Forget Canada, Cannabis 2.0 is Really the Birth of the U.S. Market

Is a Diverse Canadian Market Really Cannabis 2.0?

Or is it the Enormous Opportunity South of the Border?

In an early October research report, analyst David Kideckel of Calgary-based brokerage firm AltaCorp Capital said that the next generation of cannabis products, or “Cannabis 2.0,” would kick Canadian cannabis companies into a period of renewed revenue growth. Investors can ride a wave of novel product types and individual product rollouts to profit as cannabis becomes even simpler to find and easier to consume. A proliferation of cannabis extract products like edibles, vapes, beverages, and topicals show that cannabis is turning a corner in Canada, so it seems quite possible that the expansion of choices amounts to a second big bang for the national industry following 2018’s adult-use legalization.

Nevertheless, the October 17 Legalization 2.0 of cannabis-extract products across Canada does not fully unleash Canadian pot stocks–at least not enough to justify the multiples at which they have been trading. A two-month waiting period starts from October 17, and until the 60 days are up Health Canada won’t allow cannabis derivative license holders to sell their products. The Canadian market is also hampered by marketing and branding restrictions that show a country can legalize cannabis without being truly open.

Canadian derivative plays all face headwinds and yet they trade for heavy multiples, as shown by the comparison charts below. These prices are not justified until the true prize in the North American market comes into play–and that is the United States.

According to data from Thomson Reuters and PI Financial in the tables below, U.S. multi-state operators (MSO) with a market cap over $1 billion are on average trading at an EV/Revenue multiple of 2.9x for FY2020, and 10x EBITDA for the same year. By contrast, Canadian licensed producers (LP) > $1 billion, excluding Canopy Growth (TSX: WEED) (NYSE: CGC), are trading at an average EV/Revenue multiple of 7.8x for FY2020, and a whopping 32x EV/EBITDA. Something has to give, and that will most likely be the price per share of LPs unless they grow into their multiples quickly.

Source: Thomson Reuters

No Flower Power

“Dried flower,” Kideckel writes, “will become a commodity over the long-term.” Already, the black market differential, i.e. the difference between cannabis grown and processed with capital-intensive methods by LPs and the broadly accessible dried flower available on the streets, is hammering producers with elevated production margins. Costs must come down across Canada, otherwise, people will opt to browse the dispensary finder Weedmaps on their smartphones, or other services where consumers can instantly find ten different grey market delivery services for a lower cost than what they would pay through the government-sanctioned Ontario Cannabis Store’s e-commerce website. That grey market experience will win as long as it is more accessible and appealing to consumers.

Kideckel goes on to point out that those companies that engage in truly creative product development to differentiate themselves and build loyal brands will keep their profit margins safe from the commoditization of cannabis flower. They can cater to and keep customers if product rollouts go well, but the research and development take time and money.

Still, these companies cannot market their new product innovations under current Canadian regulations–no t-shirts, lighters, or other swag, no advertisements, and no flashy packaging. The slow and botched national rollout of dispensaries that companies can push into hurts the ultimate reach and revenue reality for firms and their shareholders. Canadian cannabis companies are all essentially operating with one hand tied behind their backs and with access to far fewer consumers than they should be able to reach. These Canadian firms will only see the full market viability of their products once they hit the U.S. market.

The U.S. market is where MSOs can really assert themselves, and once the United States market fully opens up, that will be the true “Cannabis 2.0.” Canadian cannabis stocks need to figure out creative ways to legally plant their seeds in the USA before federal legalization takes place.

Here are the U.S. MSOs currently on our watchlist:

Red White & Bloom (CSE: RWB – IPO Soon), Green Thumb (CSE: GTII) (OTCQX: GTBIF), Trulieve (CSE: TRUL) (OTCQX: TCNNF), Curaleaf (CSE: CURA) (OTCQX: CURLF), Charlotte’s Web (CSE: CWEB) (OTCQX: CWBHF), Cresco Labs (CSE: CL) (OTCQX: CRLBF) and Liberty Health (CSE: LHS) (OTCQX: LHSIF).