Our partners at CI Investments recently put out an excellent piece on pot stocks, I’ve attached it below… Before putting money into any new industry, you NEED to have a discussion on where the investment will fit in your portfolio. Risk management is everything in early stage investing. If you have any questions or wish to discuss this further, please contact us.
How high? The blossoming of recreational marijuana
November 20, 2017 | by Greg Quickmire
‘Returns in the marijuana sector have been dizzying. The stocks of the four largest producers have doubled on average this year, adding more than $4B in market value to the sector. More recently, momentum has accelerated, as provinces have started releasing their distribution plans and incumbents have ramped up capacity to meet recreational demand.
The excitement is understandable; prohibited goods rarely become legal overnight. As a result, an existing multi-billion-dollar black market will become accessible to investors for the first time. But as markets start to estimate the potential, it’s important to consider the many unknowns we still face:
- Distribution Models
The federal government is leaving distribution to the provinces, meaning we’re likely to see a diverse range of channels across the country. For example, a group of 12 producers banded together as the Canadian Cannabis Cooperative to push for privatized retail. Under this model producers could sell directly to consumers, thus allowing vertical integration. This would allow producers to reap the full estimated sale price of $8-$10/gram, and thus a larger portion of the profits.
On the other end of the spectrum is Ontario’s proposed public distribution network. This would see marijuana retail controlled by the province, similar to the current LCBO structure. Under this framework, manufacturers would be restricted to selling wholesale to the province, reducing the estimated sale price for producers to as low as $4.50-$5/gram.
As such, the distribution structure will be a key factor in manufacturer profitability. With additional provinces submitting proposals, there will likely be significant fluctuations in the market value addressable by producers. Maintaining a cost advantage through scale will be critical as the market unfolds.
- Taxation
The federal government recently outlined their proposal for taxing marijuana. Under this framework, an excise tax of the greater of $1 or 10% of the sale price would be levied per gram. Marijuana would then be subject to standard provincial and federal sales taxes at the till. This would mean that an $8 gram of marijuana in Ontario would pay $1 in excise tax and $1.17 ($9 x 13%) in HST, for a total cost of $10.17. This compares with an average black market price of $8.64 in Ontario, per a 2016 Parliamentary Budget Office report.
Initially, this should make legal marijuana competitive with black market alternatives. In the long term, however, it leaves room for the government to increase taxation. A recent Globe and Mail article pointed out that taxes on cigarettes make up 63% of the retail price in Quebec and 71% in Manitoba. It’s not crazy then to think that as production costs decline and the black market is wiped out, the government will move to take a greater share of profits.
- Competitive Landscape
Per a leading industry analyst, there are already 70 cultivation licenses held by 50 different entities in Canada, and another 300–400 applications in progress. Though current producers will certainly enjoy a first-mover advantage, it’s reasonable to assume that a large, profitable rec market will draw new entrants. Health Canada has indicated there is no intention to cap licenses, as a primary goal of regulators is to ensure enough supply to replace the black market. This means the only regulatory barrier is time, and approval times are already shortening from the 2–4 years seen historically.
The ultimate attractiveness of the market will likely drive the entrance of large, well-financed competitors from other sectors (think alcohol, tobacco, or pharmaceutical giants). Facing these goliaths, the primary advantage of incumbents will be brand. Even this benefit is uncertain, however, as nuances of provincial distribution could lead to advertising restrictions and opaque coverings on shelf space (think tobacco in Ontario).
These factors are just some of the many that obscure the eventual winners and losers in the space. While the creation of a new market is certainly exciting, Harbour remains (as always) more focused on avoiding losses than on missing speculative opportunities. We continue to track developments in the industry and, like many Canadians, are curious to see how this nascent market evolves.’
http://blogs.ci.com/harbour/greg-quickmire/how-high-blossoming-recreational-marijuana
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