Ever since cannabis use moved out of the back alley and into the open in Canada, marijuana companies have been scrambling to make the most of their first move advantage. With a projected growth in Canadian legal cannabis spending estimated to rise from US$569 million in 2018 to nearly US$5.2 billion in 2024, the industry is in high spending mode with full investor support despite radical stock price ups and downs.

The Canada Leads the Way on Global Cannabis Legalization report, released in April by Arcview Market Research and BDS analytics, says Canada’s five largest producers - Canopy Growth, Tilray, Aurora Cannabis, The Cronos Group and Aphria - closed out the 2018 year with a combined market capitalization of US$22.8 billion in 2018. Over the last year, a Stockwatch search shows this mix of companies experienced stock price swings ranging from Aphria’s CAD$4.76 to $22.00 to Canopy’s $31.81 to $76.68.

Optimism, Despite a Rocky Start

Cam Battley, Chief Corporate Officer for Alberta-based Aurora Cannabis, admits much of the growth was made possible by improved capital flow. “While three years ago we had a very difficult time acquiring capital, with favorable conditions this year we have excellent access and on very good terms,” he says. As proof he points to Aurora’s recent $250 million loan negotiated with the Bank of Montreal as the world’s largest cannabis-related traditional debt instrument so far.

Nawan Butt, portfolio manager for Purpose Marijuana Opportunities Fund in Toronto says the scope and expanse of investor interest has also evolved as cannabis has gained widespread acceptance in Canada. “We’re seeing more older Canadian investors who’ve used cannabis medicinally and want to get more involved in the recreational side, as well as millennials, institutions, family office and hedge funds.” As an example, he notes, more people are picking up Canopy Growth stock because it’s just been inducted into the TSX 60, a major benchmark for top stocks.

Baron Lee, the lead portfolio manager for Calgary-based Matco Cannabis Investment Fund, says high net worth individuals were the first to invest, but now investment management and pension funds from across Canada are starting to kick in, including Canada Post.

And this is despite the fact that many heavy hitters in the Canadian marijuana game are still struggling to bring their sales in line with predictions and revenues. In April, a Marijuana Business Daily article reported a BMO warning to investors that Canadian adult-use sales revenues would be coming in lower than expected due to the slow build-out of retail stores, flat sales and inventory shortages. In its report, BDS Analytics downgraded its January 2019 forecast for Canadian sales from US$5.9 billion by 2022 to US$5.2 billion by 2024. Aurora posted a 305 per cent growth in net revenue to CAD$65.1 million, but a 0.10 earnings per share reduction and modest 20 percent improvement in EBITDA in its third quarter (Q3) report ended March 31, 2019. Even so, Battley thinks Aurora is several quarters ahead of its peers in making the transition to a positive EBITDA and predicts his firm will get there in its Q4.

Alberta Leading the Way

Alberta’s weed industry still leads the way in per capita consumption because of its efficient retail roll-out. The province only represents 11 per cent of Canada’s population but still accounted for 28 per cent, or CAD$7 million, of the CAD$51.3 million in national sales as of February 2019. “We’re seeing a large amount of cultivation through Aurora, Sun Dial Growers Inc. and GTEC Holdings that have found it reasonably attractive to invest in Alberta’s growing operations,” says Butt.

Read: Westleaf Breaking New Ground, Putting the Pieces in Place to Succeed in the Cannabis Market

Aurora’s CCO attributes his Q3 results to a rapid facility expansion required to satisfy an expanding market base, a fact of life that has been jacking up debt for many public cannabis companies. According to Marijuana Biz Daily, debt raised among publicly traded cannabis companies up to April 4, 2019, amounted to US$764.9 million through 33 transactions. These figures significantly outpace the US$478.8 million raised through 19 transactions in 2018.

Aurora Cannabis' Sky facility in Leduc county, Alberta.
Photo: Aurora Cannabis

Challenges Ahead

Other culprits blamed for flagging sales range from supply chain hiccups, black market competition, slow research results and a delay in the approval of cannabis concentrates, to marketing constraints, a negative stigma still attached to marijuana use and management limitations imposed by appointing provincial agencies as wholesale distributors.

The Bank of Montreal’s March 2019 Outlook for the Canadian cannabis industry reported only a 25 per cent displacement of black-market transactions by legal sales, largely because illicit pot is cheaper than legal.Illegally sold pot can be purchased for as low as CAD$5.71 per gram compared to Alberta’s average legal price of CAD$9.07 per gram.

