Canada’s Phase 2 Legalization Winners: Follow the Money

Canada’s Phase 2 Legalization Winners: Follow the Money
Canada’s Phase 2 Legalization Winners: Follow the Money

Labor Day is now behind us. This means that Phase 2 of Canada’s national cannabis legalization is even closer, due to take effect October 17, 2019.

These next generation cannabis products aren’t expected to reach store shelves until mid-December. But that still provides Canadian consumers with the opportunity to make this Christmas even “merrier” – cannabis-style.

For investors still not familiar with these regulatory changes, Phase 1 of legalization only allowed the sale of dried flower products. All of the cannabis edibles and concentrates that are already legal in most of the U.S.’s dual-use markets are only about to become legal in Canada.

As noted in a recent Seed Investor article, this regulatory change is expected to add another 3 million Canadian cannabis consumers. Let’s put this into perspective.

In its National Cannabis Survey, second quarter 2019, Statistics Canada announced that 16% of the population (1 out of 6 Canadians) had reported using cannabis in the previous three months. That’s less than 5 million people.

This means that the size of Canada’s cannabis market is about to grow by as much as 50% -- in terms of the total number of consumers.

That’s good news for Canada’s cannabis industry, under any circumstances. But let’s put current circumstances into context.

Unlike Phase 1 of legalization, this new market isn’t being built literally from the ground up. Supply chains are already in place. Online distribution networks are already in place. Most importantly, Canada has finally reached a critical mass in terms of its total retail storefronts.

The most recent national statistics (June 2019) reported three consecutive months of double-digit sales growth. As The Seed Investor has explained previously, retail storefronts are the crucial variable here.

For various reasons, cannabis consumers strongly prefer to shop in person. In Ontario (Canada’s largest market), opening a mere “handful” of stores caused sales to more than double in the first month. The problem is that it took the province nearly six months to open its first cannabis store.

Ontario continues to stumble badly in rolling out legalization for its 14+ million residents. But with 22 stores now open, most residents have at least reasonably proximate access to a retail store.

British Columbia has also lagged most of Canada in this respect. This is especially unfortunate (and ironic) given that the province has the largest black market cannabis industry.

However, as the numbers above indicate, Canada as a whole has turned the corner in terms of retail cannabis sales. Now Phase 2 is arriving.
 
  • 50% more consumers
  • Retail network already in place
  • Value-added cannabis products offer potential for much stronger margins

U.S. data also shows that the market for edibles and concentrates is growing at least twice as fast as the market for dried cannabis flower. In other words, many of the ~5 million current consumers will shift some of their spending to these new products – and very possibly increase overall spending.

Colorado has the most mature (and well-regulated) cannabis market. But the state has still been setting new sales records – in three of the last 4 months.

Phase 2 of cannabis legalization has the potential to turbocharge the Canadian cannabis industry. Who will be the biggest winners? Here are four groups of candidates.

#1 Cannabis retailers

Cannabis retail sales have already ignited in Canada. Now consumers are about to be presented with a vast array of additional products.

Picture a Baskin Robbins that sold nothing but vanilla ice cream. Now add another 30 flavors and see what that does for sales.

Canada’s cannabis retailers are about to go from plain vanilla to a full spectrum of cannabis consumer products. Of equal importance to the number of new consumers this is expected to attract is that this will mobilize female Canadians as cannabis consumers.

Currently, males are nearly twice as likely as females (21% to 12%) to purchase cannabis products. But when it comes to Phase 2 cannabis products, those numbers virtually reverse.

In the most recent data from Statistics Canada, nearly twice as many females (23% to 12%) report consuming only cannabis products other than dried flower. And those products aren’t even (fully) legal yet.

Canada’s cannabis retailers are about to experience an influx of ladies. Currently, four publicly-listed companies dominate in terms of total retail storefronts: National Access Cannabis (CAN:META), Alcanna Inc (CAN:CLIQ / US:LQSIF), Choom Holdings (CAN:CHOO / US:CHOOF), and Fire & Flower Holding Corp (CA:FAF / US:FFLWF).

National Access has the largest cannabis retail footprint at present, with 34 licensed stores. But Fire & Flower recently made the news through a major investment by grocery/convenience store giant Couche-Tard Alimentation (CAN:ATD.A / US:ANCTF). Couche-Tard is prepared to commit up to CAD$380 million in growth capital.

