The Marijuana Industry

2018-04-10

The marijuana industry had a stellar year of growth in 2017, so much so in fact that it might now be causing investors to have irrational expectations with regards to its potential to keep delivering stellar returns for the next twelve months. Although this sector could very well continue to experience phenomenal upside in 2018, it is important to keep in mind that this is a new industry whose growth expectations are based on a multitude on uncertainties. Below are some facts to make sense of this still green opportunity.

(all sources have been quoted with hyperlinks for further reading)

Based on a report from Statistics Canada, the estimated amount of marijuana consumption in 2015 was almost 700 tons. Assuming a price of $8 per gram, this would mean that the size of the marijuana industry would be equivalent to roughly 70-90% of the wine market, and a bit more than 50% of the beer market for that same year. Furthermore, contrary to popular belief, the report indicated that the demographics for marijuana users have changed dramatically over the past decade. What was once a market dominated by teenagers is now described as having 60% of its user base aged 25 and over.

Bill C-45 will legalize recreational marijuana in Canada in 2018, giving provinces the flexibility to decide on how marijuana will be distributed and used within their jurisdiction. Here’s a quick summary as to what Quebec & Ontario have decided thus far:

Ontario

Age: 19+

Where to buy: private businesses – in store & online

Personal production: up to 4 plants

Where can you smoke: private residences only

Other notes: 40 businesses will hit the ground running once legalized, with 150+ being open by 2020

Quebec

Age: 18+

Where to buy: government owned locations only (SAQ)

Personal production: none allowed

Where can you smoke: only at locations where tobacco is permitted, except CEGEP and Universities

Other notes: 15 distribution locations will be opened in time for the legalization, with over 150 being opened by 2020. You will only be able to possess a maximum of 150 grams per residence

Numerous debates have been had regarding the pros and cons of legalizing a substance that was perceived as being a criminal drug. Here are some highlights of both sides:

Arguments for Legalization

Increased Tax Revenue for the Government

  • It can be a source of job creation – the marijuana sector employed over 200 000 people in the U.S. in 2016
  • In Colorado, the state has collected over $198M in taxes in 2016

Ability to control consumption

  • The government will have total control on how marijuana is presented and explained to the public
  • It will reduce the dependency on the black market, which is a source of crime and violence

Positive effects on certain medical conditions

  • It will help reduce the consumption of other illegal drugs and help with the opioid epidemic
  • Will help with certain issues such insomnia, anxiety, pain and seizures

Arguments against Legalization

Associated Health Issues

  • Many see it as a step backwards for all of the effort the government has made in reducing tobacco consumption
  • Studies have shown that smoking marijuana can multiply the risks for mental issues for those who were already pre-disposed to such problems
  • If smoked, marijuana can result in lung cancer
  • Brain development issues have been found in children or young teenagers who smoke

Driving Under the Influence

  • No device can accurately detect how much THC is in your system
  • No agreement on how much time should pass before it’s ok to drive after having smoked marijuana
  • Urine and blood tests are still unreliable as THC can remain in your system days and weeks after having consumed marijuana
  • Saliva based tests are still in trial

At Work

  • Certain companies have expressed concern regarding a potential loss in productivity, a lack of judgement and safety at the workplace
  • No guidelines have been provided as to the latitude employers have in disciplining an employee who is found to be working under the influence

From the Investors Point of View: A Bit of Caution

Canada will now be the second country in the world after Uruguay to legalize the recreational use of marijuana. Whereas certain states in the U.S. have legalized marijuana for recreational purposes, it remains illegal at the Federal level. With Canada being a relative first-mover, many analysts are wondering how they should be valuating marijuana companies. According to Bloomberg, there are currently 84 marijuana related companies listed on the stock exchange, for a total market cap of $37B. Among the most popular are Canopy (WEED), Aurora Cannabis (ACB), and Aphria (APH), with all three competing to solidify their competitive advantages in distribution, quality and in which provinces they do business in.

Long time professional money managers have stated that it is almost impossible to truly know the intrinsic value of these companies due to the uncertain regulatory environment and the difficulties in estimating the market size for marijuana. Additionally, the information provided by Statistics Canada are only estimates and are based on certain big hypotheticals that have a large margin of error. They also mentioned that due to the close relationship of our Canadian banks with those of the U.S., they still need to be cautious when debating on whether they should finance companies in this sector.

One of the bigger issues with marijuana companies is in the manner they report their revenues. Certain analysts have rung the alarm around the fact that certain companies are using questionable accounting practices to substantially increase their revenues. Canada is part of the IFRS reporting standard, which allows agricultural companies to use growth estimates when it comes to their inventory, in turn allowing them to offset the impact expenses have on their gross profit. In order to illustrate this in simple terms, you can liken this practice to counting the amount of chickens a farm has while they’re still unhatched eggs. As a result, many companies are inflating their plant inventories (although they have not yet matured) at a rapid pace in order to increase their supposed accounting value. This problem is further compounded when you take into consideration that the majority of companies all use different calculations to estimate the value of their crops, making it hard to properly evaluate and compare their productivity and revenue potential.

In conclusion, it would be possible to spend days debating the growth prospects and the future of the marijuana industry, but it remains that much of the information are currently working with are estimates and hypotheticals. Some would argue that we live in a time akin to that of the end of the Prohibition in the United-States in 1933, whereas others make reference to the Tech bubble in the early 2000’s. Regardless of the many opinons, it’s a very interesting time for this young, and for the time being, speculative, sector.