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business briefing

Briefing highlights

  • Outlook for legal marijuana
  • Aurora to acquire MedReleaf
  • Markets at a glance
  • What to expect in CREA report
  • What else to watch for this week
  • Brookfield eyes Australia’s HealthScope

The marijuana market

Who’d have thought, in around 1972 when some of your school acquaintances may have been getting busted, that in 2018 we’d be talking about the outlook for EBITDA among producers and sellers of legal marijuana.

Even those who later ventured into financial services and accounting probably didn’t think they’d see the day when they were analyzing pot stocks and projecting earnings before interest taxes, depreciation and amortization.

(Just the word amortization might have made them giggle.)

But here we are, decades later, with Canada’s Liberal government aiming for legalization this summer, with a strong outlook for a new marijuana industry.

Just consider the fact that a recent report from CIBC World Markets came under the subject of “consumer staples” as it studied everything from producers and retailers to prices and tax revenues.

And the conclusion, from CIBC analyst John Zamparo, is that Canada is looking at “a legitimate industry” ripe for the taking.

“We believe that, by 2020, the legal market for adult-use cannabis will approach $6.5-billion in retail sales,” Mr. Zamparo said.

“For context, this is greater than the amount of spirits sold in this country, and approaches wine in scale,” he added.

“We believe the provinces will be the greatest winners from legalization, but the shift from the black market will be a boon to private enterprise, as well. As part of the shadow economy becomes legitimate business, we estimate private firms will generate nearly $1-billion in EBITDA.”

Some of Mr. Zamparo’s findings:


Production should represent more than 85 per cent of that EBITDA by 2020, with the rest “coming from retailing — largely in western Canada.”

While provincial governments “may claim otherwise, they are the big winners of legalization, with income estimated at more than $3-billion either in profits or tax take.

Consistent with the development of other transformational industries in history, we believe that while many players currently exist, only a select few will become industry titans.”


Citing Statistics Canada data, CIBC noted that almost five million Canadians spent more than $5.5-billion on medical and non-medical marijuana last year.

Consumption is believed to have increased by 5 per cent a year since the early 1960s, eclipsing “population growth by nearly 400 basis points.”

The legal market will top 800,000 kg., worth $6.8-billion by 2020, 95 per cent of it for adult recreational use.


To start with, prices are now at their lowest since 1981, Mr. Zamparo said.

Expect the provinces to be “bold,” looking at a 55-per-cent markup, or a 35-per-cent margin, to what they pay to producers.

Some other math: Retailers could see gross margins of about 30 per cent at an average $8 a gram. Add in harmonized sales taxes, assumed at 13 per cent, and excise tax of $1, and you’re looking at slightly more than $10 a gram. (Talk about the man.)


“The provinces will hold all the cards when it comes to distribution,” Mr. Zamparo said.

“This ostensibly is to safeguard product quality and security, which are reasonable enough goals,” he added.

“But it also provides the benefit of ensuring a significant level of profits flow to the provinces. In fact, we estimate that provincial governments will capture a stunning 70 per cent of industry profits.”

Mr. Zamparo calculated that a legal pot market of about $6.5-billion a year would bring the federal government its maximum take of $100-million, with provincial governments grabbing “a stunning $700-million from excise taxes alone.”

Add in sales taxes, assumed at 13 per cent, and Ottawa is looking at $300-million more, and the provinces and at an additional $500-million.


Producers will break down along the lines of “haves” and “have-nots,” and “those with product ready to go, production capacity already built, and supply arrangements in hand can jump out to a sizable lead, in our opinion.”

Capacity among existing producers is now about 350,000 kg. a year, with the country’s six biggest companies controlling more than 90 per cent.

“This is more than enough to supply the current medical demand, but it’s also nowhere near enough to supply an adult-use market.”

But, when you look further out, we could be looking at more than 1 million kg., which is more than will be needed.

“In fact, even if the market share of illicit dealers goes to zero, the current plans in place will vastly exceed demand,” Mr. Zamparo said.

“This suggests two critical questions that investors must ask,” he added.

“First, when assessing [licenced producers’] plans, how quickly will current expansion arrangements be executed? And, second, will investors still fund future development proposals once sufficient capacity exists and distribution channels are already filled?”

It’s “reasonable” to assume licenced producers could see a 60-per-cent gross margin, or a product markup of 140 per cent.


Some retailers could choose to link up with producers — did anyone think back then they’d be discussing vertical integration — though that may be hampered by the regulatory regime.

“Retailers will have materially less profit available to them than in a vertically integrated world, as the provinces can essentially set a ceiling on the retailers’ EBITDA margins through the wholesale model in which cost-of-goods pricing is regulated,” Mr. Zamparo said.

