Canadian Marijuana Legalization: What’s Next, Who Wins?

By admin_45 in Blog

Big news on the disruption front: Canada’s upper house of parliament passed a bill to legalize recreational marijuana which will go into effect on October 17th. This is a huge deal. Uruguay may have been the first country to legalize retail use of the drug, but Canada will be the second and the only G7 country to do so.

These legalization efforts have been in the works for a while, as it was a major issue Prime Minister Justin Trudeau ran on during his party’s 2015 federal election campaign. This was summed up by his tweet about the news: “It’s been too easy for our kids to get marijuana - and for criminals to reap the profits. Today, we change that. Our plan to legalize & regulate marijuana just passed the Senate. #PromiseKept.”

So how will this all work? A few points:

• Age limit: The minimum legal age to buy and ingest marijuana in Canada will be 18 (or 19 in some provinces) compared to 21 in the US in states where it is allowed.

• Purchase/possession: Canadians will be able to start buying marijuana by licensed producers at dispensaries in a few months after provinces and territories have enough time to prepare. Adults won’t be able to buy edibles likely until sometime in 2019, however, as the government needs to prepare a framework to regulate those products.Canadian adults will also be able to grow up to four plants per household, and possess up to 30 grams (1 ounce) of dried marijuana in public.

• Regulations: The Federal government will regulate the production of marijuana, but each province and territory will control how marijuana is sold and distributed. For example, Alberta will allow several private retailers to sell marijuana, Ontario will allow some state-run stores to sell it, and Newfoundland and Labrador will allow grocery stores to offer cannabis. Above all, packaging of cannabis must be plain and include health warnings, similar to many US states’ approach where retail marijuana is legal.

• Taxes: There will be an excise tax and regular sales taxes on transactions. The excise revenue will be split 75/25 between the provincial and federal governments for the first two years. The excise tax will equal $1 per gram or 10% of the retail price.

As for how this will impact the Canadian marijuana market, a recent report from Deloitte estimated that retail sales could produce up to C$4.3 billion ($3.2 billion in US terms) in 2019. That’s in addition to as much as $1.8 billion ($1.4 billion in US terms) in medical sales. Here are some other takeaways based on their survey of +1,500 current and likely cannabis consumers in Canada:

• Legal vs. black market: Current cannabis consumers are “likely to move nearly two-thirds (63%) of their purchases to legal channels” despite expecting to have to pay 10% more per gram after legalization. Deloitte thinks that they could switch to legal options completely “through the right mix of quality, price and safety”.

• Purchase patterns: Current marijuana consumers are expected to buy more frequently and spend more after legalization.

• Other products: Canadians will have to wait at least a year to buy edibles, but 6 out of 10 “likely consumers are expected to choose edible products”.

• Retail vs online: Current and likely consumers are expected to buy most of their products at retail stores, but one-third will also “buy products online through approved retailers’ websites”.

• Potential substitution effect: Almost half (41%) of respondents say they use cannabis as an alternative to alcohol, so the survey “suggests that cannabis may serve a larger role as a substitute for beer, spirits, and wine”.

• Consumer type: “Legalization of recreational cannabis will create a new type of cannabis consumer who is older than today’s typical consumer (aged 35-54 versus 18-34), better educated (university or graduate school education versus high school or college education), less of a risk taker and likely to consume cannabis less frequently (less than once a month versus several times a week)”.

No doubt all this translates to huge opportunities for marijuana companies to tap into a multi-billion dollar new market. With that said, here are our investment takeaways:

#1 If you want potential direct investments in the space, there are two Canadian marijuana companies that started trading in the US this year. The first is the largest Canadian marijuana producer by market value, Canopy Growth (NYSE: CGC), which has a market cap of +$6.6 billion. The second is another medical marijuana producer, Cronos Group (NASDAQ: CRON), with a market cap of +$1.3 billion. There is, of course, a lot of hype around these names and neither has a strong history of profitability. Still, they are good ways to monitor investor interest in the space.

#2 Now that a country with a major economy is set to legalize cannabis, keep an eye out for big tobacco and liquor companies making greater strides into this area. For example, Philip Morris owns a patent for marijuana plants and previously invested $20 million in Israeli startup Syque Medical that makes 3D-printed marijuana inhalers. Additionally, spirits company Constellation Brands took an almost 10% stake in Canopy Growth last year. We see efforts like this as a strong signal of which companies are best poised to take advantage of this major growth industry, especially as more countries legalize recreational use in the coming years.

#3 This past February Molson Coors Brewing Company listed legal cannabis as a potential “risk factor” to its business in its 10-K filing: “the emergence of legal cannabis in certain U.S. states and Canada may result in a shift of discretionary income away from our products or a change in consumer preferences away from beer”. Large companies with substitution effect risks have been cautious on the marijuana front especially in the US because it is federally illegal. With national standards becoming more flexible, however, this could enable companies to better adapt to the industry and seize a new market. Those that don’t will be left behind.

Sources: Deloitte Report, Deloitte Press Release, Molson Coors 10-K