Raymond James: Here’s why pot stocks could rebound

There’s good news at last for the cannabis industry, says Raymond James analyst Rahul Sarugaser who thinks pot stocks should get a bounce at some point from the Ontario government’s new approach to retail.

In an update to clients on Friday, Sarugaser said that influx of new licenses and other measures will eventually relieve the current over-supply issue faced by Canada’s pot producers.

Last week, the Alcohol and Gaming Commission of Ontario announced changes to its much-criticized cannabis retail lottery system which has so far seen just 24 stores open across Canada’s largest province along with a further issue of 42 licenses distributed in a second lottery which should have more stores open this month.

The province will move to “a more open market for retail cannabis,” one which will do away with the lottery approach and have prospective retailers undergo screening and training by provincial regulators prior to having their applications accepted. The goal will be to have about 20 store licenses issued per month, with regulators now allowing operators to own up to ten stores, a number which will increase to 30 by September of 2020 and then to 75 by September of 2021. Licensed producers will also be allowed to participate in the market and to open up a shop at their respective production facilities.

“In response to the federal government’s decision to legalize cannabis, our government is determined to open the cannabis market as responsibly as possible,” said Attorney General Doug Downey. “We have said all along that opening more legal stores is the most effective way to combat the illicit market, protect our kids and keep our communities safe. That is our number one priority.”

Sarugaser said it’ll take some time before the widening of Ontario’s market will show its effects in quarterly numbers for Canada’s LPs, many of whom had revenues drop as a result of a slower-than-expected roll-out of retail across the country.

“This is positive news that we expect to be well-received by the market,” wrote Sarugaser. “It is important to note, however, that we expect this system-opening to only begin relieving Ontario’s sales bottleneck during the back half, or even last quarter, of 2020. Also in 2H20, we will be seeing the first full quarters of Cannabis 2.0 revenue appearing in LPs’ earnings: a confluence of events that—in the back half of 2020—we believe will serve to breathe new life into this battered industry.”

In addition, Sarugaser pointed to licensed producer Organigram Holdings (Organigram Holdings Stock Quote, Chart, News TSX:OGI), which last week received a number of license approvals from Health Canada including approval for cannabis operations in its chocolate production line, part of the newly-opened cannabis derivatives market.

The approvals will allow OGI to operate 16 additional grow rooms and will likely increase OGI’s capacity to about 89,000 kg per year from about 76,000 kg per year, still in line with Sarugaser’s expectations for the company but a material regulatory de-risking for the company, nonetheless.

Sarugaser said that Cannabis 2.0 production is “firmly within OGI’s wheelhouse” but is at the same time “well beyond the capabilities of some of its peers,” intimating that the emergence of derivatives will further differentiate the cannabis sector.

“We expect 2020 to be a transformative year—positively so—for strong cannabis operators like OGI, and a very, very difficult one for operators that have not yet differentiated themselves on the bases of high-efficiency, low-cost manufacturing processes and technology-driven product innovation,” said Sarugaser.