Preparing for Canada’s Multi-Billion Legal Cannabis BoomMay22

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Daily Intelligence Briefing – May 22, 2018

FEATURED TOPIC: CANNABIS – Preparing for Canada’s Multi-Billion Legal Boom

In January, MRP noted the United States’ burgeoning crackdown on the fledgling cannabis industry with the rescindment of the Cole Memo, which effectively allowed states to legalize marijuana with little-to-no government interference. This reversal of policy, combined with a drive for full legalization of marijuana in Canada, has created a huge opportunity for America’s northern neighbor. Final legislative approval by the Canadian government is expected in a June 7 Senate vote, ahead of which many companies and even some banks have been preparing for a transformative change to the country’s economy.

At least $1.23 billion was invested in the industry in the first five weeks of 2018 alone. Canada’s Parliamentary Budget Officer (PBO) projected that marijuana sales would be between CA$4.2 billion and CA$6.2 billion. The midpoint of that range amounts to around $4 billion USD. The midpoint of Deloitte’s estimated range is roughly $5.3 billion in U.S. dollars. However, over time, this market has the potential to double if we compare it to Colorado’s legalization a few years back. Canada and Colorado’s legalization scenarios are similar in that both permitted legal use of medical marijuana for several years before moving to legalize recreational use of the drug. Marijuana legalization also enjoys public support in both areas. Colorado is probably on track to record total marijuana sales of $1.6 billion this year. Assuming Canada’s marijuana market follows a similar path of growth, and accounting for the difference in population sizes, Canada could be in store for a marijuana market of $10.4 billion annually within a few years.

Most provincial estimates and Wall Street reports have called for approximately 800,000 kilograms (1.76 million pounds) of domestic annual demand. However, a report issued last month by Health Canada, the regulatory agency responsible for overseeing the legal cannabis industry, as well as issuing cultivation and sales licenses, projects that domestic demand could reach 1 million kilograms (2.2 million lbs) by the end of 2018. However, the number of startups and other companies prepared to fill that demand have some fearing oversupply. Oregon is currently in the midst of such a situation as the state currently has nearly 1 million pounds of marijuana flower in inventory, a staggering amount for a state with a population of 4.1 million people. The retail price for a gram of pot has fallen about 50 percent since 2015 from $14 to $7, effectively pushing growers to begin illegally modifying their product for sale on the black market.

Oversupply worries for Canada, however, are likely overblown considering the country already has very limited inventories and a complex distribution network for the country’s small number of dispensaries. With the exception of Canopy Growth, most licensed producers’ (LPs) inventories are likely to not grow substantially over the next few months, especially as some LPs meet medical patient and export demand. In March, Health Canada reported inventories held by LPs as of the end of December totaled only 50 million grams. To put that in perspective, assuming 0.3 grams per joint, this would effectively amount to about four joints per Canadian per year. While production will undoubtedly pick up after legalization is official, this existing supply/demand imbalance will have to be addressed before any worries of a cannabis glut.

Canadian supply will also have more than just domestic demand to fill. Globally, there is a massive excess of demand over supply for legal, regulated medical cannabis, and Canadian companies have little competition in supplying it. The average price of American marijuana per 1/8 ounce is equivalent to $40.00. Meanwhile, the same amount of Canadian crop sells for only $27.90, more than a 30% discount. Furthermore, at every small purchase quantity from 1/8 of an ounce to a full ounce it’s still much cheaper to buy in Canada versus the United States.

Canadian cannabis farmers and manufacturers are already shipping marijuana to Germany, Czech Republic, Australia, New Zealand and other destinations. At least seven producers in Canada have been granted licenses to export cannabis. Canadian shipments of dried medical cannabis have soared since 2015. More than 522 kilograms of dried cannabis was exported to four countries last year, more than 10 times the 44.8 kilograms shipped abroad in 2016. Shipments of cannabis oil in 2017 topped 400 kilograms, nearly quadrupling the 2016 amount of 100 kilograms.