“That said, stores are relatively inexpensive to build, licences are in limited supply, and manageable operating costs still make this an attractive business to be in, with potential after-tax returns on capital of 20 per cent.”


This bit’s from analysts Matt Bottomley and Neil Maruoka of Canaccord Genuity, which built its own index to track the fortunes of publicly listed companies:

Valuations among those companies “took a slight dip” in April, down 6.3 per cent after a so-so March. That brought the loss from an early January high to more than 28 per cent.

“During April, many licenced producers reported quarterly earnings (with varied results) and operational updates that highlighted continued penetration into Canada’s medical market and progression on what appears to be a growing number of expansion plans throughout the country,” Mr. Bottomley and Mr. Maruoka said.

“However, to kick off the month of May, speculation surrounding potential M&A activity and consolidation in advance of recreational legalization has resulted in upward momentum to industry valuations, particularly for licenced producers with moderate capacity and relatively cheaper valuations that could be considered attractive to larger cap producers.”

Indeed, added CIBC’s Mr. Zamparo, merger and acquisition activity “will likely continue at a frenetic pace, as producers flush with cash look to quickly increase capacity or to acquire medical expertise, distribution channels or international exposure.”

Mr. Bottomley and Mr. Maruoka believe that “sector multiple expansion” could pick up soon given expected developments, including legislative approval, and the potential for more consolidation.

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Aurora strikes MedReleaf deal

And on that note, consolidation in the marijuana sector is indeed picking up steam, with a deal today between Aurora Cannabis Inc. and MedReleaf Corp.

Aurora struck an all-stock deal it valued at about $3.2-billion for rival MedReleaf, saying its offer implied $29.44 a share.

“The proposed transaction brings together two of Canada’s premier cannabis companies with fully aligned strategic visions and production philosophies, as well as complementary assets, distribution networks, products and capabilities,” the companies said in a statement.

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Markets at a glance

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What to watch for this week

Call it Goldilocks and the three housing bears, because bearish is what Tuesday’s report on home sales and prices will be.

If you own your home, it will be too cold. If you’re looking to buy, it might still be too hot. But if you’re a Canadian policy maker, it should be just right and, maybe, you can live happily ever after.

The Canadian Real Estate Association is expected to report that national sales and prices suffered hefty declines in the wicked month of April, though the drops should be less severe than in March.

“The overall picture will continue to look weak,” said Bank of Montreal senior economist Robert Kavcic.

Canada’s housing markets have been adjusting to measures meant to cool them down, from taxes on foreign buyers, aimed at Vancouver and Toronto, to new mortgage-qualification rules from the Office of the Superintendent of Financial Institutions, the bank regulator.

There have been other measures in British Columbia and Ontario, as well.

Having already seen some local reports, Mr. Kavcic expects CREA’s latest reading to show a 15-per-cent drop in national sales and a 7-per-cent decline in the average price. Those would follow drops of almost 23 per cent and 10.5 per cent, respectively, in March.

The MLS home price index, considered a better measure, should still show a rise, though of just 2 per cent from a year earlier, compared to the March gain of 4.6 per cent, Mr. Kavcic said.

While April’s report should be stronger than that of a month earlier, it will still suggest “soggy underlying conditions in the wake of new OSFI rules, Bank of Canada rate hikes and some provincial policy measures,” he added, citing Toronto’s April sales plunge of 32 per cent from a year earlier, and the 5.2-per-cent decline in benchmark prices for the worst showing since the recession.

“Vancouver sales fell 27 per cent year over year and, in both markets, we continue to see pronounced weakness at the higher end (versus strength in condos),” Mr. Kavcic said.

“Elsewhere, the picture is mixed, with Calgary and Edmonton very sluggish, while Ottawa and Montreal are still seeing markets tighten and prices accelerate.”

Home sales are feeling the impact of the new mortgage-qualification rules, which stress-test buyers as to what they can handle.

“Stress-testing ensures that when interest rates rise at the end of the first five-year period of a variable rate mortgage, homeowners can still afford their mortgage,” said Moody’s Analytics economist Thomas Nichols.

“This helps prevent mass foreclosures and a housing market crash,” he added, noting Canada’s exceptionally high ratio of household credit to disposable income.

“In an environment of rising rates and high leverage, Canadian regulators are wise to discourage lending.”

As for Goldilocks and fairy tales, there’s more than just home prices this week. NAFTA negotiators, for example, are scrambling against a congressional deadline, and there are still some quarterly corporate results to come.

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That would be the S&P/TSX Composite Index, which has lagged its peers, though shares of energy companies have gained on the rise in oil prices. So we’ll see how markets open the week.

