Will Canadian Recreational Laws Effect Marijuana Stocks?

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In the midst of rocketing growth for the legal marijuana industry in North America, all eyes are fixed on Canada as the country prepares to become the second in the world – and first among developed countries – to legalize recreational marijuana. Since Canada’s legalization of medical marijuana in 2001, Health Canada has overseen the industry. With support for marijuana running high throughout most of North America, Canada’s government seems to be months away from legalizing marijuana for adult use.

The ramifications of legalizing recreational marijuana could be huge for weed stocks in Canada.

Some estimates suggest the recreational market could generate revenue of $5 billion or more, in addition to revenue from domestic medical marijuana and exports. A legal recreational market will likely have a significant impact on jobs creation in the marijuana industry, adding growers, processors, distributors and dispensaries; indirectly, jobs may be generated in other fields such as financing, consulting and accounting.

The Canadian government has already surmounted many of its expected hurdles. With a parliament majority of more liberal-minded politicians, the conservative votes in opposition of the C-45 bill should not be sufficient to block its passing. The federal government has also established a two-year-tax-sharing agreement with all provinces (except Manitoba) answering the significant question of where collected tax revenue will go. For the first two years, 75% of a province’s tax revenue will return to the province and the remaining 25% will go to the federal government.

However, not all is smooth sailing for marijuana stocks in Canada; some remaining issues need sorting out prior to the Senate vote on the bill scheduled for June 7.

Health Canada addressed several of these remaining issues at the end of March. If the bill passes and becomes law, Health Canada outlined requirements for packaging of recreational marijuana intended to prevent underage access to the drug. The regulations will also introduce a new class of licenses for cultivation and processing.

Pertaining to packaging, cannabis companies will be required to package all recreational weed products in a child-resistant and temper-evident translucent or opaque container. Each container must include a standard marijuana symbol, note the product’s THC or cannabidiol content, and feature a bright yellow health warning. No images or graphics will be allowed and only restricted logos and branding. In short, these requirements were relatively on par with what the industry expected.

The introduction of a new class of cultivation and processing licenses could backfire for marijuana stocks in Canada.

Back in May 2017, Health Canada had already relaxed its licensing regulations, in hopes of encouraging new growers to enter the industry and help meet the demand for medical marijuana. However, Health Canada’s latest announcement of these new micro-cultivation and micro-processing licenses appears to be an attempt to allow smaller cannabis businesses access to a piece of the estimated $5 billion market share. With a micro-cultivation license, growers with an authorized area of less than 2,153 square feet of plant canopy can operate a business. A micro-processing license can be issued for businesses processing under 1,323 pounds (or 600 kg) of dried weed per year.

The intentions behind this new licensing policy are good, but, considering the current status of cannabis supply in Canada, it could end up backfiring in a huge way.

The biggest issue facing the impending legal recreational market and marijuana stocks in Canada is the virtual impossibility to predict supply or demand since no other developed country has a legal adult-use market.

While a number of reports and analysts have wagered guesstimates of the country’s demand to be around 800,000 kg annually, these are only rough estimates. Meanwhile, Canada’s major growers have all expanded their capacity as quickly as their balance sheets allow.

The largest among them by market cap, Canopy Growth Corp. (NASDAQOTH:TWMJF) has already procured seven facilities, a total of 665,000 square feet, with greenhouses in development or construction in British Columbia, for a total of 3.7 million square feet of capacity. The company has remained private about its annual production capacity, but, most analysts predict it could easily top 300,000 kg while others have projected it closer to 784,000 kg. In the latter case, Canopy Growth Corp. could theoretically supply most of Canada’s projected demand. 

Others among Canada’s other major growers – Aurora Cannabis (NASDAQOTH:ACBFF), Aphria (NASDAQOTH:APHQF), MedReleaf (NASDAQOTH:MEDFF), and OrganiGram Holdings (NASDAQOTH:OGRMF) – they are not that far behind Canopy Growth. The respective forecasts of fully-funded outputs per year for these growers are 283,000 kg, 230,000 kg, 140,000 kg and 113,000 kg. While a few of these companies’ projects may not be up to full production capacity until 2020 or 2021, the collective group is capable of delivering nearly 1.1 million kg of dried pot each year. This far exceeds the predicted domestic demand and, worse, does not factor in the dozens of licensed growers not mentioned or the new, soon-to-be-issued licenses for micro-cultivators, assuming legalization pans out.

In short, Canada may have shot itself in the foot in an effort to level the playing field for the little guy in a competitive marketplace.

Issuing micro-licenses may require taking a bigger step toward the threat of cannabis supply glut, dooming weed stocks in Canada to rampant oversupply. 

Issues of rampant oversupply could lead to dried cannabis experiencing margin collapses in the coming years. In the short-term, consumers could benefit from this scenario, but, small cultivators wouldn’t stand a chance against these major growers with deeper pockets.

That’s not to say larger marijuana stocks would do well, either; rather, they would just be equipped with more resources to survive the challenges. Exporting some of the supply to countries with legal cannabis markets could take some of the pressure off the expected cannabis glut, but, it wouldn’t solve everything.

While no one knows what to expect regarding Canada’s impending legalization and the supply/demand to follow, things are panning out more in the favor of oversupply.

(For more information on the potential cannabis oversupply, read Will Canada’s Glut Affect Marijuana Stocks?)

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