To better address these needs, companies are trying to scale up their operations and M&A activity in Canadian Cannabis is heating up as a result. Just last week, Canada’s Aurora Cannabis Inc. agreed to buy rival MedReleaf Corp. for about C$2.9 billion (US$2.2 billion) in stock. The deal will create a producer with the capacity to grow 570,000 kilos (1.26 million pounds) a year of cannabis at nine facilities in Canada and two in Denmark. This deal, the biggest in the industry thus far, will create a merged company with better distribution networks at home as well as in Europe, South America and Australia. Helping the new company along even further, while also setting a powerful precedent, is the Bank of Montreal (BMO).

The cannabis industry’s biggest hurdle has long been gaining support from the banking sector, but BMO Capital Markets has taken a huge step with Aurora after advising the company on the takeover of MedReleaf, and encroaching on the territory dominated by smaller investment banks like Canaccord Genuity Group. Canaccord, the top adviser for Canadian cannabis companies, has advised four deals with a combined value of US$5.15 billion. BMO Capital Markets originally became involved in Canada’s pot industry in January after helping lead a C$200.7 million equity financing for Canopy Growth Corp., becoming the first major Canadian bank to arrange a stock sale for a pot company. While BMO has yet to take on deposits, Alterna Savings & Credit Union has been the most marijuana-friendly bank and currently holds about C$750 million in pot-related loans and deposits, about two-thirds of the almost 100 licensed producers in the business bank with Alterna.

Corporate Cannabis is just getting its feet on the ground in Canada, and it already has fleshed out production capacity on the ground, along with a friendly regulatory framework. The potential for the market it could create, domestically and internationally, promises to be a compelling opportunity for years to come. Investors can gain exposure to Canadian cannabis via public companies including Canopy Growth Corp. (TWMJF), Aurora Cannabis Inc. (ACBFF), and Aphria Inc. (APHQF). The Alternative Harvest ETF (MJ) provides broader exposure, but has been significantly outperformed by many Canadian stocks over the last year.

HERE IN THE MEANTIME are some articles relating to this featured topic (the stories are summarized in the SERVICES section of today’s report):

• Cannabis – The Looming Canadian Cannabis Shortage
• Cannabis – Canadian Marijuana Demand to Hit 1 Million Kilograms by the End of 2018
• Cannabis – Here’s How Much Marijuana Costs in the United States vs Canada
• Cannabis – U.S. Attorney: Oregon has a major marijuana overproduction issue

CHART: Cannabis ETF (MJ) vs Aurora Cannabis (ACBFF) vs Aphira (APHQF) vs Canopy Growth Corp. (TWMJF) vs S&P 500 (SPY)

OTHER DISRUPTIVE CHANGE:

• Economics and Trade:
  • Trade War – U.S. Puts ‘Trade War’ Against China on Hold, Mnuchin Says
• Finance:
  • Banks – This is exactly the wrong time to roll back financial reform
  • Cryptocurrencies – Coinbase looking to apply for federal banking license
  • Banks – Banks seek tech talent for digital shift
• Real Estate:
  • 3DP – 3D printed homes built in less than 24 hours will ‘be mainstream by 2025’ in UK
• Labor, Education & Demographics:
  • China – China may scrap limits on family size by end of year
• Services:
  • Blockchain – Blockchain in Retail: Changing the Shopping Experience
  • F&B – Small Brands Are Taking a Thousand Little Bites Out of Campbell’s Business
• Commodities:
  • Oil – Small Outages Have Big Impact on Oil Prices
• Energy & Environment:
  • Renewables – Investors With $10.4 Trillion Assets Urge Big Oil To Tackle Climate Change
  • Energy Storage – Storage Will Be Energy’s Next Big Thing
  • Batteries/LNG – Kokam Shows Gas and Batteries Can Get Along
  • Batteries – Batteries are the next frontier of industrial competition
  • Solar – Raising the heat to lower the cost of solar energy
• Biotech:
  • Robotics & Automation – Robots Can Grow Humanoid Mini-Organs From Stem Cells Faster And Better Than People
• Endnote:
  • Crypto Wealth Sinks $45 Billion in One Week