Meanwhile, Choom has released a flurry of announcements on new store openings. This includes the acquisition of The Green Room, which (by itself) adds another 7 cannabis stores to Choom’s total.

Cannabis retailers will be strong and (almost) immediate beneficiaries of Phase 2 legalization. But they are far from the only segment of Canadian cannabis companies expecting a large boost from these new regulations.

#2 Larger vertically-integrated LP’s

Size matters.

It’s not always true in the corporate world, but in this case it appears to be so. Cannabis is still in its infancy as a legal industry. Most of the smaller vertically-integrated cannabis companies have had their focus (and most of their energies) completely geared to Phase 1 of legalization.

These cannabis juniors are certainly not unprepared for Phase 2. But when it comes to the multiplication of new product offerings, it is generally the largest companies that will be bringing the most products (and most variety of products) to market: edibles, concentrates, and (in many cases) infused beverages.

Here some familiar names will attract attention: Canopy Growth (US:CGC / CAN:WEED), Aurora Cannabis (US:ACB / CAN:ACB), and HEXO Corp (US: HEXO / CAN:HEXO).

All of these cannabis heavyweights have major U.S. listings to go with their TSX listings. Two of the three also boast multinational beverage companies as major partners.

In the case of HEXO, it has a joint venture with Molson Coors (US:TAP) specifically to produce cannabis-infused beverages. Opinions vary on the potential size of this market, but HEXO will also bringing additional Phase 2 products to market in its retail stronghold – the province of Quebec.

Constellation Brands (US:STZ) has invested more than $4 billion into Canopy Growth. More and more, it appears to be calling the shots in terms of corporate strategy. It’s unlikely that the maker of Corona beer has bought into cannabis to focus purely on dried flower.

Expect Canopy to exert a much stronger presence in Phase 2 than it did in Phase 1. It has recently beefed-up its cannabis extraction capacity dramatically to prepare for these next generation products.

Aurora Cannabis will also we well-positioned for Phase 2. It now has more than 150,000 kg’s per year of cultivation capacity. Aurora is ramping up its own cannabis extraction capacity. And it also has a joint venture with cannabis extraction specialist, Radient Technologies (CAN:RTI / US:RDDTF).



#3 Cannabis extraction specialists

Why focus on the cannabis extraction capacity of Canada’s major LP’s? Why are the companies themselves making increasing this capacity a priority? The cannabis oils produced from cannabis extraction are the building blocks of all these value-added products.

No cannabis oils? No concentrates, edibles, or infused beverages.

Here it’s not speculation to suggest that these cannabis specialists will be Phase 2 winners. Industry leaders Valens GroWorks (CAN: VGW / US:VGWCF) and MediPharm Labs (CAN:LABS / US:MEDIF) have posted two of the strongest stock performances in the cannabis sector over the past year.

Both companies are already profitable. Both continue to rapidly expand their extraction capacity. These were the first winners of Phase 2 since this is where Canadian cannabis companies needed to begin their own preparations.

A previous Seed Investor article focused on some of the other Canadian extraction specialists, including Radient, NASDAQ-listed Neptune Wellness (US:NEPT / CAN:NEPT) and Nextleaf Solutions (CAN:OILS / US:OILFF).

#4 Other specialty producers

The cannabis extraction companies aren’t the only “specialists” in the cannabis sector looking forward to Phase 2. This ranges from companies that will be specializing in only the production of Phase 2 cannabis products to companies that will be licensing various technologies that are necessary to produce these value-added products.

Technology is a vital component of value-added cannabis products. It requires special processes (and ingenuity) to optimize fat-soluble cannabinoid molecules for commercial applications. This is necessary for both consistency of dosing, the efficiency in production/consumption, and product aesthetics.

Among the companies claiming to have pioneered ideal technology for cannabis infusion are Lexaria BioScience (CAN:LXX / US:LXRP),  Nanosphere Health Sciences (CAN:NSHS / US:NSHSF) and Sproutly Canada (CAN:SPR / US:SRUTF).

Arguably, everyone will be “winners” when Phase 2 arrives in Canada: consumers as well as cannabis companies (and their shareholders). But some players are better positioned to cash in on this Cannabis Christmas.



DISCLOSURES: Choom Holdings is a client of The Seed Investor. The writer holds shares of Nanosphere Health Sciences.
 

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