The first 12 months of cannabis legalization in Canada have seen scandals, struggles, and shortages dominate the headlines, with pot stocks across the board correcting from overvaluations or shrinking off the back of internal issues and underwhelming consumer demand. Legalization 2.0 comes into effect October 17, and cannabis companies throughout Canada are hoping it will provide the catalyst that the industry needs to finally live up to the pre-legal hype.
What is Legalization 2.0?
In October 2018, Canada made history by officially legalizing the sale of cannabis for recreational use across the country. However, the legislation was not all-encompassing and was instead split into two parts. The first wave of legalization only accounted for dried cannabis flower, cannabis oil, and sublingual sprays. This means that many highly sought after alternatives such as edibles, infused beverages, and vapes were still technically illegal for the first year.
The second wave of legalization comes into effect October 17, 2019, in Canada, exactly one year on from the first, but consumers will have to wait a little bit longer for these popular derivatives to hit shelves. October 17 marks the first day in which cannabis companies can file the necessary paperwork to begin selling these products, a process that will take about 60 days, meaning edibles, vapes, and all the rest should be in stores just before Christmas.
Deloitte estimates in a recent report that the second wave of cannabis legalization will open a $2.7 billion CAD market in Canada, with cannabis-extract-based products, including edibles, accounting for about $1.6 billion CAD.
How is it Going to Impact Stocks?
The struggles of the Canadian cannabis industry during its freshman year are no secret. Companies originally viewed as industry leaders have tanked under the weight of expectation or been involved in a mire of scandal, or both. For example, Canopy Growth (TSX:WEED) (NYSE:CGC), the largest cannabis company in the world, saw over 60% of its value wiped out in 2019 after the very high-profile dismissal of its founder and pot stock pioneer, Bruce Linton. Elsewhere, CannTrust (TSX:TRST) (NYSE:CTST) lost 86% and its cultivation licenses in another prominent scandal.
Cannabis indexes sunk to their lowest post-legalization point last week after HEXO Corp (TSX:HEXO) (NYSE:HEXO) withdrew its guidance for the year, leading to a significant drop off in nearly all pot stocks. For that reason, legalization 2.0 can't come quick enough to the market, but only time will tell if it can provide the major boost that many companies appear to be banking on.
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Which Stocks Should You Look Out For?
The 2.0 market is expected to add up to three million new consumers for cannabis companies to target, so most stocks that have some sort of derivative product line in their portfolio are set to benefit. Naturally, some companies are better positioned to take advantage than others, given the type of product or service they offer or how strong their brand portfolio looks. Let's check out some of the best-placed companies ahead of legalization 2.0:
Valens GroWorks (TSXV:VGW) (OTCQX:VGWCF) is a market leader in the field of cannabis extractions, a service that is set to be at the heart of the 2.0 market given its importance in the production process of cannabis derivatives. The demand for extracts and edibles is actually growing faster than the sector as a whole can keep up with. Valens’ client list boasts some pretty big hitters with Shoppers Drug Mart, HEXO, and Canopy Growth all on the books. With an extraction capacity of over 240,000 kilograms/year, 2020 could be a big year for Valens GroWorks.
Canopy Growth (TSX:WEED) (NYSE:CGC) may have been one of the biggest losers in the first year of legalization, but that doesn't mean it's in a bad place going into year two. Following a major investment from alcoholic drinks giant Constellation Brands (NYSE:STZ) back in 2017, Canopy has put infused beverages at the forefront of its cannabis strategy, a product that is set for huge popularity once made legal. The company plans to market multiple cannabis beverages later this year, including zero calorie and low-calorie drinks.
Canopy Growth also took over a former Hershey's chocolate factory, which will be the center of its operations in the edibles market, with plans to roll out a wide range of infused treats. The company has also backed big on the vapes market, spending a not-insignificant amount on research and development for its line of 15 vape-related products. While the vape crisis may threaten to derail that, Canopy looks to have invested more on broadening its product portfolio than any of its competitors, and that's why it looks like a good bet right now.
The Takeaway
In the long-term, the derivative market will do far more for pot stocks than the flower market did, given the substantially higher margins and access to a consumer base who may never have experienced cannabis. Whether legalization 2.0 can provide the miracle boost, and kick off the "green rush" that many investors expected a year ago, remains to be seen. While stocks may rise in the first few days of the 2.0 market off an initial wave of optimism, it will be when Q1 2020 results start rolling in that we see the real impact.
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