It's been a good year for marijuana stocks so far. Investors have seen many cannabis companies announce impressive sales growth in taking advantage of new opportunities across the globe, including the legalization of recreational pot in Canada and the recently passed U.S. Farm Bill, which made it legal at the federal level to produce and sell hemp-based products.
Marijuana stocks are entering the mainstream, and that means that Wall Street stock analysts are starting to weigh in on their prospects for the future. In late February, Jefferies became the latest well-known financial institution to start covering cannabis stocks as part of its analysis, and in general, it was positive on the industry. Yet although Jefferies picked five pot stocks to do well in the current marijuana boom, it also identified two -- Cronos Group (NASDAQ:CRON) and HEXO (NYSE:HEXO) -- that it believes won't keep up with its cannabis rivals.
Check out the latest earnings call transcript for Cronos Group.
Why Jefferies likes marijuana in general
Like other analysts, Jefferies has a general thesis for the cannabis industry that includes projections for extremely fast growth. With estimates of about $17 billion in sales for marijuana companies in 2019, the analyst company believes that the size of the market will triple to $50 billion in the next decade using its base assumptions. If things work out a bit better than it expects, then its stretch target for the industry would be $130 billion.
Even with all the press that the recreational cannabis market has gotten after Canada's rollout last fall, Jefferies believes that the industry will retain a balanced split between general adult-use and medical marijuana. The company's projections are for recreational sales to rise from $9 billion to $31 billion over the next 10 years, compared to growth from $8 billion to $19 billion on the medical marijuana front.
Much of the attention that marijuana has gotten early on has centered on production and sale of dried cannabis. However, Jefferies expects that the drive for brand building and innovation will make it more important for cannabis companies to dovetail on other successful products in adjacent industries, such as snack foods, beverages, and tobacco. That will give marijuana stocks that successfully work together with companies that specialize in those other areas a competitive advantage over their rivals.
Why will Cronos and HEXO miss the party?
However, Jefferies wasn't positive about the prospects for every pot stock in the industry. It issued underperform ratings to Cronos and HEXO. Cronos earned a price target of about $13 per share, while HEXO's stock got a target of roughly $4.25 per share. With Cronos recently trading above $21 per share and HEXO having a price above $5.50 per share, Jefferies has strong views about the likelihood of the two stocks seeing outright declines from current levels.
Of the two, the negative call on Cronos Group might seem to be the more surprising. After all, with its high-profile tie-up in December with cigarette giant Altria Group (NYSE:MO), Cronos seems to have exactly the kind of partnership that Jefferies said would be important for future growth. In addition to Altria's pull in the tobacco industry, its substantial stakes in e-cigarette pioneer JUUL Labs and beer maker Anheuser-Busch InBev (NYSE:BUD) give Altria a lot to bring to the table in fostering Cronos Group's growth.
Yet Jefferies argues that Cronos hasn't yet figured out how it will use Altria's vast financial and other resources. That leaves Cronos as a second-tier cannabis stock in terms of production, dramatically lagging the leaders of the field yet carrying a valuation far in excess of what companies with similar production levels currently fetch. That, in Jefferies' view, justifies the negative call.
HEXO, meanwhile, has given investors more time to digest its partnership with Molson Coors Brewing (NYSE:TAP). The creation of the exclusive joint venture Truss will give Molson the ability to explore cannabis-infused beverages with HEXO, an area that has considerable promise. But even though the two companies announced the joint venture last August, there hasn't been a huge amount of news coming from the business. Jefferies sees HEXO shareholders as having been too optimistic about the partnership and believes that HEXO could struggle to build out its core cannabis business to maximize growth.
Not all marijuana stocks are the same
All that said, analysts aren't infallible, and Cronos and HEXO have plenty of opportunities to defy negative calls. Cronos is in the better position at the moment because of the huge ownership stake that Altria has taken, giving the Marlboro maker a financial incentive of its own to generate success. With the industry still in its infancy, changing conditions will make for volatile stock movements.
The Jefferies report is a powerful reminder that cannabis companies have different business models, market share, and growth prospects. Even if the industry as a whole is a long-term winner, that doesn't mean that Cronos Group, HEXO, or any other individual stock will produce big gains for shareholders.