The bulk of the value generated from this industry will accrue to Canada’s provinces, the analysts write

Cannabis sales could soon eclipse hard liquor sales in Canada, according to a new report by The Canadian Imperial Bank of Commerce analysts, with provincial governments, rather than private companies, expected to reap the most benefit.

Legal recreational marijuana sales could hit $6.5 billion by 2020, topping the $5.1 billion Canadians spent on spirits in 2017 and approaching $7 billion spent on wine, according to the report released Tuesday.

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“The bulk of the value generated from this industry will accrue to Canada’s provinces. In fact, we estimate that provinces will generate over $3 billion of income, either in the form of earned profits or taxation revenues,” the CIBC analysts John Zamparo, Prakash Gowd and Mark Petrie wrote in the report titled, Cannabis: Almost Showtime.

“The provinces will hold all the cards when it comes to distribution… In fact, we estimate that provincial governments will capture a stunning 70 per cent of industry profits.”

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In contrast, private companies “ will generate nearly $1 billion in EBITDA (earnings before interest, taxes, depreciation and amortization),” the authors estimate, “as part of the shadow economy becomes legitimate business.”

The calculations are based on the assumption that Canadians will be buying roughly 800,000 kilograms of legal recreational marijuana by 2020 at a price of around $8 per gram (or $10 a gram at the counter once you add excise and sales tax).

That’s up from roughly 773,000 kilograms that Statistics Canada estimates was sold on the black market in 2017, and assumes that the legal market will be able to capture the lion’s share of consumers within a short period of time.

Keeping retail prices relatively low is key in the process of transition, the analysts write.

“Retailers who think $20/gram cannabis is attainable will quickly find consumers walking out of their stores, pulling out their phones, and DM-ing their previous dealer to see if they can still get that deal on Bruce Banner at $8/gram,” CIBC analysts said.



The prospect of an $8 gram doesn’t, however, mean licensed producers will be achieving massive markups on their product which they can grow at well under $2 a gram.

“As a starting point, investors should assume that any value added to distribution (also thought of as wholesaling) of the product will be within the government sector,” the analysts write.

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Although public information about wholesale prices is scarce, the authors point to Aphria Inc., which sells wholesale product to other LPs for around $4.75. Based on this number, the authors estimate that producers can reasonably be expected to earn around $3.60 a gram, meaning gross margins of roughly 60 per cent.

Government distributors in turn could capture around $2 per gram sold, while retailers (either public, as in Ontario and Quebec, or private, as in Alberta or Manitoba) could be looking a further $2.40 per gram sold, based on assumed mark-ups.

The report presents a relatively optimistic picture of the emerging industry, albeit one qualified by the view that many of the companies piling into the cannabis space are destined to be squeezed out by pricing and the inability to get their product to market.

In contrast to the widespread view that publicly traded cannabis companies are, as a whole, overvalued, the analysts say that valuation is relatively fair, when compared with the tobacco and alcohol industries and once you take growth prospects into account.

The risk for investors, however, lies with particular companies that have ridden the wave of investor enthusiasm, but are late to the game when it comes to building out production facilities or signing supply deals with provincial wholesalers.

“We suspect some of the jobs that are “in progress” likely won’t ever see the light of day. It’s our view that for producers who are only now getting started, they probably will not secure supply agreements with buyers, and the capital required to complete these projects will disappear,” the authors write.