Canada needs to double its pot shops, analyst says

Does Canada have enough pot shops?

With a forecasted $6.4 billion in adult-use sales expected by 2024, the Canadian cannabis sector is sorely underserved by the current retail market, says Echelon Wealth Partners analyst Matthew Pallotta.

In a report delivered on Thursday the analyst argued that investors should be thinking about retail and retail infrastructure as one of the more attractive opportunities in the Canadian cannabis market. In truth, Pallotta says, Canada should be able to support two to four times the current number of pot outlets.

The cannabis sector was rocked on Thursday by news from Canadian licensed producer HEXO Corp that sales figures for both its upcoming quarter and fiscal year would likely be lower than previously expected. The news dropped pot stocks across the board by high single and low double digits, pulling many to levels not seen since 2017.

HEXO management blamed the drop in revenue on a delay in the federal rollout of cannabis edibles and derivatives (set to be on store shelves by December at the earliest), early signs of pricing pressure and on slower-than-anticipated store rollouts across the country.

The lack of expansion on the retail end is, Pallotta argues, likely the single-most significant factor limiting the growth of Canada’s pot sector, as not enough brick-and-mortar stores are available to service customer demand.

Billions into pot, not enough into Canadian pot shops…

“Over the past five years, billions of dollars in capital have been invested by Canadian cannabis businesses in building out the cultivation and manufacturing infrastructure to support the production of legal cannabis products in the country,” writes Pallotta.

“Until very recently, there had been virtually no capital invested into the building of retail and distribution infrastructure to support the legal adult-use market, which remains woefully underdeveloped today, and wholly inadequate to service Canadian cannabis consumers,” he says.

Pallotta says that while the so-far sluggish start to adult-use cannabis could in the earlier days be pinned on supply chain issues, where Canadian licensed producers were struggling to scale up fast enough to meet demand, the problem now has more to do with the retail end where the provinces have done a mostly poor job across the board at providing good product selection and adequate store penetration to satisfy market needs, to support consumer education through retail exposure and ultimately to help bring users in from the black market, which is still where a majority of Canadians are sourcing their cannabis.

“With just about 720 dispensaries licensed today, and not all of them in operation, the market currently has approximately one licensed store per every ~42K adult citizens nationally,” writes Pallotta.

“We estimate that a fair point of balance between attractive economics for retailers and adequate service to Canadian consumer demand for cannabis would suggest this figure should end up in a range between 10-20K adult residents per dispensary, or between 2-4x the current number of dispensaries,” he says.

Pallotta says that investors should be looking at the retail end of cannabis, where companies like National Access Cannabis, Fire & Flower Holdings and Alcanna are already bringing in sales numbers that rival those of the licensed producers such as Aphria and Tilray whose market caps are many times higher than the retailers.

“The retail vertical offers one of the fastest routes to generating a return on capital for businesses, and consequently, investors in the cannabis space. The relative capital intensity and speed at which that capital can be turned over is much greater for the retail business than the licensed producers who are manufacturing and marketing products,” Pallotta writes.