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  • Writer's pictureTed Ohashi

Will Cannabis stocks surpass the highs of late 2017 after legalization?

Question: “With the exception of Canopy Growth (TSX: WEED), do you think the cannabis sector will revisit or surpass the highs we saw in December 2017/January 2018? I am talking about within one to two years after legalization.”

From G.C. in Montreal, Quebec, Canada.

Answer: Yes, I believe Canadian cannabis stocks will revisit or surpass the old highs. This was my forecast before the Canopy/Constellation deal but I am even more convinced of it now.

First, given the timing of Constellation’s (NYSE: STZ) offer for their interest in Canopy leads me to believe big pharma, big beverages and big tobacco are much closer to moving into the industry than I thought before. Prior to “the deal” I thought it was at least a year or more before we would see majors making cross-industry investments into cannabis. Now I think it will be much sooner. I understand that Constellation is a smaller, more aggressive Fortune 500 company. They are willing to adopt a vision of the future and act on it in the theory that being an early adopter will be beneficial. I would argue that in Canopy, they got the number one cannabis company in the world. In that context, $5 or $10 billion is not much to pay.

If the Constellation move motivates one of the really big companies to act, it could trigger a stampede. Just because a company is big doesn’t mean it isn’t driven by the same emotions of fear and greed. Then we will have the elephants fighting to get through the mouse hole. In fact, if Canopy is successful and establishes a beachhead in many of the international cannabis markets, a really big company might take over Constellation to get Canopy! Constellation is one of the 500 largest companies measured by Fortune magazine and has a market cap of approximately $40 billion or over five times the value of Canopy Growth prior to their offer.

But let’s take a look at some of the big companies in pharmaceuticals, beverages and tobacco. For example, the world’s largest pharmaceutical company is Johnson & Johnson (NYSE: JNJ) with a market cap of almost $365 billion. We’ve all heard of a beverage company named Coca-Cola (NYSE: KO). It has a market cap of nearly $200 million. Altria (NYSE: MO) is the world’s largest tobacco company with a market cap of approaching $150 billion. Never heard of it? You probably know its predecessor company – Philip Morris.

Most Canadian cannabis leaders are worth a small fraction of these giants. The three mentioned are the largest in their industries but let me throw out some names with their approximate market caps in U.S. dollars in brackets so you have some perspective: Pfizer ($250 billion), Anheuser-Bush ($170 billion), Roche ($210 billion), British American Tobacco ($92 billion), Merck ($185 billion) and PepsiCo ($160 billion). It is companies such as these that will be looking to enter the cannabis industry over the next five or ten years.

Next let’s look at where the leading Canadian cannabis companies are going. International. Bruce Linton, CEO and Chair of Canopy Growth says there are 29 countries around the world planning to replicate Canada’s cannabis model for medical and/or recreational cannabis. Canada has a population of 37 million with 115 licensed producers competing for the business. The international market can be grouped as the United States, Europe and Latin America with a combined population of approximately 1.7 billion. In other words, the population of the “international market” is roughly 50 times larger.

We can allow for economic differences by comparing Gross Domestic Product (GDP) or the total value of goods and services produced in a year in U.S. dollars. Canada’s GDP is approximately $1.5 trillion U.S. The GDP of the international market as I have defined is almost $50 trillion U.S. From an economic perspective, the international GDP is over 30 times larger than Canada.

Bruce Linton’s figure is the international market is 20 times the size of Canada. Of course, the competition is considerably less as well. Let’s be conservative and cut Linton’s estimate in half. That’s still ten times larger than Canada. Let’s be ultraconservative and cut it in half again. It’s still five times more.

As we turn our collective eyes to the international markets, our expectations will also expand beyond the limitations of Canada which is, after all, a relatively small market. We rank around 38th in terms of world population and approximately 10th in terms of economic size.

This illustrates the appeal of international markets for Canadian cannabis companies and why our investment expectations will expand significantly as our focus de-emphasizes Canada and turns to international markets. I still suspect it will be a bumpy ride but the long term returns will more than justify the added risks.

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