The Canadian Imperial Bank of Commerce has released a report that provides a positive outlook on Canada’s upcoming legal cannabis industry. In their report, titled “Cannabis: Almost Showtime,” CIBC analysts predict that the cannabis industry will surpass the alcohol industry by the year 2020.
According to the CIBC analysts, sales of legal recreational cannabis is expected to reach C$6.5 billion ($4.6 billion). This represents 95% of all legal sales.
The analysts say that legal recreational cannabis sales will top the C$5.1 billion that Canadians spent on spirits as well as the $7 billion spend on wine in 2017. Meanwhile, Canadians spent $16 million on tobacco last year.
What is the basis for these projections?
CIBC’s calculations are based on the assumption that people are going to be buying about 800,000 kg of legal pot by 2020 at a price of $8 per gram, or $10 per gram at the retail store once excise and sales tax is added. CIBC’s estimate is up from the 773,000 kg that Statistics Canada estimated was sold on the black market last year.
CIBC’s projection also assumes that Canada’s legal recreational cannabis market will capture the bulk of consumers within two years.
Why cannabis retailers should keep prices low
The analysts also say that keeping retail prices relatively low is essential in the transition process.
According to them, retailers who think that C$20 per gram of marijuana is a realistic price are quickly going to find their consumers walking out of their shops and pulling out their phones to see if they can get a better deal of C$8 per gram elsewhere.
They clarify, however, that the prospect of an $8/gram pricing does not mean that licensed producers will be doing huge markups on a product that they can grow at well under C$2 per gram.
The analysts write that, as a starting point, investors must assume that whatever value is added to cannabis distribution will be within the government sector.
Although there is not much available information about wholesale cannabis prices, the analysts point to cannabis producer Aphria Inc., which had set its wholesale price for around C$4.75. So, based on this, they estimate that producers can be expected to earn about C$3.60 a gram, which places gross margins at roughly 60 per cent.
In turn, government distributors could capture C$2 per gram sold, while public and private retailers could be looking a further C$2.40 per gram, based on assumed mark-ups.
Canada’s provinces start to benefit more
In their report, CIBC analysts Prakash Gowd, Mark Petrie, and John Zamparo write that a bigger portion of the value generated from the cannabis industry “will accrue to Canada’s provinces.” In fact, they estimate that the provinces will generate an income of over $3 billion, either in earned profits or in taxation revenues.
The analysts add that the provinces are going to hold all the cards as far as distribution is concerned. In fact, they estimate that the provincial governments are going to capture 70 per cent of the industry profits.
Private companies, on the other hand, are estimated to generate nearly $1 billion in earnings before interest, taxes, depreciation and amortization (EBITDA) as part of the shadow economy starts becoming a legitimate business.
There will be losers along the way
In contrast to the popular opinion that publicly traded cannabis companies are generally overvalued, the analysts state that this valuation is relatively fair, especially when you take into account the growth prospects and when you compare it with the alcohol and tobacco industries.
They say, however, that the risk for investors lies with those companies that have just ridden the wave of investor enthusiasm but have entered late in the game in terms of building production facilities and securing supply deals with wholesalers.
It is their view that for those producers who are only getting started now, they will probably be unable to secure supply agreements with buyers. “There will be losers along the way,” they say.