The countdown is nearly over. Following months of debate in the Senate and the passage of the Cannabis Act on June 19, Canada is set to become the first industrialized country in the world to legalize recreational marijuana, and only the second overall behind Uruguay, exactly one week from today, on Oct. 17.
When legal, marijuana will be a big business. Although estimates vary wildly, as we'd expect to see with an industry that has very little legal precedence on an adult-use basis worldwide, Wall Street is looking for somewhere in the neighborhood of $5 billion in added annual sales. The "added" part comes from the fact that the legal pot industry in Canada is already selling medical cannabis domestically, as well as shipping it abroad.
With investors now able to count on two hands how close legalization truly is, here are the six things to know as we approach Oct. 17.
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1. Emotions and volatility will remain high
The first thing you should be well aware of is that volatility in marijuana stocks is expected to remain high for probably weeks or months following legalization. Because demand for adult-use cannabis is perceived to be enormous, investors have piled into marijuana stocks with the expectation that sales and profits will soar for at least the next couple of years.
Of course, that also means there are dangerous marijuana stocks that investors will want to avoid at all costs. As an example, New Age Beverages Corp. (NBEV) recently announced its entrance into the cannabidiol-based beverage market with a new line of drinks. Alternative cannabis products like infused beverages are a hot commodity at present. Yet, the field is growing more crowded by the day, and New Age Beverages existing line of drinks aren't profitable. In fact, New Age Beverages current product line should result in a year-on-year sales decline in the current quarter, which is a notable red flag.
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2. Every province has different rules and regulations
Second, it's important to understand that Canada's legalization, much like the state-level legalizations in the United States, aren't one size fits all. Instead, provinces are free to set up their rules and regulations, which can include the age of legal purchase at 18 or 19, whether to allow home grow as an option, and/or whether to allow private retailers to operate dispensaries within a province.
Although not all provinces will allow private retailers, one of the intriguing beneficiaries of Canadian legalization is software-as-a-service platform Shopify (SHOP 4.90%). Already growing like a weed (pun fully intended), Shopify partnered with the Ontario Liquor Control Board in February to handle its brick-and-mortar, online, and mobile sales within the province. Shopify has also partnered with pretty much all of the largest cannabis growers to assist with online sales and perhaps even help anticipate future consumer buying habits.
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3. Exports will comprise more than half of all sales
Next, don't overlook the expectation that a majority of Canadian pot sales will come from overseas markets. Even though recreational marijuana is expected to bring in plenty of sales in Canada, more than half of all production is liable to find its way to the roughly 30 countries that've legalized medical weed in some capacity.
Again, while estimates vary, Health Canada believes that domestic demand will total around 1 million kilograms a year. However, by the time 2020 rolls around, Canadian growers could be working on a run rate of 3 million (or more) kilograms a year. Where does this excess supply go? The hope is that foreign countries that've legalized medical pot will gobble it up. Since most of these overseas markets either have nascent or nonexistent grow facilities, they're expected to be active buyers of Canadian cannabis.
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4. High-margin products are still on the back burner
Another thing you may not realize is that not all forms of consumption will be legal a week from today. According to the Cannabis Act, dried cannabis and cannabis oils can be purchased on Oct. 17, but other alternatives, such as vapes, cannabis-infused beverages, concentrates, and edibles, won't be legal.
The expectation among the industry is that Parliament will discuss and approve new consumable options sometime in 2019. There is, however, no timetable on when exactly that could happen or if a resolution will be reached. This makes the partnership between HEXO Corp. (HEXO) and Molson Coors Brewing Co. (TAP -0.53%) particularly interesting.
HEXO and Molson Coors formed a joint venture at the beginning of August with the expressed intent on producing cannabis-infused beverages. There are no guarantees, though, that these alternative products will be approved anytime soon. Any delay could be viewed as somewhat of a negative for the larger Molson Coors, but would be a substantial negative for HEXO, which aside from a large five-year supply deal with Quebec, received a big boost from its joint venture with Molson Coors.
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5. Initial shortages appear likely, but should give way to oversupply
Despite what the Canadian federal government has suggested, the chance of an initial supply shortage when the proverbial green flag waves in a week looks to be pretty high (again, pun fully intended). Many of the biggest growers are still in the process of ramping up their production, which could make meeting the initial consumer demand wave a challenge.
If there is a positive to be had here, it's that many of the biggest growers have been actively building their inventories prior to the Oct. 17 launch date. Growers have also done a relatively good job of sticking to their budgets and timelines with regard to capacity expansion.
The downside is that when all of this production does come on line, there is a real chance that it could be far above and beyond actual demand. If Canadian marijuana producers can't find an effective way to move their excess production, which, as noted, could top 3 million kilograms annually by 2020, it'll adversely weigh on the per-gram price of weed, hurting margins.
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6. Profits could be elusive in the early going
Sixth and finally, investors should really understand that marijuana stocks aren't expected to be substantially profitable right out of the gate. There's still a lot of spending to be done with regard to capacity expansion, as well as brand building, marketing, product innovation, and developing their international infrastructure. Looking at this purely from an operating basis, and not including fair-value crop adjustments, most pot stocks are probably going to lose money.
One of the best examples is Canopy Growth Corp. (CGC 15.03%), which could arguably be described as the most well rounded of all marijuana stocks. Despite a peak (author-estimated) projection of around 500,000 kilograms for Canopy Growth, a well-recognized brand name in Tweed, and a massive partner in Constellation Brands, the company isn't expected to be profitable in its current fiscal year. Canopy Growth will probably be far too busy spending on its international strategy and via acquisitions to turn a profit.
In other words, the start of the green rush doesn't mean a "green rush" of money for investors.
