High valuations justifiable if investors factor in potential of U.S. legalization on a federal level and legalization in the EU

The potential of the global cannabis industry is so vast that it could eventually make the sky-high valuations of some Canadian licensed producers look like bargains, according to a new report from Bank of Montreal.

In the report, the bank’s cannabis sector analysts, Tamy Chen and Peter Sklar, sought to determine just how big the total addressable market Canadian producers will be competing for in the coming years, one that doesn’t stop at Canada’s borders.



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Assuming a blue-sky scenario in which the U.S. and all 28 countries in the EU legalize marijuana for both recreational and medical use — and in which Latin America allows the medical use of cannabis — they project that in seven years the market could reach $194 billion, a number that significantly dwarfs the $5.9 billion in potential revenue they anticipate will be generated by the Canadian medical and recreational markets.

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Currently, the biggest three licensed producers in Canada — Canopy Growth Corp., Tilray and Aurora Cannabis — have a combined market capitalization of more than $30 billion.

Cannabis stocks have taken a hit in the weeks since Canada legalized recreational weed, as investors have seemingly reassessed the sector given serious product shortages, supply chain hiccups and a sense that it will take longer than expected to reach full capacity.



The Horizons Marijuana Life Sciences ETF, for instance — which holds a basket of the biggest marijuana stocks — has lost a third of its value since legalization, wiping out approximately $500 million.

But if there’s hope for the sagging stock prices, it lies in the opportunities abroad, the BMO report suggests.

“We believe current valuations for Canadian LPs are elevated when only the Canadian cannabis opportunity is considered,” the analysts wrote.

They believe, however, that if investors start factoring in the potential of U.S. legalization on a federal level and legalization in the EU, the Canadian cannabis sector, as first-movers globally, could easily justify those high valuations.

Chen and Sklar forecast that in Germany alone — a country with a population of 82 million people two which Canadian producers such as Aurora Cannabis and Canopy Growth Corp. are already exporting — the medical marijuana market could potentially produce more than $5 billion in revenue for global cannabis producers.



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There are currently 30,000 medical patients in Germany and an annual legal consumption of 7,200 kilograms. The BMO report arrives at the $5 billion figure primarily based on an assumption that in seven years, 7.5 per cent of sleep, anxiety and pain prescriptions in Germany will be replaced with medical cannabis, opening up the medical pot market to roughly 26 per cent of the overall population.

“Although prices are currently higher, we are projecting that in seven years, more supply will reduce the average wholesale prices to seven euros per gram,” Chen and Sklar wrote.

The report also predicts the total addressable market if all 28 countries in the European Union legalize cannabis for medical use would be $30 billion in seven years, with another $68 billion if they also legalize recreational cannabis.

Again, that is a best-case scenario calculation given that a only a number of European nations including Germany, Italy, Portugal, Denmark, Switzerland, Croatia and the Netherlands have legalized medical cannabis, to varying degrees. The drug still remains illegal, albeit decriminalized, in most of the EU.

With regards to the U.S., Chen and Sklar made their projections assuming that five per cent of sleep, anxiety and pain prescriptions will be replaced with medical cannabis over the next seven years. Despite expected intense competition from Big Pharma, the BMO analysts projected cannabis producers would see $19 billion in total potential revenue from the medical market in the U.S. and $49 billion from the recreational side.

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Our market share assumptions for international markets are lower than Canada as we believe Canadian LPs are likely to face competition from other Canadian LPs and international players BMO analysts

While BMO’s estimates of “total addressable market” and “total potential revenue” are essentially the overall market Canadian LPs could have access to in seven years, there is no way of knowing, at this point, how big their slice of those pies will be.



“Our market share assumptions for international markets are lower than Canada as we believe Canadian LPs are likely to face competition from other Canadian LPs and international players,” the analysts wrote.

To put all these estimates into context, a company such as Canopy Growth currently has a market value of roughly $14 billion, serves just 82,700 medical patients, and pulled in revenue of approximately $80 million in the 2017/18 fiscal year. Of course, these figures are expected to rise, given that sales of legal recreational cannabis have just begun in Canada.

Most of the top ten licensed producers have already begun staking claims abroad, particularly in the EU. Canopy has operations in 11 countries under its medical entity, Spectrum Cannabis. Cannabis sales in Germany, according to the company’s first-quarter fiscal 2019 report, accounted for 14 per cent of product revenue, or roughly $3.65 million.