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Cannabis: Prepare for Canada’s Multi-Billion Dollar Boom

In January, MRP noted the United States’ burgeoning crackdown on the fledgling cannabis industry with the rescindment of the Cole Memo, which effectively allowed states to legalize marijuana with little-to-no government interference. This reversal of policy, combined with a drive for full legalization of marijuana in Canada, has created a huge opportunity for America’s northern neighbor. Final legislative approval by the Canadian government is expected in a June 7 Senate vote, ahead of which many companies and even some banks have been preparing for a transformative change to the country’s economy.

At least $1.23 billion was invested in the industry in the first five weeks of 2018 alone. Canada’s Parliamentary Budget Officer (PBO) projected that marijuana sales would be between CA$4.2 billion and CA$6.2 billion. The midpoint of that range amounts to around $4 billion USD. The midpoint of Deloitte’s estimated range is roughly $5.3 billion in U.S. dollars. However, over time, this market has the potential to double if we compare it to Colorado’s legalization a few years back. Canada and Colorado’s legalization scenarios are similar in that both permitted legal use of medical marijuana for several years before moving to legalize recreational use of the drug. Marijuana legalization also enjoys public support in both areas. Colorado is probably on track to record total marijuana sales of $1.6 billion this year. Assuming Canada’s marijuana market follows a similar path of growth, and accounting for the difference in population sizes, Canada could be in store for a marijuana market of $10.4 billion annually within a few years.

Most provincial estimates and Wall Street reports have called for approximately 800,000 kilograms (1.76 million pounds) of domestic annual demand. However, a report issued last month by Health Canada, the regulatory agency responsible for overseeing the legal cannabis industry, as well as issuing cultivation and sales licenses, projects that domestic demand could reach 1 million kilograms (2.2 million lbs) by the end of 2018. However, the number of startups and other companies prepared to fill that demand have some fearing oversupply. Oregon is currently in the midst of such a situation as the state currently has nearly 1 million pounds of marijuana flower in inventory, a staggering amount for a state with a population of 4.1 million people. The retail price for a gram of pot has fallen about 50 percent since 2015 from $14 to $7, effectively pushing growers to begin illegally modifying their product for sale on the black market.

Oversupply worries for Canada, however, are likely overblown considering the country already has very limited inventories and a complex distribution network for the country’s small number of dispensaries. With the exception of Canopy Growth, most licensed producers’ (LPs) inventories are likely to not grow substantially over the next few months, especially as some LPs meet medical patient and export demand. In March, Health Canada reported inventories held by LPs as of the end of December totaled only 50 million grams. To put that in perspective, assuming 0.3 grams per joint, this would effectively amount to about four joints per Canadian per year. While production will undoubtedly pick up after legalization is official, this existing supply/demand imbalance will have to be addressed before any worries of a cannabis glut.

Canadian supply will also have more than just domestic demand to fill. Globally, there is a massive excess of demand over supply for legal, regulated medical cannabis, and Canadian companies have little competition in supplying it. The average price of American marijuana per 1/8 ounce is equivalent to $40.00. Meanwhile, the same amount of Canadian crop sells for only $27.90, more than a 30% discount. Furthermore, at every small purchase quantity from 1/8 of an ounce to a full ounce it’s still much cheaper to buy in Canada versus the United States.

Canadian cannabis farmers and manufacturers are already shipping marijuana to Germany, Czech Republic, Australia, New Zealand and other destinations. At least seven producers in Canada have been granted licenses to export cannabis. Canadian shipments of dried medical cannabis have soared since 2015. More than 522 kilograms of dried cannabis was exported to four countries last year, more than 10 times the 44.8 kilograms shipped abroad in 2016. Shipments of cannabis oil in 2017 topped 400 kilograms, nearly quadrupling the 2016 amount of 100 kilograms.

To better address these needs, companies are trying to scale up their operations and M&A activity in Canadian Cannabis is heating up as a result. Just last week, Canada’s Aurora Cannabis Inc. agreed to buy rival MedReleaf Corp. for about C$2.9 billion (US$2.2 billion) in stock. The deal will create a producer with the capacity to grow 570,000 kilos (1.26 million pounds) a year of cannabis at nine facilities in Canada and two in Denmark. This deal, the biggest in the industry thus far, will create a merged company with better distribution networks at home as well as in Europe, South America and Australia. Helping the new company along even further, while also setting a powerful precedent, is the Bank of Montreal (BMO).

The cannabis industry’s biggest hurdle has long been gaining support from the banking sector, but BMO Capital Markets has taken a huge step with Aurora after advising the company on the takeover of MedReleaf, and encroaching on the territory dominated by smaller investment banks like Canaccord Genuity Group. Canaccord, the top adviser for Canadian cannabis companies, has advised four deals with a combined value of US$5.15 billion. BMO Capital Markets originally became involved in Canada’s pot industry in January after helping lead a C$200.7 million equity financing for Canopy Growth Corp., becoming the first major Canadian bank to arrange a stock sale for a pot company. While BMO has yet to take on deposits, Alterna Savings & Credit Union has been the most marijuana-friendly bank and currently holds about C$750 million in pot-related loans and deposits, about two-thirds of the almost 100 licensed producers in the business bank with Alterna.

Corporate Cannabis is just getting its feet on the ground in Canada, and it already has fleshed out production capacity on the ground, along with a friendly regulatory framework. The potential for the market it could create, domestically and internationally, promises to be a compelling opportunity for years to come. Investors can gain exposure to Canadian cannabis via public companies including Canopy Growth Corp. (TWMJF), Aurora Cannabis Inc. (ACBFF), and Aphria Inc. (APHQF). The Alternative Harvest ETF (MJ) provides broader exposure, but has been significantly outperformed by many Canadian stocks over the last year.

 

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