JOE MAC’S MARKET VIEWPOINT

• Joe Mac’s Market Viewpoint: The INFLATION COMPLICATION
• Joe Mac’s Market Viewpoint: A Review of MRP Themes
• Joe Mac’s Market Viewpoint: Beyond the HOUSING HEADWINDS
• Joe Mac’s Market Viewpoint: The Coming Value Rotation
• Joe Mac’s Market Viewpoint: Beyond the BOND BUBBLE

CURRENT JOE MAC THEMES

Autos  (S)	Electric Utilities  (L)	TIPS  (L) / Long-Dated UST (S)
Defense  (L)	Industrials & Materials (L)	U.S. Financials & Regional Banks (L)
ASEAN (L)	Oil & U.S. Energy  (L)	U.S. Homebuilders & Construction (L)
France  (L)	Greece (L)	Palladium  (L)
U.S. Healthcare Providers (S)	Saudi Arabia (L)	Solar (L)
Gold & Gold Miners (L)	Robotics & Automation (L)	Video Gaming (L)
Lithium (L)	Steel  (L)	Value over Growth  (L)

About the DIBs: MRP focuses on identifying transformational change in the global economy and offering an investment thesis whenever an opportunity arises that has not yet been recognized by the market. The DIBs are MRP’s compilation of articles and data from multiple sources on subjects reflecting disruptive change that have potential investment implications for an industry or group of securities. We share these with our clients who may already have or may be considering exposure in the industries affected. The subjects change daily and constitute an excellent update on featured topics. 

MAJOR DATA POINTS

Top

Dollar Hits New 2018 Peak

The dollar index rose 0.4% to 94.0 in early trading on Monday, its highest level in 2018, after the US and China agreed to put their trade war “on hold” while investors await Wednesday’s Fed meeting minutes for further clues on the path of interest rate hikes. TE

British Pound Sterling Hits 20-week Low

GBPUSD decreased to a 20-week low of 1.3449. TE

Taiwan Export Orders Rise 9.8% YoY in April

Export orders from Taiwan went up 9.8 percent year-on-year to USD 39.11 billion in April of 2018, following a 3.1 percent increase in March and above market expectations of an 8.85 percent gain.

Orders increased mostly for electronic products; basic metals & articles thereof; machineries; plastics & rubber ; chemicals ; electrical machinery products and mineral products. On the other hand, orders dropped for information & communication products. Among major trading partners, export orders went up from Japan; Europe; China & Hong Kong; ASEAN countries and the US. TE

Soybeans Prices Rally on Monday

Soybeans futures surged on Monday, after trade tensions between the US and China eased as the two countries decided to put the tariffs ‘on hold’ while they work on a wider trade agreement. The US is the biggest exporter of soybeans and around 60% of its sales go to China. Soybean futures went up more than 2% to $10.22 a bushel around 05:00 PM London time. TE

Palladium Prices Rally

Palladium increased by 2% to 986.3 USD/t.oz. TE

ECONOMICS AND TRADE

Top

Trade War – U.S. Puts ‘Trade War’ Against China on Hold, Mnuchin Says

The Trump administration won’t impose tariffs on Chinese products for now, after the two nations made progress on trade issues during two days of talks. Asian stocks were set to start the week higher and S&P 500 contracts gained 0.7 percent, an unusually large gain for early Asian trading.

Even so Trump can always decide to put the tariffs back on if China doesn’t go through with their commitments. It’s also not clear how long any truce will last. Trump has often switched his position on trade issues. He has frequently declared that talks on a new North American Free Trade Agreement are going well, for example, only to threaten again to withdraw from the pact.

