckel: Thanks for having me, Ben.

Benjamin A. Smith: Now, last week AltaCorp initiated HEXO with an outperform rating and a $10.50 per share price target. That implies another 50 percent or so upside from current prices. Now, could you explain why you like HEXO so much, and where the salient points on that report?

David M. Kideckel: Absolutely. So I’ll take a step back for a second; we actually launched on a number of names last week. HEXO was one of them. We also launched some Cardiol Therapeutics.

As you know, Ben, April 1st was a big day for Ontario when legalized cannabis dispensaries were allowed to actually open up. One of the big problems, I toured, or I was at the Grand Opening, I should say, of Fire and Flower just last week out in Kingston, Ontario. One of the big problems with branding for any cannabis company out there is the restrictions that Health Canada puts on any company, or how they’re actually allowed to brand product. This was clear for most of the companies, not one in particular.

Looping that back to HEXO, and we initiated on them as you mentioned, we view this whole cannabis sector as going in a few different directions. One of them, which is one of the biggest areas, will be branding, beverages, and the CPG space. HEXO really does this all, and they do a lot more. They’re one of only three cannabis companies, major cannabis companies, in the world to have an industry-leading partnership with Molson-Coors. The joint venture, or the JV, is called Truss. We view this as a big deal for HEXO, and we feel that most people on the Street really haven’t given them the credit for senior management at HEXO to really be able to pull this deal off.

You look at a company like Molson-Coors, one of the world’s leading beverage companies, and now with Molson-Coors and HEXO with Truss, the JV, they’re conducting world-leading product innovation and general R&D.

Benjamin A. Smith: Now, do you think that the cannabev space is going to take off? I know there was a lot of chatter about that last year when, you know, the partnership talk was taking place at the high end of the Tier 1 cannabis space, and of course, you know, HEXO snagged that deal with Molson-Coors and Aurora with that extra equity stake from Constellation Brands.

Now, is it your belief that the cannabev space will take off, or was it sort of a, you know, perhaps a fad and that has a chance or risk of not really catching on with mainstream consumers?

David M. Kideckel: No, I think it’s, one of the big problems in the entire industry – this is also true in the US – is the technology just isn’t there to produce quality, non-alcoholic cannabis beverages. I don’t think this is a fad at all, and in fact, if you look at very mature markets like Colorado, where as a percentage of total cannabis spending, beverages only contribute maybe about 2 to 4 percent depending on which year we’re talking about – a big reason for that is because the drinks just don’t taste good. You get companies like Molson-Coors and HEXO now, that are tweaking these types of products, and I think the market will respond appropriately.

Now, a big part of this too with the US Farm Bill being approved back in late December of 2018 – this just opened up a huge opportunity for HEXO in particular to move into hemp-based, CBD infused beverages. And in fact, the way we’ve modeled HEXO, we’ve taken our usual discounted cash flow analysis and we put that, we’ve assigned a price, both on HEXO with Truss and HEXO without Truss. So we see this as contributing to the overall share price, and I just want to –

Benjamin A. Smith: Sorry to stop you, there: is it hard to make assumptions what that discounted cash flow might be, or with that model? Or is it, are the assumptions sort of hard to make, seeing that the product isn’t out there yet and that the space hasn’t really taken off?

David M. Kideckel: That’s a great question. So in fact, we’ve come in quite conservative, just like all of our research reports, and we’ve taken our numbers down to a level that we’re comfortable with, using really the Colorado market in particular as a very mature cannabis area. And we’ve modeled those according to how we think Canada will eventually catch on with the beverages.

So I would say certainly there, in any analyst’s role, you have to make certain assumptions. What I could say is that our assumptions have been very conservative, and there’s a lot of room for upside for HEXO. Just pointing out, you probably saw the deal a few weeks ago, I remember speaking with James about it, HEXO and Newstrike; this really has bolstered HEXO’s distribution now, and now they’ll have solid distribution throughout nine provinces in Canada.

