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Here's why Bank of America's Christopher Carey is high on these three pot stocks.
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Once upon a time, Wall Street analysts wouldn't touch a marijuana stock with a 10-foot pole. Now many of the same analysts are cuddling up to quite a few pot stocks.
The latest example of Wall Street's fascination comes from Bank of America. Last week, analyst Christopher Carey initiated coverage on three marijuana stocks with positive views: Aurora Cannabis (ACB +0.05%), Canopy Growth (CGC +0.25%), and HEXO (HEXO +0.00%).
Carey was most enthusiastic about HEXO's prospects, setting a one-year price target that reflects a premium of more than 40% above the current share price. He also thinks that Aurora and Canopy could move nearly 20% and 8% higher, respectively. But while this top Wall Street analyst loves these three pot stocks, should you?
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Canopy Growth has been a favorite among analysts for a while. Analysts like Canopy's sizable production capacity, its strength in the Canadian market, and its global operations. Perhaps most of all, they like the company's relationship with big alcoholic beverage maker Constellation Brands.
Constellation first invested in Canopy Growth in 2017, buying a 9.9% stake in the company and teaming up to develop cannabis-infused beverages. But Constellation really upped the ante last year with another $4 billion investment in Canopy. This provided Canopy Growth a huge cash stockpile to fund its expansion efforts. This cash is still reaping benefits within the analyst community, with GMP Securities upgrading Canopy to a buy earlier this week on the company's $300 million purchase of the right to buy U.S.-based cannabis operator Acreage Holdings.
Aurora Cannabis hasn't always been analysts' darling, but that has changed significantly in 2019. Cowen analyst Vivien Azer now rates Aurora as her top pot stock pick. Aurora's attractions include its large capacity and its international strength, particularly in Germany. It also helps that the company's market cap remains well below Canopy Growth's, which arguably gives Aurora stock more room to run.
The major downside to Aurora is that it doesn't have a large partner. That issue could be resolved in the not-too-distant future, though. Aurora recently brought billionaire Nelson Peltz on board as a strategic advisor to use his extensive connections to help find partners in key markets that cannabis could disrupt.
HEXO isn't nearly as big as Aurora Cannabis or Canopy Growth. It doesn't have an impressive international presence, either. So why is Bank of America so optimistic about the stock? HEXO's lower valuation is a big plus. So is the company's great supply deal with Quebec that gives it a market share of at least 30% in the province's adult-use recreational cannabis market.
Another advantage for HEXO is its partnership with Molson Coors Brewing. But Bank of America's Carey thinks that it's possible that HEXO could develop additional partnerships in the future.
There are two common denominators for Aurora, Canopy, and HEXO that are perhaps most important in winning analysts' affections. One is the growth opportunity in the Canadian adult-use recreational marijuana market. The other is an even bigger growth opportunity in international medical cannabis markets.
It's sometimes easy to lose track of the fact that the adult-use market in Canada has been open for only six months. Marijuana producers are still scrambling to crank up enough capacity to meet demand. And this market should expand significantly perhaps as early as October 2019.
Regulations for cannabis edibles and beverages haven't been finalized yet. Aurora, Canopy, and HEXO anxiously await the opportunity to launch edibles and beverages and are likely to enjoy nice sales boosts when the market for these products opens.
All three companies also see tremendous opportunities in international medical cannabis markets. Aurora and Canopy have established significant operations in Europe and Latin America. HEXO isn't as far along but teamed up with a Greek medical cannabis company to form a joint venture to ship medical cannabis to European markets.
It's only fair to note that not every analyst is as bullish about these pot stocks. Scotiabank recently slashed its revenue estimate for Canopy Growth for reasons that don't bode well for Aurora or HEXO. Jefferies analyst Owen Bennett is especially pessimistic about HEXO after the company's lower-than-expected sales last quarter.
The fact is that many investors won't love these stocks, either. Aurora, Canopy, and HEXO all sport valuations that are based on expectations of huge growth. Anything that gets in the way of this growth could cause the stocks to plunge.
Aggressive investors with long-term perspectives, though, could find any or all of these marijuana stocks appealing. Aurora Cannabis and Canopy Growth are likely to be top contenders as the global cannabis market expands. HEXO's lower valuation combined with its rapid capacity growth stemming from the Newstrike Brands acquisition could position the company as a formidable second-tier competitor.