Given the industry’s struggle to keep supplies flowing in 2018, the BMO report expressed concern about whether cannabis producers would be able to keep up with an even greater demand once Canadian legislation approving concentrate use occurs in October, and a new wave of pot infused beverages, edibles and vape pens hits the market. A report released by Deloitte June 3, 2019, says the Canadian market for next-generation cannabis products is worth an estimated CAD$2.5 billion annually, with edibles contributing more than half.

Aurora is not concerned about meeting demand, though. The company produced 15,590 kilograms of cannabis in Q3 and is planning to ramp up to 625,000 kilograms by 2020. Lee wonders about the short supply reports when he sees how much stock is being held back. Statistics Canada reports that the total finished and unfinished inventory held by cultivators, processors, distributors and retailers amounted to 174,575 kilograms at the end of March, approximately 22.9 times the amount of total sales in the month. Lee thinks licensed producers in Canada are hoarding product as they wait for greater margins on concentrates and for higher prices from medical and international sales. In a mature market, he estimates Canada’s top 20 licensed producers could generate as much as 2.5 million kilograms of cannabis annually, which could eventually lead to an oversupply and lower prices.

Competition Heats Up in the Space

The facts of Canadian cannabis supply will likely contribute to an already busy merger and acquisitions trend, says Lee. He thinks Health Canada is issuing too many cultivation licenses, which will lead to numerous failures. Butt agrees and estimates Canada has about 50 odd companies operating about 90 licenses. “We see them consolidating or dropping off to 15-20 to adequately supply all of Canada,” he adds.

As competition heats up, cannabis companies are beginning to place more emphasis on building brands, expanding internationally and stocking management teams with high flyers in consumer goods and U.S. marijuana expertise. Aurora, for example, has brought in widely regarded U.S. billionaire and consumer goods expert Nelson Peltz as an advisor and so far has set up strategic partnerships in Malta, Portugal, Denmark, Germany and Uruguay. Battley says that the fact that the U.S. cannot expand internationally yet offers Canada a remarkable advantage.

Chief Commercial Officer Adam Coates of Alberta-based Westleaf says his company has brought in members experienced in the long-established Colorado pot scene because investors expect a team with deep expertise across cultivation, production and retail. Butt says investors want to know how much skin management teams have in the game and whether they have what it takes to set up supply chains, establish supply agreements, meet construction goals and communicate with shareholders.

Canadian companies could be more competitive, says Lee, if they were allowed to fully integrate from seed to retail and use traditional marketing methods. In Canada, cannabis must be sold to and bought back from provincial wholesaler agencies, such as the Alberta Gaming and Liquor Commission (AGLC) and the Alcohol and Gaming Commission of Ontario. “Valuations in Canada are as much as 20 times lower compared to U.S. companies operating in the 33 states where cannabis is legal,” he says. “Full integration can substantially lower costs and improve quality control.” Restrictions on pot marketing make it difficult for companies to differentiate themselves from competitors, a factor U.S.-based BDS Analytics says is critical to growth.

Yet, TSX listed Westleaf seems to be one of the few Alberta companies that has found a way to vertically integrate its operations by setting up Thunderchild as its cultivation arm, The Plant as the extraction and manufacturing arm and its separate brand Prairie Records as the retail chain. Coates says they’re also using a modern-day record shop theme to differentiate from competitors. “We offer retail customers a more informed and tactile experience in a comfortable and familiar environment,” he says. Customers who walk into any of the soon-to-be national Prairie Records outlets can go through record sleeves that offer information on everything from where a cannabis brand was produced and the forms it comes in, to product explanations, the THC and CBD content and even recommendations for music to accompany use. In other words, for innovative companies, there are still potential paths to profit, despite regulations.

Prairie Records
Prairie Records store opening in Saskatoon.
Photo: Desiree Martin

Prairie Records in Saskatoon.
Photo: Desiree Martin

Canadian companies anxious to cash in on a huge American market, estimated by Arcview to reach US$23.4 billion by 2022, are already rotating capital from Canada to the U.S., where cannabis is still illegal at the federal level. Matco has already increased its U.S. exposure to 50 per cent and reduced its Canadian position to 35 per cent. Says Lee, “it’s not a matter of if cannabis will be federally approved in the U.S., it’s a matter of when.”

CIBC World Markets analyst John Zamparo was recently quoted in Marijuana Business Daily as saying, “I think if Canadian companies can start demonstrating competence in this industry and building out international operations, it will signal to investors they’re moving forward in a thoughtful way.”