This new information comes after the two nations on Saturday released a joint statement in which China proposed to significantly increase purchases of U.S. goods. The statement released by the White House didn’t place a dollar figure on the increased purchases by China, or address a comment on Friday by Kudlow suggesting that Beijing had agreed to slash its annual trade surplus with the U.S. by $200 billion. The U.S. had a $376 billion trade deficit in goods with China last year. B

FINANCE

Top

Banks – This is exactly the wrong time to roll back financial reform

Financial crises always start the same way. Loose monetary policy leads to an increase in debt and a rise in risk-taking. This coming week the US Congress may very well pass a bill to rollback the post-financial crisis-era Dodd-Frank reforms. This is happening at a time when interest rates have been at historic lows for nearly 10 years, public and private debt is at record levels, consumer debt loads and subprime defaults are rising, and politicians are looking to throw a bit more kerosene on the economy to seduce voters in the run-up to November’s midterm elections.

The bill is being couched as a way to reduce onerous regulatory burdens on regional and community banks so that they can do more of the plain vanilla lending. Yet the numbers show that loan growth at community banks is already stronger than the industry average – there’s zero evidence of a credit supply problem.

Now would be a good time to raise capital standards on safe haven banks that sit at the centre of the capital markets, rather than lower them. It is always a good idea to have a cushion before the next crisis comes. This bill will do just the opposite.

Is this where we want to be at the end of a recovery cycle, with debt loads at record levels and the interest rate environment changing? No. Sadly, short memories and rollbacks of post-crisis reform are another common refrain in financial history. FT

Cryptocurrencies – Coinbase looking to apply for federal banking license

Cryptocurrency brokerage firm and exchange Coinbase has been meeting with U.S. regulators to discuss the possibility of acquiring a banking license.

If Coinbase acquires a banking license, this would expand the gamut of services that the San Francisco-based company could offer its customers and would also remove the need for it to team up with a banking partner that would be willing to work with a cryptocurrency trading firm. This issue has cropped up within several jurisdictions such as Malta, where banks have been reluctant to engage with cryptocurrency trading firms applying to open a bank account. Other large exchanges are also reportedly considering applying for a banking license themselves to avoid these obstacles which appear to be quite a hurdle for operations. Acquiring a banking license would also assist Coinbase’s sales pitch to large institutions which it hopes to attract to its platforms.

Still, there are several new regulations if a company wishes to open a banking institution that would probably offset the benefits of owning such a bank. Coinbase is only one of five firms which have received New York’s elusive BitLicense that is essential to conduct cryptocurrency trading in the state. CoinGeek

Banks – Banks seek tech talent for digital shift

European banks have increased recruitment of technology specialists more than tenfold in the past three years as they rush to fight rising competition and find new sources of growth after years of restructuring. The number of adverts for IT and engineering roles at banks across the EU in the first quarter of 2018 was 11.4 times higher than in the same period in 2015. IT and engineering positions accounted for 17 per cent of bank job postings in the first three months of the year, up from just 7 per cent at the start of the period.

The recruitment data come as a report shows that responding to digitisation has, for the first time, become a bigger priority for bank executives than the threat of regulatory fines. The result also highlights the belief among senior bankers that the sector is close to completing its recovery from the financial crisis, with companies able to focus on new drivers of growth after a decade of restructuring and addressing legacy issues.

The report noted that “the regulatory backlash to the global financial crisis continued to sap banks’ strategic planning resources until last year. There are still outstanding regulatory issues, particularly around consumer protection, but they are no longer the priority.” FT

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REAL ESTATE

Top

3DP – 3D printed homes built in less than 24 hours will ‘be mainstream by 2025’ in UK

A new report details how Brits are less than a decade away from enjoying lower house prices thanks to a robot revolution in the construction of homes. 3D-printed homes, which can be built in 12 to 24 hours depending on size, could put an end to the housing crisis. The report also posits that drones would be carrying materials up building sites by 2025 too.

While recent decades have brought major advances in personal technology, construction practices remain relatively unchanged since the 1950s, Icon aims to change this, ushering in a new era in construction to meet the needs of the future. The first concept home was built using a Vulcan 3D printer, which is able to print a single-storey 600-800-square-foot home in a single day. The launch of the homes is expected to take place in El Salvador before the end of 2019, providing a community of homes for underserved families. Sun

LABOR, EDUCATION, & DEMOGRAPHICS

Top

China – China may scrap limits on family size by end of year

China is considering a plan to scrap all limits on the number of children a family can have in what would be a historic end to a policy that spurred countless human-rights abuses and left the world’s second-largest economy short of workers. The State Council, China’s cabinet, has commissioned research on the repercussions of ending the country’s roughly four-decade-old policy and intends to enact the change nationwide.

