Highlights from Life Sciences

Frederico Gomes, CFA 437 778 5172

The Canadian cannabis market is volatile, but there is one consistent trend—growth rates are slowing. Retail sales in Q1/22e are estimated at $1.0bn, up 21% y/y. While this double-digit growth appears healthy, in Q1/21 the industry was growing at 73% y/y, and in Q1/20 at 189% y/y. Growth rates have declined every quarter for the past two years, and for the first time, sales declined q/q. We believe this cannot be fully attributed to a seasonally weak Q1; rather, it signals a maturing market. We wrote previously that it would take at least two years for LPs to consolidate. If the growth slowdown continues through 2022, as the trend indicates, consolidation could accelerate because market participants would have to adjust for a smaller-than-expected industry size. This report highlights the consequences of this slowdown and what we believe are the best-positioned LPs in our coverage. 

A Smaller Market, Lower Multiples
In our last market sizing, we forecasted rec. sales of $4.8bn in 2022e, a 23% growth over $3.9bn sales in 2021. While still early to adjust our forecast, the trend in Figure 1 indicates industry sales could grow less than 20% in 2022. In our view, slowing industry growth could lead to multiple compression across the space, as it has been happening for the past two years. 

Scarcer Capital
Since the early days of legalization, much capital was invested in LPs driven by high growth expectations in a nascent industry. Capital is still flowing into the space, but we believe it will become increasingly scarce as capital providers incorporate more modest growth expectations into their assessments. 

Race To Profitability
Most LPs are operating with losses in a market marred with oversupply and competition; however, capital scarcity is mounting pressure for profits. We expect companies to increasingly direct resources to operating efficiency as opposed to growth. LPs are still pursuing sustainable adj. EBITDA profitability; as the market matures we believe participants will shift focus to EPS and FCF, which we view as better financial indicators of self-sustaining operations. 

In This Environment, We Favor (1) A Strong Capital Position, (2) Market Share Momentum, and (3) Efficient Operations
(1) With capital becoming scarcer and consolidation accelerating, having a strong balance sheet is paramount to weather the storm and seize distressed-assets opportunities. (2) Industry sales are still increasing, but LPs targeting +20% y/y growth rates must gain market share. (3) To reach profitability, LPs will have to keep costs in check and operate efficiently.