The S&P 500 gained almost 2.5 per cent last week as the index “broke comfortably above its 50-day moving average, and looks to have forged an upward path out of the tight range it had been consolidating in since early in the year,” BMO’s Mr. Kavcic said.

However, higher oil prices “have done little to help relative TSX performance,” Mr. Kavcic said.

“To be fair, Canadian energy stocks are up roughly 7 per cent in the past month, almost matching their U.S. counterparts as the best performing sector in North America,” he added.

“But, they’re still down about 5 per cent from a year ago. Pipeline capacity concerns probably haven’t helped; and we’ve also seen strength in areas such as technology and consumer discretionary, sectors that are well underrepresented in the Canadian index.”

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Everyone on the Ontario election campaign trail will be watching for Hydro One’s financial results, given the controversy over chief executive officer Mayo Schmidt’s golden compensation.

Hydro One chief executive officer Mayo SchmidtChristopher Katsarov/The Globe and Mail

The Liberals, whose government owns a big chunk of the utility, oppose the $6.2-million 2017 pay package, while Conservative Leader Doug Ford has threatened to fire the board.

Also worth watching will be the second reading of economic growth in the euro zone, the April report on U.S. retail sales, and other quarterly results from the likes of Linamar Corp., Park Lawn Corp. and others.

Economists believe U.S. retail sales rose 0.3 per cent or 0.4 per cent from March.

“Even though consumer spending growth slowed dramatically in the first quarter, that was partly due to the fact that Q4 was flattered by replacement spending following hurricanes,” Andrew Grantham of CIBC World Markets said.

“With disposable incomes getting a boost from tax reform and solid job creation, we expect consumer spending to accelerate again in Q2 and maintain decent momentum later in the year, as well.”

Also on tap are some indicators from China.

“We think that industrial production growth picked up in April, as the government’s pollution controls were removed altogether at the end of March,” Chang Liu of Capital Economics said.

“By contrast, slower infrastructure spending probably dragged down fixed investment growth. Retail sales growth probably slowed a touch, too, given the recent softening in consumer confidence.”

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Let’s see how Park Lawn stock opens after Tuesday’s post-market earnings. Because, you know, it’s not often you get to see an undertaker’s profit report. Park Lawn’s U.S. peers have already reported.

Statistics Canada, meanwhile, is set to release a report expected to show manufacturing sales rose about 0.5 per cent in March.

“That would build on a 1.9-per-cent jump in February that more than retraced a big 1.3-per-cent drop in January,” Royal Bank of Canada economists said in a lookahead.

Markets will also be watching for Japan’s report on first-quarter economic growth.

“We think that the preliminary estimate of Q1 GDP (Wednesday) will reveal a small fall, but the economy should rebound this quarter,” said Marcel Thieliant of Capital Economics.

“Meanwhile, consumer prices (Friday) are likely to show a broad-based moderation in price pressures in April.”


(Or, if you prefer, Mexican Economy Minister Ildefonso Guajardo as Hansel, Foreign Affairs Minister Chrystia Freeland as Gretel, and U.S. Trade Representative Robert Lighthizer as the wicked witch. And, for good measure, U.S. President Donald Trump as Pinocchio since, by his own admission, he made up trade facts in a meeting with Prime Minister Justin Trudeau.)

Chrystia Freeland, Idelfonso Guajardo and Robert LighthizerEdgard Garrido/Reuters

Officials renegotiating the North American free-trade agreement may well need a genie given that, as The Globe and Mail’s Adrian Morrow and Greg Keenan report, they’re deadlocked on auto sector issues.

And U.S. House Speaker Paul Ryan has warned that there wouldn’t be enough time for Congress to vote on a new NAFTA if it’s not done by May 17.

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Observers expect to see stable April inflation from Statistics Canada, and just a tiny pickup in March retail sales, given how the housing slowdown has affected building materials.

“Canadian consumer spending has simmered down, and the March retail report will likely reinforce that theme,” said BMO’s Mr. Kavcic.

“Auto sales volumes and prices both dipped in the month (seasonally adjusted), but gas prices rose modestly,” he added.

“Elsewhere, resale housing weakness could continue to dampen furniture and building material spending. Look for total retail sales to edge up 0.1 per cent, or a slightly firmer 0.3 per cent excluding autos.”

Annual inflation, in turn, is expected to come in at between 2.2 and 2.4 per cent, compared to the March level of 2.3 per cent.

“Looking ahead, with gasoline prices likely to rise into the summer, we expect headline inflation to continue to firm and peak at 2.7 per cent, year over year, in June,” said Toronto-Dominion Bank economists.

“This trajectory reflects relatively stable core inflation near 2 per cent, reinforcing the view that inflation remains in check.”

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