The policy change would close the book on one of the largest social experiments in human history, which left the world’s most-populous country with a rapidly ageing population and 30 million more men than women.

An initial feasibility study was submitted to Premier Li Keqiang in April that found there would be “limited” benefits to lifting birth restrictions. The move underscores growing concern among Chinese policymakers that more dramatic action is needed three years after allowing all families to have two children instead of one. Births fell 3.5 per cent to 17.2 million nationwide last year, erasing almost half of the increase in births caused by relaxing the policy.

China’s ageing society will have broad consequences for the nation and the world. The State Council last year projected that about a quarter of China’s population will be 60 or older by 2030, up from 13 per cent in 2010. SCMP

SERVICES

Top

Blockchain – Blockchain in Retail: Changing the Shopping Experience

Besides non-financial applications like cloud storage, contracts, and smart cities, blockchain is viewed as an ideal solution for disrupting the retail landscape. Blockchain delivers an efficient way to collect and analyze the available information, like OSA DC, a decentralized platform that gathers and assesses data in real-time from sources like consumers and retailers.

What has happened is that so much data is now available from so many locations that it is fragmented. This fragmentation makes it challenging to sift through and find the type of patterns that can direct how a retailer changes their customer experience to respond to specific needs and expectations described within the data. A blockchain platform collects data from across the supply chain. Then, it uses machine learning to add structure to the information.

As mega-chains aim to reduce stock-outs and have their shelves full at all times, the situation results in significant inefficiencies. Blockchain ensures supply chain and logistics data remains authentic and secure. Examples of blockchain inventory and supply chain management systems include those developed and launched by IBM, Microsoft, and Mojix. 

And blockchain can shut down the chances of receiving fake merchandise. The technology tracks and verifies a product’s entire lifecycle. That means there is no way that a fraudulent distributor can get their fake items past a retailer that uses a blockchain platform for its merchandise. RW

F&B – Small Brands Are Taking a Thousand Little Bites Out of Campbell’s Business

As Americans become more adventurous with the grocery cart, food aisles are undergoing a transformation. But the disrupters in food are more likely to look like a guy at the farmers market selling some unique recipe from the bed of a pickup—and this presents a unique challenge to publicly traded giants struggling to cope in an era where buying mainstream grub is increasingly passé.

The creativity struggle transcends the food business as a number of consumer-product giants are fending off the little guys on everything from razors to laundry detergent. Procter & Gamble Co. has been under pressure from investor Nelson Peltz to look to smaller, niche brands, which he thinks represent the future of the consumer business. Dove soap maker Unilever PLC, outfoxed by more nimble rivals, has decided to imitate smaller competitors rather than swim against the tide.

In some instances, Big Food is responding: Hershey Co. recently bought Amplify Snack Brands, maker of chic and healthy SkinnyPop, for $1.6 billion; Mondelez International this month bought Tate’s Bake Shop, paying $500 million for a Long Island-based company known for thin crispy cookies. WSJ

Cannabis – The Looming Canadian Cannabis Shortage

While many Canadians are ready to make legal cannabis purchases, it appears that the industry will be slow to ramp up. A new distribution network that won’t be fully ready and limited inventory in the vaults of the producers suggests that there will be a large initial imbalance between supply and demand. There are likely to be few stores open in the provinces, but the bigger issue is that the supply of cannabis is likely to fall short of demand. With the exception of Canopy Growth, most LPs have very limited inventory.

