Marijuana market opportunities loom large as Liberal government announces legalization plan

Marijuana market opportunities loom large as Liberal government announces legalization plan

Analysts tracking the evolution of marijuana production and sales in Canada have some advice for those following this unique industry.For investors, look for licensed producers with committed shareholders and nimble business models. For recreational users, the path to legalization was laid out on April 20, 2016, when Health Minister Jane Philpot announced the Liberal government would be introducing legislation next year.It’s a dynamic time for the sector. There are expanding opportunities for legal companies, and potential for explosive growth as the recreational market emerges. There is also uncertainty.Investment analyst Aaron Salz, formerly with Dundee Capital Markets, noted that the Liberals’ task force for researching legalization—led by former Toronto police chief Bill Blair—has yet to be launched although the legalization timeline is now established.“The Prime Minister wants to try to get it done in his first term of office in my opinion,” Salz said. “It’s going to take time to put together and I think people have to be patient. It took years to put together the framework for MMPR (Marijuana for Medical Purposes Regulations)—and it involved consultation around the world with experts on other medicinal programs.”Even as Blair prepares the task force, the regulatory environment surrounding businesses taking an early position in the sector continues to evolve. This has generated some volatility and opportunity for investors. For example, share prices for publicly traded licensed producers went on a four-month run after the election of Justin Trudeau’s Liberals. Then in February 2016, shares took a dip after a federal court judge ruled that Canadians have the right to grow their own marijuana.“My advice to companies is to make sure you don’t get too stuck on one specific strategy. You could wake up tomorrow and there may be a development that totally blows it out of the water,” Salz said. “Whatever you’re doing, you have to be very nimble and fluid with your strategy and your abilities.”One thing coming into focus is the industry’s capacity to generate revenue for itself, and for government.A recent CIBC World Markets commentary by Avery Shenfeld estimated final sales of $5 billion to $10 billion per year in Canada as a consequence of legalized recreational use. Shenfeld had some interesting caveats. A sharp drop in illegal growing and exporting would benefit both licensed producers and government revenues. As well, his calculation excludes the emergence of potential export markets.“Even in the near term, looking only at the medical marijuana market, revenues are projected as significant—with capacity for exponential growth,” said Alan Brochstein of 420 Investor. Brochstein, a Houston, Texas-based CFA and marijuana legalization advocate, recently launched an index that tracks on a monthly basis the performance of publicly traded companies in the Canadian MMPR sector.“It’s a very young industry. The person that starts the race with the lead doesn’t necessarily win,” Brochstein said.On the medical market alone, he estimates a range of customer scenarios between 200,000 and 400,000 by 2020. “I figure about $2,000 per year per patient, roughly. On the high end, it’s $1.6 billion. Base case is $800 million. There is potential for a few companies to have 15–20% share. 15% of $800 million is $120 million in revenue and the margins are really high.”Among publicly traded companies, Brochstein looks for low cost producers with access to capital and shareholders who are confident enough in a company to maintain a buy-and-hold strategy.“When you look at a young company, you definitely want to look at the people who are involved. Are they in it for the right reasons? Do you have confidence that they are going to make good decisions going forward? I think these are things that investors look for.”One emerging company that caught Brochstein’s eye is Supreme Pharmaceuticals (CSE: SL). Supreme trades on the CSE and OTC markets and has a wholly owned subsidiary, AMMCan, that was awarded a federal license to produce. The company is working towards a sales license later this year.Brochstein said Supreme President John Fowler is, “engaged and passionate. He’s untested but he is helped by an active board of directors and management team members.”Supreme is working to become a leading supplier of cannabis in legal markets. It has begun production at a 342,000 sq. ft. hybrid greenhouse located in Kincardine, Ontario—the second largest marijuana greenhouse in Canada and the first hybridized, modular greenhouse in the world. It is focused on lowering production costs while simultaneously building a brand known for quality and affordability.The facility was formerly a tomato greenhouse. Supreme has spent about $5 million to transform it into a secure, state of the art, automated medical marijuana facility.