Complete Cannabis Guide #4: Provincial Regulations In Canada
Despite federal legalization of cannabis, it is provincial plans that dictate final execution and following regulation.
Ontario, British Columbia, and Alberta are the largest marijuana markets in Canada that have yet to announce supply deals.
Producers equipped with provincial supply agreement will hold the key to market once legalization happens.
Other players will have to turn to the wholesale market which is unpredictable, volatile, and low margin.
In our "5 Predictions For the Cannabis Industry", one of the predictions we made was that provincial supply agreements will take over licensed capacity as the most important driver for revenue profitability. We think supply agreements are important because cannabis will still be a somewhat "controlled" product given that procurement and retailing will be regulated on a provincial level. Investors need to understand the provincial plans because provinces will be the ones that determine the distribution and final sales of marijuana across Canada. Federal legalization is essential, but it is provincial plans that dictate the profitability and the future of cannabis companies.
To understand the full story, we will start by getting a lay of the land by reviewing legislative progress so far across the Canadian provinces and discuss what to expect in the coming months. We will discuss each province in the order based on population (2017 census by Statistics Canada), which we think is a good proxy for potential market size for cannabis consumption. Most provinces will control distribution themselves except Saskatchewan and the retail model is a mix of government and private. The two largest markets being Ontario and Quebec will not allow private companies to run retail, a big loss for companies involved in the retail business model.
|British Columbia||4.8 million||Government||Private/Gov't|
|Nova Scotia||0.9 million||Government||Government|
|New Brunswick||0.8 million||Government||Government|
|Newfoundland and Labrador||0.5 million||Government||Private|
Source: Author based on public information
Ontario (Population: 14.2 million)
Ontario announced plans to retail cannabis in up to 150 stores. The retail stores will be run by the Ontario Cannabis Retail Corporation (OCRO), a subsidiary of Liquor Control Board of Ontario (LCBO). The initial rollout after legalization will include 80 stores and online shopping will be available as well which is also run by the OCRO. Early indications are that cannabis shoppers won't be able to browse products in stores. Instead, there will be a behind-the-counter setup similar to what's seen now when buying cigarettes. Ontario also announced that it will use Shopify (SHOP) platform to run its online and in-store sales platforms. Our take: Being the largest province in Canada, Ontario is the must-win market for any cannabis company that plans to become a national player. We expect the province to select a number of vendors similar to Quebec; the government will likely prefer to deal with a smaller number of vendors. Companies, however, will only have wholesale opportunities in the province as OCRO will control retailing and online cannabis sales. For companies that place a heavy emphasis on retailing such as Hiku (OTCPK:DJACF), Ontario is not the place to be. For other companies, Ontario will be a competitive marketplace which will result in low margin. However, for larger players, it is essential to secure this market, otherwise, they will struggle to sell all their productions given the sheer size of Ontario.
Supply Agreement: To be announced. Top contenders include Canopy (OTCPK:TWMJF), Aurora (OTCQX:ACBFF), Aphria (OTCQB:APHQF). Would also include MedReleaf (OTCPK:MEDFF), Cronos Group (CRON), and CannTrust (OTC:CNTTF).
Quebec (Population: 8.4 million)
Quebec is the second largest market in Canada and one of the earlier provinces to announce its RFP results. The province plans to sell cannabis through the provincially-run liquor board. On the retailing side, similar to Ontario, Quebec plans to open 15 marijuana stores by July 1 with online sales available as well. The Société Québécoise du Cannabis (SQC) will buy cannabis from licensed producers and take care of transportation and storage. The province will make it illegal to cultivate marijuana for personal or commercial use unless authorized, which bodes well for licensed productions. Our take:As we wrote in "Canopy Clinched Quebec Victory", the outcome of the RFP can be used as a proxy for the upcoming Ontario auction. MedReleaf is getting acquired by Aurora, so there will only be five suppliers in the deal. Hydropothecary (OTC:HYYDF) is clearly the largest winner in the deal. However, we note that the Quebec market is the complete opposite of Ontario with only a handful of licensed producers and a low level of competitiveness. The Ontario RFP will be a lot more competitive which on the other hand shows the favorable position that Hydropothecary is in.
Supply Agreement: Six companies announced supply agreements with the Quebec government, including Hydropothecary, Canopy, Aphria, Aurora, MedReleaf (being acquired by Aurora), and Tilray (private).
British Columbia (Population: 4.8 million)
British Columbia and Alberta have chosen a different strategy where retail sales will be allowed through both public and private stores, similar to its current setup for liquor retail in the provinces. Retailers will have to get their supply of cannabis from the government's wholesale distribution system, similar to how it works for alcohol now. The government will control online cannabis sales exclusively Our take: British Columbia also announced that physical retailing of cannabis and liquor will have to be separate, meaning stores cannot sell both products. This rule has an impact on existing liquor retailers aiming to convert some of their stores to sell cannabis. Aurora invested in Liquor Stores (renamed to Alcanna (OTCPK:LQSIF)) which has been struggling for years in the liquor business. Other pharmacy chains will also participate in the RFP as we have seen in Loblaw's recent win in Newfoundland and Labrador. We think for many cannabis companies the path to winning those retail licenses will be a challenging one with the competition from multiple sources. The licenses will be hotly contested given that B.C. is the largest market to allow private retailing, leaving us cautious on those companies betting big on winning those contracts. The likely outcome is that a large number of companies will each win fewer contracts.
