Yesterday, the Ontario government announced private cannabis retail stores will be permitted in the province after all, delighting investors and cannabis management teams.

However, the announcement wasn’t all good news as Ontario announced that brick-and-mortar stores won’t be open for business until April 1, 2019, well after cannabis is legalized on October 17, 2018.

This delay means zero retail revenue for 6 months longer than expected, implying a 5 – 6% lower value for cannabis stocks for every six months retail revenue is delayed.

The stock sell-off yesterday implies the market is already pricing in a six-month delay, though depending on when the licensing process starts, the first stores may not open until the summer of 2019.

Until April, Ontario residents will only be able to buy their legal supply from the government-run website, likely contributing to weak legal market sales in the early days.

This is a dramatic turn of policy in less than a year and demonstrates the new Ontario government is committed to at least some free market experimentation.

Bottom Line:

The news is positive for big producers with deep pockets and smaller retail specialists. 

This news is negative for stock prices in the short term due to the retail delay, but is positive longer term for large operators like Canopy Growth (Hiku), Aurora Cannabis (Alcanna), Cronos Group (Medmen) and the standalone retailer Fire and Flower, not to mention smaller operators like Namaste, Choom, Inner Spirit and National Access Cannabis.

Depending on the final rules, licensed producers now have a much larger market to sell into which will lead to more stores and higher overall profit from retailing.

For investors we would recommend some caution due to the government’s control of distribution and the risk that black market stores are left out of the licensing process, increasing retail competition.

 

The Government Still Controls the Market

Even though the government is giving up their control over the retailing of cannabis, they still are the only game in town when it comes to wholesale distribution.

What this means is that growers have no control over their revenue and must accept the price they are paid by the government distributor.

Retailers on the other hand must accept whatever price the government charges for wholesale cannabis effectively giving them no control over their costs.

This is an extremely important feature of the market to keep in mind.

The government will have to be nimble in adjusting their buying and selling prices to challenge the black market or else growers and retailers could face financial difficulties if consumer demand disappoints expectations because of unrealistic retail prices.

 

Black Market Retailers Could Persist for a Time

The Minister of Finance made comments on Monday demonstrating a low regard for illegal dispensaries.

Though illegal stores can apply for licenses, we wonder whether they will actually be approved.

When looking at all the other provinces, large well capitalized corporations have won all of the licenses so far, leaving black market dispensaries completely out of the legal market at this point.

As Oregon has shown us, when the black market is not given a chance to assimilate into the legal market, illegal retailers and growers will persist longer than if given a chance to join the new market on day one.

 

Much More Information is Needed

The government announcement was very light on details so a few very important clarifications need to happen before we really know what the market landscape will look like.

How Many Licenses Will be Awarded?

Social media rumours point to 500 store locations, which would be twice the number planned for Alberta, although Ontario has more than three times the population.

We also don’t know if 500 stores would be the final limit or if 500 would be permitted to start with more future stores to follow as well.

If there’s no cap on the number of licenses one company can own, as rumoured, it would allow companies with deep pockets to control a majority of retail locations, a great scenario for the largest publicly traded producers.

Can Licensed Producers Own Retail Stores Outright?

Certain provinces have set limits on a producer’s ability to also own retail stores.

B.C. for example places restrictions on what products a store can sell if it’s partially or fully owned by a licensed producer.

We need clarification on if Ontario will introduce any similar restrictions.

Other Concerns

  • Will stores have to be at least 100 metres from a hospital or school like in Alberta or will it be 300 metres like in Manitoba?
  • When will the application process open and how many applicants will actually be approved for licenses by April 1st?
  • Will there be stringent security requirements for the store and will smoking be allowed on the premises?

And much more….

August 13 marks only the beginning of the journey retailers will face setting up shop in Ontario, but with a population of over 14 million, there is tremendous opportunity.

Ontario has a lot of work ahead of it and the big question remains whether private retailers and investors will like what comes next.