Benjamin A. Smith: Terrific. Now, last week as well, you initiated a speculative buy and $9 per share price target on Cardiol Therapeutics. What is it that you like about this company in particular, and is it a biosynthesis play, which you know, could be, you know, the next cannabis 2.0 trade in due course?

David M. Kideckel: Cardiol Therapeutics, yeah, that’s another name that we’re very bullish on. They really stand out. I would position them as a biotechnology company. They’re engaged in clinical trials, and also they’re going to be selling medical cannabis, whether that’s through online or through pharmacies or direct to consumer, we have yet to see how that strategy is going to move forward. But they’re, I wouldn’t say right now they’re into biosynthetics; they’re into chemical synthesis, and in fact, their exclusive partner out in the US is Noramco. They’re arguably the world leader in chemical synthetics when it comes to controlled substances.

So through Noramco, what you’re going to see through Cardiol’s product, at least on the medical cannabis side, this is going to be a 99.9 percent pure CBD product. I’m certainly not aware of any other products like this –

Benjamin A. Smith: Synthetic products.

David M. Kideckel: Synthetic. But you have to remember: CBD is CBD is CBD. It doesn’t matter. The chemical structure, it doesn’t matter whether you’re talking, if it’s coming from a plant or through the chemical synthetic side. Now, so medical cannabis is one area that they’re very active in.

The other two, one of the most massive unmet market needs, market medical needs, is in the area of heart failure, and this is another area that they’re pursuing active clinical trials in. They’re going to be starting Phase I, and also, that’s a massive unmet medical market need, and then they’re also engaged in rare diseases, or orphan diseases. And I used to work for the world leader in rare diseases, a NASDAQ-listed company.

So this rare disease is called glioblastoma. It took the lives of, you know, Gord Downey, some famous people, and we feel – well, I’ll back up a step. The approach we’ve taken, we’ve taken a sum of the parts analysis. So we valued each part of their business, and not looking at it just as a whole thing. So we’ve modeled medical cannabis, glioblastoma, and also heart failure. And there’s a couple of other things, too, which I don’t think it’s necessary that we get into. But this was a very thoughtful approach, and again, backed by really strong management.

And I can’t emphasize enough, in this whole cannabis space, the premium that folks should be taking when it comes to strong management, because we’ve seen certain companies out there, some have failed, some are on the verge of failure, and not going to point out anyone in particular, but we feel that the ones that will win will have very strong management teams. And Cardiol Therapeutics and HEXO are just two examples of that.

Benjamin A. Smith: Of course. Now, speaking of the biosynthetics trade, even though Cardiol Therapeutics is on the periphery of that, a lot of people like myself, some other analysts and other people I’ve spoken with, believe that there’s a lot of potential there, but the time may not be now. Sort of timelines are a little bit dicey. You know, is it a few months from now? Is it a year from now, two years from now?

David M. Kideckel: Sure.

Benjamin A. Smith: In your opinion, since AltaCorp and yourself personally specialize in the biosynthetics industry or side of the cannabis trade, how long, how much of a long cycle item is that, and when do you expect that trade to emerge?

David M. Kideckel: Sure, so it’s a very timely question, Ben, because we were just published just this morning in the Wall Street Transcript Live, and the feature headline was on biosynthetically derived cannabinoids. We actually give a whole sector oversight in general, but biosynthetics is one of them.

Now, this is a very infant area as well, but we do feel it’s poised, the whole cannabis sector is poised, for a big disruption. We don’t believe that the question becomes plant-derived versus biosynthetically derived, we see the two working really in tandem, and the major reason, one of the major reasons, is because when you’re talking about very rare cannabinoids, whether this is CBN, CBG, there’s over 100 different cannabinoids in the plant – it’s just too cost-prohibitive for any company to extract these from the plant.

So there’s a huge opportunity. Now –

Benjamin A. Smith: Is the technology there right now to bring it to market, to get the regulators onside? Or when are those timelines going to take?

David M. Kideckel: Good question. No, I would say the technology isn’t there, in fact. So I would say from the timeline to commercialization, the estimates I’ve seen, and I’ve spoken with a number of different these biosynthetically derived cannabinoid companies – anywhere from 18 to 24 months until companies are going to be able to produce this at scale.