Supply Agreement: To be announced. Top contenders include Canopy, Aurora, Aphria, and Emerald (OTCQX:EMHTF). Aphria expanded its west coast capabilities through its acquisition of Broken Coast Cannabis. Canopy also significantly ramped up its production through BC Tweed. For retail licenses, we see a number of interested companies including Cronos /MedMen, Aurora/Liquor Stores, Hiku, Canopy.
Alberta (Population: 4.3 million)
Similar to British Columbia, Alberta government will control online cannabis sale entirely but will leave physical retail sales to the private sector. Cannabis retail stores would have to be physically separate from liquor stores. The Alberta Gaming and Liquor Commission (AGLC) would be responsible for regulating the private retail of cannabis and the government agency recently said that it expects to issue 250 licenses across the province in the first year of legalization. The agency also said that no one business or person can hold more than 15% of licenses "to help create a level playing field." Our take: The impact of the Alberta policies is that there will essentially be a cap on the potential market share for companies due to the 15% rule. Larger companies such as Aurora/Alcana will struggle under this regime because of the cap. Alcana currently has 174 stores in Alberta and 33 in British Columbia, so clearly it faces a scale problem (too large) in Alberta. We also note that the grocers and pharmacies will compete heavily in the province. Loblaw has made the move already and we expect other companies to follow suit.
Supply Agreement: To be announced. Top contenders include Canopy, Aurora, Aphria. Note that Aurora is building its largest facility, Aurora Sky, besides the Edmonton International Airport.
Manitoba (1.3 million)
The Manitoba Liquor and Lotteries Corporation (MBLL) will control the procurement and the private sector will be responsible for retail. In February 2018, Manitoba announced the results of its retail license RFP and four groups have been awarded the retail licenses for running cannabis retail stores in the province. A joint bid from Canopy and Delta 9 (OTC:VRNDF) was among the selected winning groups. Other winners are Hiku/BOBHQ, National Access Cannabis, and a group of First Nations bidders. The provincial supply agreements have yet to be announced.
Saskatchewan (1.2 million)
The province is planning to open cannabis retail to the private sector while imposing regulations. The Saskatchewan Liquor and Gaming Authority (SLGA) announced its plans to issue 60 retail permits to private retailers. The announcement included that eligible First Nations and municipalities will have the option to opt out of cannabis retail, which will determine the final number of retail permits. Supply agreements have yet to be announced. Notable players in the province include Aurora/CanniMed.
Nova Scotia (0.95 million)
The province decided to take a complete opposite approach from British Columbia by planning to sell cannabis alongside alcohol. The cannabis sales will be handled by Nova Scotia Liquor Corporation (NSLC) and has announced 12 locations recently. Suppliers have yet to be announced, but we expect Canopy and OrganiGram (OTCQB:OGRMF) to do well given their success in the Maritimes.
New Brunswick (0.76 million)
The province has already announced the locations of its 20-planned government-run stores. It also has unveiled a design blueprint for its cannabis stores. New Brunswick is moving fast and has also secured supply agreements with a number of suppliers. Deals have been signed with Nuuvera (Aphria), Zenabis (private), Organigram, and Canopy.
Newfoundland and Labrador (0.53 million)
The province will allow private retail sales while the Crown-owned liquor corporation will oversee the distribution. A supply deal has been signed with Canopy in December 2017 for 8,000 kg over the initial two years. As we reported in our Weekly Cannabis Report, Loblaw and Canopy were among the largest winners in the recent RFP of retail licenses in the province.
Prince Edward Island (0.15 million)
The province plans to see marijuana at standalone stores operated by its liquor commission both physical and online, so no private sector for retail. A supply deal has been signed with Canopy (1,000 kg per year), Canada's Island Garden (private), and OrganiGram (1,000 kg per year).
Other Provinces and Territories
(Yukon, The Northwest Territories, and Nunavut) all proposed or is expected to release regulations similar to the federal guidelines.
The current landscape of provincial plans supports a full legalization this summer with most provinces opted for a regulated distribution and retail model similar to alcohol. There are differences among the approach and regulations taken by each province, as expected. Supply agreements have been announced for several smaller provinces, but the biggest markets (Ontario, British Columbia, and Alberta) have yet to announce any supply agreements or retail licenses where permitted. We expect provinces to have a preference for established players with local roots for their jobs creation. The race to secure supply agreements will likely become the new drivers for differing performance among the pot sector in 2018. If 2016 and 2017 have seen investors focus on expansion capacity and licenses, we think 2018 will mark the year when more rational thinking and discipline will be required by investors. Producers equipped with provincial supply agreement will hold the key to market once legalization happens. Other players will have to turn to the wholesale market which is unpredictable, volatile, and low margin.