Contrarian Idea: Canadian Cannabis

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I'm probably part of the minority of Canadian investors who haven't been burned on cannabis stocks during the 2017-2019 bubble. I never had any interest in the industry before 2024 because I felt it was a commoditized industry with atrocious pricing dynamics, primarily due to oversupply in the market.

However, last year, I noticed a few companies growing their revenue profitably despite the challenging pricing environment. It got me curious, and I started digging some more…

Industry Overview

The cannabis industry has seen significant consolidation activity in recent years, driven by pricing pressures, regulatory challenges, and capital constraints. Due to a major bubble in 2017-2019 surrounding Canadian cannabis legalization, a significant amount of capital was invested in the sector, leading to overcapacity building and, subsequently, oversupply in the market and collapsing cannabis prices.

From January 2022 to January 2025, approximately 66 companies in the cannabis industry have entered insolvency proceedings in Canada. Of those, only 5 have successfully restructured their operations, while the rest resulted in liquidation (source).

Collapsing cannabis prices have also led to the Canadian excise tax regime becoming highly punitive to industry players. When legalization was passed, the expectation was that cannabis would sell for upwards of $10/gram, and the federal excise tax was introduced at 10% of the selling price or $1/gram, whichever was higher. However, cannabis has been recently selling closer to $4/gram. Consequently, the $1/gram tax has become very expensive, resulting in most licensed producers (LPs) sending over 25% of their revenues directly to the government.

Some major LPs, burdened by expensive and underutilized facilities, high overhead costs, compressed margins, and significant debt, have seen their share price collapse over 99% from their highs. Here are stock charts from former highflyers Canopy Growth (TSX: WEED) and Aurora Cannabis (TSX: ACB). These companies were worth north of $20 billion and $10 billion, respectively, in 2019.

As you would expect, after such a massive bubble and collapse, almost every Canadian investor has been burned and has exited the space, vowing never to touch it again. The industry is now extremely overlooked.

So, Why Now?

There are a couple of reasons to believe that the industry has normalized itself and is starting to turn around.

Following the recent wave of bankruptcies and consolidation, the oversupply problem seems to have been resolved. Several greenhouses have been shut down or repurposed to grow other plants, reducing the cannabis supply in the market.

Secondly, the opportunity to export internationally in new markets like Germany, Australia, and Israel has also diverted some of the supply away from the Canadian market, leading to improved domestic pricing dynamics. Recent financial results from Aurora Cannabis (TSX: ACB) and Avant Brands (TSX: AVNT), for example, provide evidence of the robust export market lately. Companies are incentivized to export if they can because they don't need to pay the excise tax on those exports, leading to improved margins.

Multiple industry sources I've spoken to have confirmed that Canadian cannabis wholesale prices have bounced off their lows and have roughly doubled during the last twelve months.

Catalysts For The Industry

While I think the industry is already well on its way to a better pricing and competitive environment, there are a few additional catalysts I'm watching for. Any one of these events would improve the market dynamics and lead to even better economics for LPs:

1. An excise tax reform: As mentioned earlier, the current excise tax regime is prohibitive for LPs. It's unclear if the next government will want to ease the pressure on the industry by changing the tax regime. Still, reform would be a major catalyst, immediately improving everyone's profitability.

2. Higher THC limits on edibles: The current regulations allow for a maximum of 10 grams of THC per edible package, which isn't enough for many consumers. This low limit has likely hampered the broader adoption and consumption of edibles. If regulators increase the THC limit, many believe it will expand the market opportunity and grow the size of the market.

3. More retail stores in Quebec: The province of Quebec is severely underserved in terms of retail store count. While all other major provinces have 10 to 20 dispensaries per 100,000 residents, Quebec only has 1.4, according to Ventum Financial. Quebec is Canada's second most populated province, representing about 20% of the Canadian population. A retail expansion in Quebec would go a long way toward converting consumers from the illicit to the legal market and growing the pie for active LPs in the province.

How I Approach The Space

I don't think you need to overthink it when it comes to the current opportunity set. Some legacy players are obviously struggling and burning capital, so I'm staying away from those. Meanwhile, a few newer (and somewhat smaller) entrants have gained market share and grown profitably over the last few years.

In my mind, if a company could gain market share and do so profitably in what is probably the worst pricing environment we'll ever see, it’s bulletproof. Also, it likely has opportunities to expand margins and become more profitable in a better pricing environment.

Another thing I've been looking at is the company’s positioning in the market. Some categories, like low-cost dried flowers, are commoditized, while some of the premium brands tend to have a little bit more pricing power, in my opinion.

Lastly, I have read and heard from multiple sources that the cannabis consumer tends to favour novelty and always wants to try new products. A company that can innovate and consistently put out new SKUs that resonate with consumers should be able to create some brand loyalty and have a significant competitive advantage over the long term.

One Stock To Watch: Cannara Biotech (TSX-V: LOVE)

The fund I manage owns a few cannabis names, and there is definitely more than one attractive opportunity in the space currently, in my opinion. That said, I think Cannara provides a solid mix of many of the criteria I've highlighted in this post.

I recently discussed Cannara during a Twitter Spaces session, which I encourage you to listen to here:

Woodstock of small- and microcap investing V - Presented by MicroCapClub

The whole session is worth listening to, but if you want to skip to my sections specifically, I present my background and strategy from 16:45 to 28:55 and discuss Cannara from 1:11:27 to 1:22:00.

Please remember that this is not investment advice or a recommendation to buy the stock. I encourage you to read my full disclaimer below.

Please let me know what you think of Cannara in the comments, or feel free to share any other names in the industry that you think I should look at!

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Disclaimer

This publication is for informational purposes only. Nothing produced under the Stocks & Stones brand should be construed as investment advice or recommendations. Mathieu Martin, the author, is employed as a Portfolio Manager with Rivemont Investments. This publication only represents Mathieu Martin’s own opinions and not those of Rivemont. Rivemont may own positions and transact on any securities mentioned in this publication at any time without prior notice. At the time of this writing, the Rivemont MicroCap Fund holds shares of Cannara Biotech (TSX-V: LOVE). Always do your own research and consult a professional before making investment decisions.

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