Marijuana stocks have fallen sharply this year, bringing them into what investors might consider bargain territory. But it would be unwise to bet on that assumption.
The fact that Canada is the first G-7 country experimenting with legal sales of recreational pot should be enough warning that uncertainty is going to characterize this new market for quite some time – probably at least two years after legalization, set for Oct. 17.
The size of the legal market – a prime consideration for investors, obviously – is unknowable with any kind of precision. That’s to be expected, given that projections are necessarily based on black-market sales.
Illicit dope peddlers and wholesalers are not among the most reliable sources of market data.
It’s therefore a leap into the unknown to speculate how big a pie the scores of publicly traded North American marijuana producers will be able to divvy up.
The most common projection on Canadian market size is about $5 billion (all figures in Canadian dollars) in annual sales by 2020. That assumes a complete migration by pot users from the black market to the new legal one, an unlikely prospect, and one of many risk factors I warned of earlier this year.
Ontario complicated matters further this week by revealing it doesn’t know how many legal pot stores there will be, when nor how widespread in the province. It hasn’t determined its criteria for licensing retail outlets nor begun its promised exhaustive consultation with communities on how the market is to be set up and monitored.
Ontario is expected to be the biggest recreational weed market in North America after California. The industry’s investors have long had their eyes on that prize.
Ontario did take steps this week to suppress growth in pot demand. It has permitted municipalities to ban pot stores. It has also outlawed cannabis lounges. And it has prohibited pot use except in private residences, effectively making consumption of legal recreational marijuana a strictly middle- and upper-class activity.
In a policy reversal, the Ford government said this week there will be no Ontario bricks-and-mortar pot stores until April 1, 2019.
Given that the Ford government hasn’t yet decided on the qualifications for eligibility to open a pot store, it’s unlikely there will be very many of them come the province’s official start date.
“I’m a little suspect on these stores being open April, but maybe the first batch will be open by then,” Matt Bottomley, analyst at securities firm Canaccord Genuity, told Bloomberg News this week.
In the meantime, between federal legalization Oct. 19 and the first store openings next April, recreational pot will be available to Ontarians only online, with purchases from the provincial government’s Ontario Cannabis Store.
Selling pot exclusively online is a sure way to dissuade tokers from switching from the black market, the feds’ rationale for decriminalizing recreational pot use in the first place. An online purchase leaves a digital trail. That’s an obvious worry for consumers who don’t want employers, governments and others to know of their pot-consumption habits.
Ontario will ensure that consumers know that marijuana “is still a drug that poses risks to health and safety,” said Attorney General Catherine Mulroney this week.
What does that mean?
Does Ontario have in mind a public awareness campaign? Or is the Ford government planning to make the decisions on product pricing, the types of marijuana products that can be sold, acceptable locations for pot stores and acceptable marketing methods?
Each of those factors will affect demand and investor returns.
Ontario’s pot-plan announcement this week was sufficiently maladroit to further depress marijuana stocks. The stocks may have further to drop, though.
One of the biggest reasons for that was also revealed this week when Constellation Brands Inc., one of the world’s mid-tier beverage alcohol firms (Corona beer, Robert Mondavi wines), stunned the industry with a $5-billion investment in Canopy Growth Corp.
With that massive cash infusion, the Victor, N.Y.-based Constellation increases its stake in Canopy to 38 per cent, or 50 per cent if it exercises warrants that are part of this week’s deal. With a market cap of $52.2 billion, Constellation outclasses the entire industry in capital, which for starters, it expects Canopy to use to expand to 30 from the 11 countries in which it currently has a presence.
With Big Pharma and Big Tobacco yet to be heard from, Big Booze is quickly moving into the pot sector on several fronts. Mid-tier brewers Molson Coors Brewing Co. and Heineken NV already have forged partnerships to market beverages infused with THC, marijuana’s active ingredient.
Canopy stock leapt 31 per cent Wednesday on the Constellation announcement. But the deal sees Canopy lose its independence – the likely fate for most pot firms, destined to be absorbed by the handful of biggest industry players.
In the key Ontario market, players are free to seek market dominance, which will, as things look now, have Canopy heading for near-monopoly status in that rich market. By contrast, Alberta and B.C. have restrictions that prevent the emergence of an oligopoly or near-monopoly.
But in the huge Ontario market, it’s tough to imagine a scenario in which most pot firms aren’t outmuscled by Constellation’s new Canadian branch plant, Canopy Growth, which has targeted $1-billion worth of pot firms for acquisition.
Pot stocks were already in a swoon before Ontario’s abrupt policy reversal this week changed the rules of the game. Investor fatigue with escalating pot-firm expenses against a paucity of profits caused the pot-stock sector to tumble by 44 per cent in market valuation since its peak in January, as measured by the BI Canada Cannabis Index.
Current industry leaders such as Canopy Growth and Aurora Cannabis Inc. must achieve a bonanza in Ontario, with all its uncertainties, to recoup their enormous investment in expansion. Both firms have yet to earn a profit to justify their combined market cap of $15.4 billion.
Viability for this fledgling industry might lie with Fluffys and Barneys. Canopy Growth’s stock popped about 5 per cent early this week when it said its Canopy Animal Health unit has won Health Canada approval to research pot for pets, with an early emphasis of anxiety relief.
Canada’s publicly traded marijuana firms are on track to boost annual weed production to a staggering 3 million kilograms by 2020. The industry has to hope that among Canada’s 16.4 million household cats and dogs, there are enough stressed-out Fluffys and Barneys to help absorb all the weed they’re bringing into production.