By CHRISTINA PELLEGRINI
Thursday, April 12, 2018
Canada's two largest provinces revealed more about how they plan to buy and sell cannabis, sending pot stocks higher as investors get a better sense of future revenue.
New details emerged on Wednesday about the six previously announced supply agreements signed by Quebec, as Ontario made public its processes for procuring cannabis for recreational use.
The Quebec news lifted shares of the suppliers, including The Hydropothecary Corp., whose shares rose by 13 per cent to $4.02. The company said in a news release that it expects to sell about 200,000 kilograms of cannabis in Quebec's recreational market during the next five years.
The deal could be worth $1-billion in revenue for Hydropothecary.
MedReleaf Corp., another cannabis grower that has sealed a deal with Quebec, rose 7.5 per cent.
Hydropothecary is a Gatineau-based grower of medical cannabis. The company's stock is listed on the TSX Venture Exchange and has a market capitalization of $722-million. In its last year, it generated $4-million in sales to patients.
Sébastien St-Louis, chief executive officer, says the company can produce 4,000 kg of cannabis annually today but that will increase as it expands its production facilities, rising to 25,000 kg in mid-May and 108,000 kg by December.
In the first 12 months, Hydropothecary says it will supply 20,000 kg of mostly cannabis flower and some oil products to the Société des alcools du Québec (SAQ), the provincial retailer of alcohol that will also oversee cannabis sales. Quebec has also signed supply agreements with five other Canadian marijuana growers for three-year terms, securing a total of 56,000 kg in product in the initial year that will be sold online and in 20 stores.
But a spokesman for the SAQ in Quebec noted that the government doesn't "have the contractual obligation to buy the quantities."
"The quantities that have been agreed on are what the producers are making available to us," said Mathieu Gaudreault, a spokesman for the SAQ. "We have, in no way, a deal to buy that amount. We can buy that amount, but we haven't bought it yet. It will depend on demand."
Hydropothecary says the SAQ has already placed an order for the first three months of sales for 63 different products, of which 80 per cent is in the form of dried flower.
The company said that it will generate weighted average sales of $5.40 per gram from the contract, minus the $1 per gram in expected tax. It expects to lower its all-in costs to produce a gram of weed to about $2.
Mr. St-Louis said he thinks other Canadian producers are trying to be more aggressive with their pricing, given that product shortages are expected in the early days of the legal program, but Hydropothecary isn't.
"We made a commitment to the province of Quebec to say that we're going to supply and we're not going to play games around trying to shorten or squeeze our supply to raise our prices," Mr. St-Louis said Wednesday in a phone interview. "That's one of the reasons why we were chosen as preferred supplier.
That's why we have the longest deal, that's why we have the largest deal because we came at it from a position of trying to be a partner."
He's expecting Quebec to sell a gram of cannabis for between $7 and $8 in order to compete with the illicit market, which analysts estimate to be worth about $1.5-billion a year. He said that Quebec is aiming to convert 35 per cent of the illegal sales to legal ones in the first year, 45 per cent in the second and 55 per cent in the third.
Mr. St-Louis said that the SAQ's first-year agreement to buy 20,000 kg is "guaranteed."
But Mr. Gaudreault disagreed.
"This is a soft deal," he said. "We have the possibility to buy up to 20,000 kg from Hydropothecary.
In this commercial agreement, we haven't stated that we're going to buy all that quantity. It's a possibility, but it's not an obligation."
In its news release, Hydropothecary said it expects to supply the SAQ with 35,000 kg of cannabis in the second year of the program and 45,000 kg in the third.
"Year two, if we get outsized penetration of the black market, maybe that number turns into 40 tonnes," said Mr. St-Louis.
(1,000 kg is equal to 1 tonne.)
"If we get no penetration of the black market and nothing is moving off the shelves in year two, then the government is not obligated to buy that product. In that sense, it's not guaranteed. If the future happens the way we think it'll happen, then the government is buying 35 tonnes."
He said that the Quebec government is estimating that about 70 per cent of recreational cannabis sales in the province will occur at one of its retail stores.
Mr. St-Louis believes online sales will be a much bigger part of the market than the 30 per cent that Quebec is projecting.
Mr. St-Louis said Hydropothecary is working with Montreal ad agency Sid Lee to create a new brand for the recreational market. He added that the company is in talks with Bank of Montreal and Canadian Imperial Bank of Commerce for banking and capital markets.
Also on Wednesday, the Liquor Control Board of Ontario (LCBO) clarified the process for growers seeking to supply the province with cannabis and cannabis accessories.
In what it describes as "an open and transparent procurement process," Ontario said that it expects to request product submissions twice a year. The province says the term of its agreements with suppliers will be for two years and can possibly be extended for two more years.
Applications for the first round are due May 2.
The LCBO also said that the first Ontario Cannabis Store locations will be in Guelph, Kingston, Toronto and Thunder Bay.
A worker pushes a cart of marijuana plants at Canopy Growth's facility in Smiths Falls, Ont. Last week, Beacon Securities upgraded its recommendation on Canopy to 'buy' from 'hold.'
Hydropothecary workers handle product at a company facility. The cannabis grower's CEO says it can produce 4,000 kg of cannabis annually today but that will increase as it expands its production facilities, rising to 25,000 kg in mid-May and 108,000 kg by December.