“We’re operating at about 10% of the existing greenhouse facility,” said Fowler, a Toronto-based lawyer who has been active in the medical marijuana sector for a decade. The company, he noted, has been careful to position itself to adapt to the evolving market.“We have invested in two metrics that will serve us well regardless of how the market develops: low cost of production and low cost to scale up. We project attractive margins based on production cost and I believe our costs to scale are some of the best in Canada.“We also have perhaps the lowest risk and cost to expand because we’re essentially retrofitting an existing building with existing utilities. Most importantly, because it’s all in one facility, we capture economies of scale much better than others. We have one management team, one large facility.”Initial production cost is $2.25 per gram. The company expects to slice 20% after the first expansion—and eventually bringing costs well under $1 when the hybrid greenhouse is in full production.“Peter Herburger, the visionary behind the Hybrid Greenhouse and my boots on the ground in Kincardine, is one of the best operators I’ve met. No matter how good your first proposal is, he will tell you to sharpen the pencil and make it better—and what’s great is that he’s a pragmatist. For example, through hard work and innovation our cooling load is less than one-quarter of what we initially projected.” Fowler said.The company was able to obtain its production license from Health Canada in a single inspection and advanced to its first planting within three weeks. Moving smoothly through the regulatory process is an important aspect for a company in the regulated marijuana market.“We have a lot of marijuana experience. We understand what works and what doesn’t; where innovation pays off and where it’s better to conserve capital,” Fowler said. “One reason we got licensed on our first try is that we spent two years talking to everybody who has experience in the MMPR sector. Wherever possible, we made changes through hard work, rather than capital expenditures.”Fowler said the company is focused on the business-to-business (B2B) market, positioning itself as the first downstream supplier of cannabis and, in the future, cannabis products.“The B2B market allows us to scale revenues quickly, have more stable and bankable revenue through long term agreements while saving the cost and challenges of retailing. Over time we expect to develop our brand and branded products to be distributed by retail products. In essence, we plan to be in the high-margin branded retail market without being retailers ourselves—the Coca-Cola, not the corner store,” Fowler added.The emergence of a recreational market represents a windfall opportunity for Supreme. The company was built to compete in a tight MMPR environment with a more restricted customer base.“When Supreme decided in 2014 to evaluate medical marijuana opportunities, the legalization of recreational marijuana couldn’t have been farther away. We think we will be one of the best producers of marijuana in the country. That means we’re industry agnostic. If we stay in the medical-only market, I think we’re well positioned. But by focusing on the point of production and not on the point of sale, we can pivot or operate in both markets with equal efficacy. The third market, which can’t be ignored, is the pharmaceutical market, where we can also be a supplier of input material for research and production.”Even with those opportunities, Fowler said the company is committed to taking the time to distinguish its product from competitors.“At the end of the day, we are farmers. The best, most desirable crops start with the best seeds. Starting from seed ensures our genetic stock, the backbone of our business, is ideally suited for our hybrid greenhouse and our business objectives. By working with Dinafem (a world-leading marijuana seed bank), we assure ourselves of getting the best genetics, and we can assure that we differentiate ourselves in the market space,” Fowler said.“Choosing the right cannabis genetics has a direct economic impact. Genetics impact on yield, potency and desirability, and also play a role in mitigating risk. Some varieties are just more resistant to pests or crop failure. It’s also important to keep in mind that the work we do now will create genetic stock that potentially we could be growing for decades to come.”Long term, attention to quality could be the Canadian marijuana industry’s strongest asset. More countries are expected to legalize the product in the years ahead. A reputation for quality and best practices in a well-regulated environment will give Canadian producers a competitive edge—especially those who are nimble enough to respond quickly as opportunities emerge.

Read More
No Comments

Post A Comment

Sign Up For Our Newsletter

Email *