When the year began, it looked as if marijuana stocks would take the next step in their maturation process. After promising the world to investors for the past couple of years, it was expected that the legalization of recreational marijuana in Canada, the subsequent launch of derivatives, and the ongoing legalization momentum in the U.S. at the state level, would lead pot stocks to profits in 2019. But this hasn't been the case.
Although a few cannabis stocks have bucked the trend and delivered an operating profit, most pot stocks are still losing a lot of money -- especially those focused on the Canadian market.
Canada's marijuana launch has been filled with blunders
Canada was always going to be something of a two-edged sword for pot stock investors. On one hand, it's the first industrialized country in the modern era to legalize recreational marijuana. Therefore, it had the first crack at becoming the premier marijuana market among developed countries, and had the opportunity to set the blueprint for other countries to follow.
On the other hand, with no legal precedent of a recreational weed industry to lean on, Canada's launch of adult-use weed, and now derivatives, has been filed with blunders. And, unfortunately, these snafus are responsible for the hefty losses that Canadian pot stocks keep delivering.
One issue of note is regulatory agency Health Canada and its inability to effectively work though its monstrous backlog of cultivation, processing, and sales license applications. Even with a midyear cultivation licensing application update that's designed to whittle down its queue, a number of high-profile growers have had extensive wait periods to get the go-ahead to plant or sell marijuana.
By a similar token, Health Canada dropped the ball by delaying the official launch of derivatives (e.g., edibles, vapes, infused beverages, topicals, tinctures, and concentrates). Only the regulations regarding derivatives went into effect in October, with the actual products hitting shelves this past week. This delay is important considering that derivatives are a much higher-margin product than traditional dried flower, and therefore further hurt the near-term profit potential of marijuana stocks.
But perhaps the most damning blunder of all has been Ontario's retail lottery system. To date, only 67 licenses had been issued to dispensaries through the lottery process in a province that's home to nearly 40% of Canada's population. As of Oct. 17, 2019, the one-year anniversary of recreational cannabis sales commencing, a mere 24 dispensaries were open. This works out to about one store per 604,000 people, and it's a big reason the black market have been thriving in Canada.
Ontario's retail footprint could grow tenfold in 2020
But there's good news to report, at least on this final issue. Ontario, at long last, is planning to scrap its lottery system for dispensaries and open up a relatively normal retail licensing process in 2020.
According to the Alcohol and Gaming Commission of Ontario (AGCO), the regulatory body that oversees the cannabis retail system in the country's most populous province, it'll begin accepting operating license applications from prospective retailers on Jan. 6, 2020. Roughly two months later, on March 2, 2020, it'll then begin accepting store authorization applications. By sometime in April, store authorizations should commence, with roughly 20 stores a month getting the OK from AGCO. The expectation is that Ontario will end 2020 with 250 open dispensaries, representing about a tenfold increase from the existing retail footprint.
In addition to creating a licensing application process, Ontario is eliminating a number of pre-qualification requirements that excluded some retailers from applying during the lottery process. This included that applicants had to secure leases for retail locations, as well as a letter of credit from a reputable financial institution for a minimum of $250,000 Canadian in financing.
Furthermore, licensed producers are going to be able to participate by operating a single store at their cultivation facilities.
According to AGCO, the newly implemented regulations will cap the number of retail stores a single operator can own to 10. However, this limit will increase to 30 by September 2020, and 75 by September 2021, thereby allowing well-funded retail operators to establish a substantive retail presence in what should be Canada's most lucrative marijuana market.
This is good, but not great, news for Canadian pot stocks
There's no mistaking that this long-awaited move is good news for Canada's pot industry, which has seen supply bottleneck in Ontario with so few retail outlets open to move product. In fact, Ontario's lack of an adequate retail presence is responsible for Aurora Cannabis (NYSE:ACB), HEXO (NYSE:HEXO), and Green Organic Dutchman (OTC:TGOD.F) all idling major construction projects.
In October, Green Organic Dutchman announced that it would only be operating four grow rooms at its flagship Valleyfield property in 2020. This should yield 10,000 kilos from a facility designed to operate at 130,000 kilos per year. Likewise, Aurora Cannabis has halted construction at the 1.62-million-square-foot Aurora Sun facility in Alberta and the 1-million-square-foot Aurora Nordic 2 campus in Denmark, thereby halving its annual run-rate output forecast for the end of fiscal 2020. Lastly, HEXO announced it would idle its Niagara facility and 200,000 square feet of its 1.3-million-square-foot Gatineau campus.
Presumably, if we see more Ontario stick to its timeline and push north of 200 open locations toward the end of 2020, top-line growth should pick up dramatically for all three companies. It should be particularly noticeable for those with a lot of inventory, such as Aurora Cannabis.
Then again, you'll note I said this is "good news," not great news. Ultimately, even with around 250 open dispensaries in Ontario by the end of 2020, there would still only be one retail store per 58,000 people. This is a province that could reasonably accommodate 1,000 to 1,200 retail locations, in my opinion, and it'll be nowhere near that mark a year from now. In other words, this is a clear step in the right direction for Ontario and AGCO, but it's not going to completely resolve supply issues in the province. It's also not going to drive out a persistent black market, which continues to have little issue undercutting legal-channel weed on price.
This move by Ontario may yield better-than-expected sales figures for the likes of Aurora, HEXO, and Green Organic Dutchman come 2020, but operating losses are likely to persist for some time to come as our neighbor to the north continues to work through its growing pains.