Life Sciences Canadian Cannabis 2025 Outlook

The year 2024 was mixed for Canadian cannabis investors. The sector underperformed broader indices but outperformed US cannabis by a substantial margin (the HMMJ ETF is up 5.3% while the MSOS ETF is down 49.4% YTD). Importantly, in-sector performance was correlated with fundamentals, which indicates Canadian names are starting to trade more on operational performance, and less on hopes of catalysts. Case in point: High Tide, which we think is the name with the strongest fundamentals, was also the best-performing stock, gaining 109.4% YTD. We like the set-up of increased emphasis on fundamentals as a way to dampen volatility and regain institutional investor interest in specific names. Talking about fundamentals, we think 2024 saw three trends that will continue in 2025: 

1. Persistent challenges in the domestic LP market due to fragmentation, high excise taxes, and volatile share;
2. Increased reliance on international markets, with LPs setting sights on Europe to find higher-margin growth; and
3. A consolidating retail market benefitting large retailers like High Tide and SNDL. We think investors should favor operators with strong balance sheets (avoid the risk of dilution), consistent positive FCF (or a path towards it), and a credible growth path. High Tide checks all the boxes and remains our top pick.

Highlights:

Canadian Rec. Market Forecast
We anticipate a six-year CAGR (2024e-2030e) of 5.2% from 2024e sales of $5.48bn to 2030e sales of $7.42bn (versus our previous forecast for a CAGR of 8.7% to 2030e sales of $9.21bn). Our downward revision is supported by (i) lower population growth, with the Government of Canada lowering its population growth targets (driven in part by lower immigration), (ii) lower and more gradual conversion of illicit market sales, (iii) challenging macro conditions, and (iv) flat cannabis usage (vs previous expectations for gradual increases).

High Tide is Our Top Pick
High Tide is a growth compounder with a clear runway over the next few years. The Company operates 189 stores today, and is opening new locations to reach its target of 300. Given its leading competitive position as the largest Canadian cannabis retailer (and second largest in North America), we think High Tide has reached sustainable profitability, with margin expansion potential through operating leverage. The Company is a direct beneficiary of consolidation in the Canadian cannabis retail market. We view incremental upside from international markets, notably with the recent launch of Cabana Club in the US and Europe for CBD and accessories.

We Remain Cautious on LPs
We expect LPs to continue facing difficulties in Canadian rec. due to high excise taxes, fragmentation, and price competition, which puts a dent on growth and profitability. Positive FCF generation remains an exception, and adj. EBITDA margins, when positive, are generally in the low single-digits. We are more constructive on international, a view that appears to be shared by the companies considering recent investments. If LPs realize significant growth internationally, their profitability profile could materially improve; however, this is still uncertain as international markets are subject to substantial regulatory and competitive risks.

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