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Aug 24, 2020

Cannabis Retail: What's currently going on and what can we expect on the horizon?

By Matt Maurer and Andrew J. Wilder
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Business of Cannabis View original

In less than two years since the legalization of recreational cannabis, there are currently over 1,000 cannabis retail stores open for business across Canada. Half of these stores can be found in Alberta, which got off to a fast start in awarding retail sales licenses. In fact, some industry participants are of the view that Alberta’s retail market is now sufficiently saturated. Indeed, some stores in Alberta are already starting to close down for financial reasons. Ontario on the other hand was significantly delayed in rolling out retail stores due to a number of government policy flip-flops and the decision to limit the initial number of licenses and award them through two regulatory-dense lotteries. However, as of the beginning of 2020 when the provincial government finally opened the retail system up to the public, there has been a surge in applications and store openings in Ontario. Notwithstanding the economic slow down caused by the COVID-19 pandemic (which also significantly impacted store operations), potential licensees’ ability to build-out stores has remained surprisingly strong and the time required to have license applications reviewed and issued by the various regulatory bodies, including the Alcohol and Gaming Commission of Ontario (“AGCO”), has been, up until this point, arguably better than expected. As such, we have seen a tremendous amount of activity in the cannabis retail sector across Canada and particularly in Ontario.

Statistics Canada reported that the cannabis industry contributed $8.65B to the Canadian economy in May, 2020. Of this figure, approximately $4.66B was contributed by the legal market with the remaining approximately $3.92B coming from the illicit market. Interestingly, the monthly contribution from the legal market has steadily trended upwards over the past year while the monthly contribution from the illicit market has trended downwards over the same period of time. This is a good sign for Canada’s legal cannabis industry and is a trend that we expect to continue as access is improved due to more retail stores opening across the country and the price at which cannabis is sold concurrently declining due to a number of factors including market pressure, improved cultivation efficiencies and a record number of cultivation license-holders. Based on the Ontario Cannabis Store’s annual report, which covers the period of April 1, 2019 to March 31, 2020 the median price of dry flower, which is still by far the most common way to purchase cannabis, dropped from $9.48 to $7.48 per gram for online sales and from approximately $10.62 to $9.61 at Ontario’s physical cannabis retail stores.

Legal cannabis retail sales in Canada rose to $185.9M in May representing an increase of approximately 4.2% from April. Although some months have been up and others have been down across the provinces, the trend is showing continued growth across the country. Canada’s legal recreational cannabis industry is presently operating at an annual run rate of approximately $2.23B. Sales growth has been supported by the multitude of new cannabis products that are currently available, including edibles, vapes, beverages, concentrates and topicals.

In Ontario, when the ability to apply for a retail license was opened up to the public, the AGCO advised that it anticipated issuing up to twenty retail store authorizations (i.e. the license necessary to open a particular store location) per month. Over the last few months it has become apparent that the AGCO is clearly capable of processing more than 20 retail store authorization applications per month. Indeed, in both June and July the AGCO fully completed the processing of more than 20 applications each month and is on pace to exceed that figure again in August. Unfortunately, the processing of an application has not equated with receiving a license and allowing a new store to open. This is due to the fact that the AGCO is only conducting 5 final inspections per week in order to ensure that no more than 20 stores per month are licensed. This has led to a large number of license applicants being told to essentially “sit and wait” for a long period of time despite the fact that for all intents and purposes their application has been approved and only requires a final inspection to ensure compliance with the regulatory requirements that govern cannabis retail stores. As of the date of writing, license applicants who have successfully fulfilled all of the other license criteria are being told that they can expect their final inspection in August of 2021. The reason behind the continued existence of this cap on licenses has yet to be adequately explained by the AGCO, the Ontario Cannabis Store or the Provincial Government leaving many business owners incredibly frustrated and in a challenging financial position. Not only are applicants essentially obligated to carry the costs of their store through a lengthy application process, they are now being asked to continue to carry those costs for a lengthy period of time, while not being able to earn any revenue to cover those costs.

Although the retail landscape in Ontario is continually growing with well over 100 stores authorized to be open, the current manner in which license applications are being processed  has slowed down the growth rate of the retail market in Ontario. The AGCO has advised that it continues to receive hundreds of new applications on a monthly basis. As of the date of this article there are over 600 applications for retail store authorizations that are presently under review or subject to the public notice process.

Some commentators have suggested that the Canadian cannabis retail landscape has room for up to approximately 4,000 retail stores. If this is the case we are only about a quarter of the way there which presents continued opportunities for those who wish to participate in the retail market, whether it be a mom-and-pop operator looking to open a local neighbourhood store or a regional or national brand looking to expand. In that regard, since the Ontario retail system opened up to the public at the beginning of this year, we have seen a number of retailers who entered into contractual arrangements with past lottery winners to acquire the stores that were initially awarded to the lottery winners. This has been an opportunity for certain lottery winners to monetize and exit their businesses and has facilitated a process whereby certain retailers have been able to quickly acquire these operating businesses and expand their footprint in Ontario.

Over the remainder of this year and into 2021, we expect to see continued growth in retail stores and related sales growth. In addition, we are starting to see innovative partnerships being developed between existing brands and large national retailers who have existing real estate assets and are looking to build-out cannabis retail stores next to or in certain instances as part of existing non-cannabis retail businesses, while still in compliance with all regulatory requirements.  We are also starting see certain retailers launching private label products in partnership with federally licensed cultivators and processors. We expect to see these trends to continue to develop.

 This article was originally published in Business of Cannabis.