Canadian Cannabis Sales Are Lagging - Here Is Why

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Includes: ACB, APHA, CGC, CRON, HEXO, HMLSF, MJ, TLRY
by: Jonathan Cooper
Summary

Canadian recreational cannabis sales have been flat since November.

The Globe & Mail explains this is due to a shortage of cannabis stores, pointing to Colorado's slightly higher stores per capita.

They are correct there is a retail store shortage, but stores per land area is much better correlated with cannabis sales per capita.

Canada's best-selling province, PEI, has one-third as many stores per square kilometer as Colorado - and one-third the sales per capita.

Canadian sales should begin to improve in April results, after Ontario opens its first retail stores.

All currencies herein are Canadian dollars.

Flat Recreational Cannabis Sales

Canadian recreational cannabis sales have been flat for four months.

Note: Canada legalized recreational cannabis on October 17, 2018. Because October was a shortened month, annualized sales are much higher despite flat sales in dollar totals.

Canadian recreational cannabis sales have been flat since November.

Each month, Stats Canada releases retail sales data across Canada for a wide variety of sectors including retail cannabis sales. Nationally, Canadians purchased $49.9 million of cannabis in February, down 9% from $54.9 million in January.

On an annualized basis, sales increased 1% from $646 million in January to $650 million in February. Annualized sales have been relatively stable since November 2018.

Analysts expected Canada to sell $4.3 billion of recreational cannabis. That has not happened.

Source: Deloitte.

On a per capita basis, Canadians are spending about $17 per year on recreational cannabis. This is far short of projections from Deloitte prior to legalization, which suggested up to $1.8 to $4.3 billion in legal recreational cannabis sales in 2019. Even the low end of that range looks out of reach through February, although results should improve by April due to the launch of retail cannabis stores in Ontario, Canada's largest province.

A Lack of Stores

"'Canada needs more brick-and-mortar retail stores,' AltaCorp said. Cannabis sales growth has been 'weak,' the firm added, and it attributes a big part of that to the 'lack of physical retailers across the country.'

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'The legal recreational cannabis market in Canada is in its infancy, and as such, a significant number of consumers will likely be first-time users without much knowledge of the different products and their effects,' the firm said.

'A well-developed retail platform allows customers to interact with knowledgeable staff and provide them with a holistic customer experience, which is essential to attracting first-time and existing users to the legal recreational channels.'"

"Canada ‘needs more’ cannabis stores. These charts prove it", The Globe & Mail, May 3, 2019

Why have sales been so sluggish compared to expectations? The Globe and Mail, one of Canada's leading newspapers, points the finger at Canada's lack of cannabis stores.

Colorado has far more stores per population than Canada does.

Altacorp specifically compared Canadian cannabis store density to that of Colorado, finding that Colorado has about 7.6x more cannabis stores per capita than even the number of planned stores in Canada - much less the number of stores already open.

Sales Per Province

Canadian provinces have shown very different sales per capita.

Given the provincial variation in store counts, it may be instructive to look at Canadian sales on a more granular level, by province. Above are Canadian cannabis sales per capita, annualized from February, for each Canadian province and territory.

No data is available for Nunavut. This is likely because Canopy Growth's (CGC) online Tweed store is the only source for cannabis in the thinly-populated territory. It is probable that those sales are being counted as Ontario sales (where Canopy Growth is located). Given Nunavut's small population, this is little more than a rounding error.

We can compare these sales/capita to Altacorp's stores/capita to test whether Altacorp is correct that a store shortage is correlated to low Canadian cannabis sales.

Sales per capita is only loosely correlated with stores per 100,000 residents. Excluding Colorado results, based on data from the State of Colorado, these results show a positive relationship between stores per capita and sales per capita. However, this relationship is quite weak: In statistical terms, there is a 20% positive correlation of an r-squared value of 4%.

Specifically, the positive outliers in the above graph appear to be Prince Edward Island and Nova Scotia, two small Atlantic Canadian provinces which look to be generating more sales than their relatively modest store density would suggest. Conversely, Canada's largest provinces including British Columbia, Quebec, and Saskatchewan appear to be generating relatively few sales per capita for their store count.

We can improve this correlation significantly by graphing cannabis stores by land area rather than using population:

Sales per capita is strongly correlated with stores per land area.

Cannabis stores per land area is much better correlated with observed retail sales than cannabis stores per capita. Here, there is a correlation of 90% and an r-squared of 81%. Looking at the graph, each of the provincial data-points are much closer to the overall trendline, whereas in the prior graph, data points were spread much further from the trendline.

The rationale here is simple. Outside of the Maritimes, Canadian provinces are large. In Prince Edward Island, Canada's smallest province, anyone on the island could get to one of the province's four cannabis stores in fewer than 60 kilometers. In contract, British Columbia has 22 legal recreational cannabis stores. But residents of Prince George, the largest city in Northern British Columbia, would have to travel over 400 kilometers to the nearest legal cannabis store.

Implications

Colorado has far more stores per land area than Canada - 3x more than even Canadas best province.

Canadian cannabis sales will continue to lag behind those of legal U.S. markets until provinces and territories license dramatically more cannabis stores.

In Colorado, there are more than 200 cannabis stores per 100,000 square kilometers of land area and Colorado sells approximately $285/capita of recreational cannabis (based on U$215/capita of recreational sales and U$59/capita of medical sales). It is unlikely that Canada would match Colorado's sales per capita due to several factors, including Colorado's less-restrictive cannabis laws (legal edibles and vape pens), lower cannabis prices, and higher GDP/capita.

However, even at current cannabis prices and current legality, Canada does not have nearly enough cannabis stores. Even Prince Edward Island, which leads Canada in both store density (70 per 100,000 km2) and sales per capita ($91/capita, excluding the territories), has only one-third as many stores per square kilometer as Colorado, and roughly one-third the sales per capita as well.

In my view, a lack of retail cannabis stores is the single biggest factors holding back the Canadian cannabis industry and cannabis industry sales will track new store openings.

Ontario began opening its first stores in April. One estimate suggested that adding 25 retail stores in Ontario could add $31 million per month in cannabis retail sales. If true, that could increase Canadian recreational cannabis sales by about 60%. Stats Canada's results for April 2019 will show the initial impact of these first Ontario retail stores. Those results will be released in mid-to-late June.

Until Canadian provinces open more cannabis stores, we are likely to see slow growth in Canadian recreational cannabis. Aphria's (APHA) poor results in the February quarter (as I covered previously) were perhaps the first indication of that, and other Canadian cannabis producers are likely to see ~flat recreational cannabis sales until this store shortage is rectified.

Happy investing!

Disclosure: I am/we are long CGC, HEXO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.