Canada’s Legal Pot One Year Later

Sales are below expectations, and companies are losing money.

October 17, 2019

ALEXANDRIA, Va.—Pot legalization was supposed to eliminate the black market, boost Canada’s economy and enrich investors, but according to a Bloomberg report, after one year, things haven’t turned out that way. Instead, pot stocks have lost more than half their value, retail prices are nearly double those in the black market, sales are far below expectations and most companies are losing money.

No one expected that creating a national market from scratch would be easy, and Canada’s highly regulated model has attracted plaudits worldwide. But few in the industry would call the first year a success, and more challenges lie ahead.

In June 2018, four months before legalization, Deloitte LLP predicted that legal pot sales would be as high as C$4.34 billion ($3.29 billion USD) in 2019. Instead, Canadians bought C$524 million of legal weed in the first seven months of 2019, according to Statistics Canada. Sales have steadily increased since February with the opening of new retailers, but major suppliers warn that revenue is likely to plateau in the fourth quarter before the new forms of the drug become available for sale.

Probably the biggest disappointment has been the rollout of retail locations, leaving Canadian provinces underserved by bricks-and-mortar stores. Ontario and Quebec, Canada’s two most populous provinces with nearly 23 million people between them, have only 25 stores each.

The lack of storefronts is often political. Ontario’s government delayed the province’s store rollout for nearly six months after legalization to consult with stakeholders and develop legislation. Then, Ontario officials blamed the federal government for a lack of supply when it limited the initial number of locations to 25. Whatever the reason, the impact is real. Provinces with more bricks-and-mortar stores had sales per capita nearly 2.5 times higher than their counterparts with fewer stores, according to Eight Capital analyst Graeme Kreindler.

Another reason for slow sales is that consumers are being asked to pay nearly twice as much per gram in the legal market than the black market. The average price for a gram of legal pot fell 3.9% to C$10.23 in the third quarter from the second quarter, the first drop since pot was legalized on Oct. 17. However, it’s still almost twice as high as black-market prices, according to Statistics Canada.

Currently, only dried flower and oils are available in the legal market. This leaves the black market to profit from popular formats, like edibles and vapes, until they arrive in legal stores later this year. A Statistics Canada survey found 42% of pot consumers purchased at least some of their pot from illegal sources in the second quarter. Insiders believe that eventually the black market will be replaced by the legalized market, but the question is whether that takes two years, five years or 10 years.

Investors want pot companies to turn a profit, but of Canada’s six biggest companies by market value, five have recently disappointed the market, sending their stock prices tumbling.

In addition, a growing vaping-related health crisis has generated scary headlines just before the first legal cannabis vapes hit Canadian shelves. This makes it increasingly difficult for companies to raise money and is particularly hard on smaller companies that don’t have the capital cushions of larger businesses.

It is expected though that we will see changes in the Canadian market, which should buoy the industry. The country’s legal store count is expected to grow significantly in coming months, with Ontario alone set to open 50 new stores later this year. Companies expect the addition of edibles, beverages, vapes and topicals to the roster of legal products to boost their sales and margins. And most of Canada’s big pot producers have established a significant international presence that could help to offset any ongoing weakness in the Canadian market as legalization spreads around the world.

“Everyone is so negative on what’s happening, but I suspect that will turn because this is and will be one of the fastest-growing businesses in the next 10 years globally,” said StoneCastle’s Campbell. “It’s just a function of who wins and who loses.”

While Canada struggles to develop a functional market post-legalization, the U.S. is quietly eroding its neighbor’s first-mover advantage. U.S. cannabis companies’ stocks have been battered too, but several analysts say they’re likely to rebound faster than their Canadian counterparts. The biggest U.S. multi-state operators, or MSOs, are already generating more revenue than many of their Canadian peers, and there are potential catalysts around the corner that could send them soaring.

In addition, major states like New York and New Jersey are expected to legalize recreational pot use by the end of next year, and many believe it’s only a matter of time before the U.S. government implements some form of legalization as well.