Analysts are calling it "Cannabis 2.0." The term references the next wave of the Canadian adult-use recreational marijuana market. On Oct. 17, 2019, the country's legalization of cannabis derivatives, including beverages, edibles, and vapes, will go into effect. Canada's current "Cannabis 1.0" recreational market legalized only cannabis flower, oils, plants, and seeds.
Don't expect the Cannabis 2.0 market to take off immediately, though. Companies must file a notice with Health Canada 60 days in advance before beginning to market new cannabis products. This means that the first cannabis derivatives products will be available for sale in mid-December.
Deloitte estimates that the Cannabis 2.0 market could be worth 2.7 billion in Canadian dollars (a little over US$2 billion). Which stocks are poised to profit the most in the expanded Canadian recreational pot market? Here's why Canopy Growth (CGC -0.66%), Aurora Cannabis (ACB -3.55%), and HEXO (HEXO -12.82%) could be the biggest winners.
1. Canopy Growth
Canopy Growth has been talking about the potential for cannabis-infused beverages at least since big alcoholic beverage maker Constellation Brands bought an initial 9.9% stake in the company back in 2017. In Canopy's fiscal 2020 first-quarter conference call in August, CEO Mark Zekulin reaffirmed the company's belief that cannabis beverages will "expand the cannabis consumer category to reach a larger portion of the population." The company plans to market multiple cannabis beverages later this year, including zero and low-calorie drinks.
But don't think for a second that Canopy Growth's Cannabis 2.0 focus will be limited to beverages. Zekulin noted in the company's Q1 call that Canopy occupies a former Hershey chocolate factory. He said that Canopy will roll out a variety of cannabis edibles, particularly including chocolate products.
The company could also shine in the vapes market. Canopy has conducted significant market research into vaping to develop devices that it thinks will be differentiated from current vape products. The company plans to launch over 15 new vape-related products in December.
Many investors have focused primarily on Canopy Growth's recent struggles, particularly its huge net loss in the last quarter. However, probably no company has dedicated as much time and money toward the forthcoming Cannabis 2.0 market as Canopy has. I expect that Canopy Growth and its stock will reap the rewards from this effort.
2. Aurora Cannabis
Aurora Cannabis is taking a somewhat different approach to the Cannabis 2.0 market than Canopy Growth is. Although Aurora is developing cannabis-infused beverages, chief corporate officer Cam Battley said in the company's Q3 conference call in May that it anticipates "a relatively low market share of these products" and isn't rushing into the beverages market.
The company isn't hesitant about launching cannabis edibles, though. Battley stated that Aurora plans to roll out a variety of edibles products, including hard baked goods, chocolates, and mints. Aurora CEO Terry Booth mentioned that there could also be an opportunity for organic edibles and sugar-free edibles.
In the U.S., vape products have been huge winners. Battley thinks that vape products in the Canadian Cannabis 2.0 market will also be "a terrific market segment that doesn't need a lot of market development." Aurora has partnered with Pax Labs to market its Pax Era vape devices in Canada.
One of the biggest advantages for Aurora as the Cannabis 2.0 market ramps up is its capacity. The company's 300,000 square foot Aurora Polaris facility should be completed by the end of this year and will produce high-margin products including edibles.
HEXO isn't nearly as large as Canopy or Aurora, but it should be one of the top winners in the Cannabis 2.0 market. For one thing, HEXO and big beer maker Molson Coors Brewing formed a joint venture, Truss, to develop and market cannabis-infused beverages.
Although Aurora's executives are skeptical about the Cannabis 2.0 beverages market, HEXO is making it a primary focus. HEXO CEO Sebastien St.-Louis said in June that he hasn't "seen anything else in the industry right now that compares to what we have today" with the first version of its cannabis-infused beverage.
The company isn't betting everything on beverages, however. HEXO is also developing gummies and premium vape products. St.-Louis thinks that vapes could rival beverages in terms of market opportunity. He also expects that gummies will be the biggest part of the edibles segment, a view that is supported by surveys conducted by Deloitte.
Another reason why I think that HEXO is well positioned in the Cannabis 2.0 market is the company's dominance in Quebec. HEXO has a leading market share of 30% in the province, which ranks behind only Ontario based on population.
Cannabis 2.0 isn't enough
While investors should pay attention to the winners and losers in the Canadian Cannabis 2.0 market, it's important to remember that this market isn't enough by itself to justify the valuations of cannabis producers. For that matter, the entire Canadian market isn't enough to do so.
The biggest opportunity from investing in marijuana stocks will be with companies that have a global presence. Canopy Growth and Aurora Cannabis are already key players in international markets. HEXO's CEO predicts that the company will add major partners to expand internationally, particularly in the United States. Cannabis 2.0 is a piece of the puzzle for pot stocks to win, but it's not the most important piece.