Now, that said, there’s also only a handful, maybe if any, that are actually public right now. So most of these companies are all private. So with respect to the – I wouldn’t even call it a trade; I would say from an investor point of view, if you’re looking to get in with these companies now as they transition to becoming public, now, without question, is the time.

Benjamin A. Smith: Private placement?

David M. Kideckel: Private placements, and even for companies that go through, whether they’re RTOs or IPOs, and we’re involved with a significant number of them. So now, I would suggest, is the time.

And going back just comparing biosynthetics versus synthetics, which is really what Cardiol is doing right now, I just, I can’t highlight enough the importance of a medical cannabis product, from Cardiol in particular, where you’re looking at by Health Canada’s standards. It meets the definition or criteria to be able to brand itself as a THC-free product. Now, and we believe that Cardiol will be able to put a premium on the price for the actual product because of that, because we don’t know of any other product out there that can claim that they’re THC free.

Benjamin A. Smith: Okay. So they’re going to, they passed the regulation muster, so to speak, already? Or most of it, anyway.

David M. Kideckel: Yes. In fact, we talked about Noramco, but their other manufacturer that I toured just about a week or two ago was Dalton Pharmaceuticals. And they’re a private based company, and what Noramco does, they produce the CBD. It comes in a powder-like form, pure CBD. That in turn is shipped to Dalton Pharma, which is based here out at York University in Toronto. Dalton then comes and makes the final product. And all of Dalton’s facilities are all based on, forget about EU GMP certification, which is something we hear a lot for export into the German market in particular; these are CGMP, which stands for Current Good Manufacturing Practices. This is the gold standard used in pharma.

So the fact that Cardiol now is able, or will be able, to sell medical cannabis produced in CGMP-type facilities, they’ll be able, we think, they’ll be able to command a premium price for their product.

Benjamin A. Smith: Terrific. Now finally, I want to ask you – I understand that you have a new deal coming up, or closed, or perhaps you can describe it further. Harborside, the Harborside deal. Can you explain more about that and why you like it? You know, the details of the…

David M. Kideckel: Absolutely. Well, I’ll tell you what I can share: that AltaCorp Capital just launched this deal just this morning. This is a California-based play, and we’ve already said in our previous reports, California is the second-largest market in the world. By about 2022 or so, you’re looking at anywhere from 8 to 10 billion of the market in general, so California, without question, is the place to be. We saw the deal last week with Cresco and Origin House, Origin House being another California focus. So we’re bullish on California in general as a market, and then back to Harborside, the deal, at least what I’ll comment on, it’s going to be up to a $70 million deal, and it’s not a private placement, actually. As AltaCorp Capital, we’re the lead agent for this, and we’re going to be taking them public.

Benjamin A. Smith: Okay. Are you not scared off at all about the California regs, and about some of the competition there? Because there’s a saying in cannabis that if you can make it in California, you can make it anywhere, just because there’s so many producers and some of the regulations are quite stringent. Or the opposite of that, actually, there’s a lot of players and a lot of dried flower on the market. Does that not scare you off at all, or do you think California will settle itself down and regulations will become more stringent going forward, and sort of weed out some of the, you know, menial players?

David M. Kideckel: Sure. Again, another great question, Ben. So I’ve toured California extensively, going to a lot of these dispensaries, cultivation sites, etcetera, and it’s true: California has some pretty strict rules and regulations, which I think is ultimately good for the market, because as the industry matures, it’s going to weed out, no pun intended, the so-called illicit or black market to cannabis.

So the fact that California’s coming down hard with regulations, I think, only helps companies, and those companies that can navigate around these complex regulations and rules, I think those are the ones that are going to be winners. And certainly California is a crowded marketplace. We see a number of US vertically integrated cannabis companies or MSOs playing in California, and Harborside is just another example of one of those California-based plays that we’re happy to get behind.

Benjamin A. Smith: All right, terrific. Well, David, thank you. We’re going to leave it there right now; David, thank you again for joining the program. We appreciate your insight.

David M. Kideckel: Thanks, Ben.

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