Cannabis supply will be increasing as producers continue to scale up and add new facilities and as additional applicants become licensed. While Canada may look like Colorado back in 2014 when it moved beyond medical-only, it’s important to remember that there are relatively few large-scale cannabis producers in Canada today, and it will likely take time for even these to fully ramp up their production. Investors should monitor the upcoming reports from Canopy Growth, Hydropothecary and MedReleaf in June to reassess the near-term outlook for available cannabis, but it seems clear that Canadian cannabis stores will likely struggle initially with stocking levels. NCV

Cannabis – Canadian Marijuana Demand to Hit 1 Million Kilograms by the End of 2018

Most provincial estimates and Wall Street reports have called for approximately 800,000 kilograms of domestic annual demand. Health Canada projects that domestic demand will be notably higher – 1 million kilograms (2.2 million pounds) by the end of 2018, or approximately 25% higher than most consensus estimates. With production in April tallying around 300,000 kilograms countrywide, this implies a supply deficit of about 700,000 kilograms of dried cannabis.

However, given the rapid expansion of the top seven growers, as well as the mid-tier players, it’s not out of the question that production capacity by the end of 2020 could hit 2.3 million to 2.4 million kilograms on an annualized run rate. Even if domestic demand in Canada ebbs higher in 2019 and 2020, production looks to outpace demand by as much as 1.3 million kilograms.

What happens to this excess dried cannabis? The belief is that it’ll be exported to foreign markets where medical marijuana is legal. However, not all countries have opened their arms to dried cannabis, even if medical weed is legal. As such, one of the smartest moves Canadian growers can make is in altering their production to include a higher percentage of oils and extracts.

Though no one knows exactly how the supply and demand picture will play out in Canada, there is serious concern about the possibility of a cannabis glut wrecking growers’ margins beginning in 2020. TMF

Cannabis – Here’s How Much Marijuana Costs in the United States vs Canada

Across dispensaries in the United States, the price of an eighth of marijuana is $40.0, compared to $27.9 in Canada, where it is 30% cheaper. When you look at different cities, the price differential can be even more pronounced. Legal marijuana is 39% cheaper in Vancouver than San Francisco, for example.

Part of the reason cannabis is so much cheaper in Canada than the United States is there is a much longer history of legalization in Canada, and thus a larger supply of legal marijuana growers and sellers. While cannabis companies in the United States can’t even have bank accounts, in Canada there are publicly traded cannabis companies on the stock market. In anticipation of nationwide legalization this year, supply of marijuana continues to grow.

San Francisco, a city which wins a lot of these “most expensive awards” (toast, real estate, coffee, etc), also has the most expensive marijuana of all the cities we looked at. In San Francisco, an eighth of an ounce of weed is 12% more expensive than in Seattle and 20% more expensive than in Los Angeles.

So, it turns out marijuana is about 30% cheaper in Canada than the United States. Cheaper because there has been a longer history of a legal supply of weed.  With marijuana, as with most things, when the supply is high, the prices are not. Forbes

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Cannabis – U.S. Attorney: Oregon has a major marijuana overproduction issue

The black market for marijuana is thriving in Oregon and an oversupply of weed from growers is flowing to more than two dozen states where pot remains illegal.

U.S. Attorney Billy Williams said the state has a “significant overproduction” problem and that he would prioritize enforcement of overproduction, interstate trafficking, organized crime and cases involving underage marijuana use and environmental damage from illicit pot farms. The comments, which echoed those he made earlier this year, were included in a memo that outlines his plans for enforcing federal drug laws in a state with legalized marijuana. Those in the marijuana industry reacted with cautious optimism to the memo and said it didn’t seem to change federal marijuana policy in Oregon.

The state currently has nearly 1 million pounds of marijuana flower in inventory, a staggering amount for a state with a population of 4.1 million people. That doesn’t include 350,000 pounds of marijuana edibles, tinctures and concentrates. The retail price for a gram of pot has fallen about 50 percent since 2015, from $14 to $7. Legal growers and retailers alike have felt the sting.

Oregon has 21 million square feet of legal marijuana growing and a $1 billion market statewide. Of that, about one-third — or about $300 million — is diverted to the illegal market within the state, but it is not clear how much is leaving Oregon. Columbian