Note: This video is part of Morningstar Canada's Cannabis Week Special Report
Ruth Saldanha: Canada's companies are poised to see sales grow by nearly 9 times through 2030, finds equity analyst Kristoffer Inton in a Basic Material Observer published last month, the first one that covers cannabis for Morningstar. He is here to talk about the observer in some detail.
Kris, thank you so much for being here today.
Kristoffer Inton: Thank you for having me.
Saldanha: What are some of the reasons to initiate coverage on cannabis right now?
Inton: I think the big reason that we wanted to initiate is that they have been performing so well. The cannabis companies have been some of the best-performing stocks. And so, we really wanted to ask ourselves, was the performance and a lot of the growth priced in by the market, and was it justified or not and to try and give investors the best idea about whether there is opportunity to get exposure to this fast-growing market.
Saldanha: Do you find that there are opportunities for investors even after this run-up in the stock prices?
Inton: So, I think, there's opportunities throughout the market. So, whether it's Canada, U.S. or the global market, we see tremendous growth coming. And so, companies that operate in any of these are likely to see huge top-line growth in the coming years.
Saldanha: And what do you see are some of the major risks?
Inton: So, it depends. So, for Canadian companies you can't operate in the U.S. right now. Basically, you can only operate in one country or the other with some limited exception for CBD products. But what the risk then is, is for U.S. companies, you are basically – although you are operating legally within the states that you operate with, technically, on a federal level, you are still operating illegally. And so, the federal government at some point will probably need to address this in order to sort of address an issue of disagreement in the legality between the state and federal level.
Saldanha: That apart, what are some of the key findings, especially for North America?
Inton: So, I think that our key findings are, for the Canadian market, there's still a lot of growth to come. Legalization for recreational cannabis only happened in late 2018 and we think investors would be remiss to think that the growth has already come. Distribution expansion has come at a very slow pace. At this past spring, Toronto, which is Canada's largest city, only had five dispensaries slated to open for a city of millions. And so, we think that there's still tremendous amount of growth to come, not only from black market consumers converting into the legal market, but from non-consumers converting into consumers now that it's legal.
For the U.S., we think that there's an opportunity here for more growth. Basically, there's increasingly a number of states passing more expanded access to legalized cannabis or low THC cannabis as well as additional states passing recreational cannabis. Illinois, here where we are, just passed their recreational cannabis law last week which is going to go into effect in 2020.
Saldanha: Looking outside of North America, what are some your findings for the global market?
Inton: In the global market, we see a lot of opportunity as well. More and more countries are recognizing the medical benefits of cannabis. And so, more and more of them are passing laws to expand access to medical cannabis in the countries. Now, currently, that's really an opportunity that the Canadian producers have really jumped on. The Canadian producers have been there in a legal market for a while. And so, they have been able to ramp up production and meet the strict requirement in order to export into a lot of these global markets. In the long run, the Canadian cultivation is probably not going to hold up relative to lower-cost production elsewhere in the world. Canadian production requires typically indoor or greenhouse production given the climate as well as labor costs which tend to be anywhere to be from 30% to 50% of cannabis production costs. Given that Canada is a wealthier country, it's going to be a higher cost place to operate. And so, although it will take time, there will be production that expands in places like South Africa, Colombia, elsewhere that are going to be able to grow more cheaply through outdoor production as well as using cheaper labor.
Saldanha: So, globally, where is the opportunity, both on the demand and the supply side?
Inton: From the demand side, we see a lot of European countries as the ones that are currently passing expanded medical legalization. Asia is a lot less likely and we don't think it's probably going to expand meaningfully by 2030. And so, really, most of that demand is going to come from places like Germany and other European countries that have been passing expanded medical access. From a supply side, it is really coming from all over. So, you have countries ranging from Greece, Colombia, Australia, South Africa even Lesotho that are already talking about expanding their cannabis production. A lot of countries that have had economic problems or had struggled with their economies see this as an opportunity to grow an industry in which there is really a lack of supply globally. Especially, a lot of those countries that I mentioned are in climates that are warmer and have more sun. And so, they are going to operate with the cheaper outdoor production. And then, if combined with a lower cost of labor, they are going to be able to beat higher-cost production that's coming out of Canada.
Saldanha: Thank you, Kris. Tomorrow we will focus on Canada where last year recreational marijuana use was legalized.
For Morningstar, I'm Ruth Saldanha.
