This Could Be the “Next Big Thing” for Pot Stocks

Looking to Profit From Pot stocks in 2020? Read This

Over the past two years or so, the legal cannabis industry has demonstrated its huge potential to stock market investors. While many pot stocks have had their ups and downs, getting in the right pot stock at the right time has certainly helped investors make a quick profit.

Of course, picking the right pot stock is not easy. Because a lot of marijuana companies are just starting out, it’s hard to say which ones will be the winners in the long term.

As a result, some pot stock investors choose to go with exchange-traded funds (ETFs) such as the Horizons Marijuana Life Sciences Index ETF (OTCMKTS:HMLSF,TSE:HMMJ).

These ETFs usually try to replicate the performance of a marijuana index, and could provide a convenient way for investors to get some exposure to the sector.

But like I said, the industry is still at an early stage, meaning shares of cannabis companies can have very different fates depending on how their businesses perform.

While some companies in a marijuana index could turn out to be very successful, others could be forgotten over time.

In other words, if you really want to capitalize on this booming industry, you have to do some research. And since we’re still early in the year, many investors have been searching for the best pot stocks in 2020.

As always, our paid newsletters contain the best stock picks from our expert analysts. But if you want to know which segment of the pot market could be the next growth driver for the industry, I think there’s a very good candidate: products that compete with black-market offerings.

In fact, direct competition with the illicit market could be “the next big thing” for pot.

Here’s what I mean.

After Legalization, Many Consumers Still Buy Weed From Black Market

One of the biggest things that jump-started the cannabis industry’s boom over the past two years was the nationwide legalization of pot in Canada. On October 17, 2018, the Cannabis Act came into effect, legalizing recreational cannabis in Canada.

Obviously, before legalization, recreational cannabis users in Canada would buy from black-market vendors. But since weed is now legal in the Great White North, people should have moved away from the black market and toward legal dispensaries, right?

Well, not quite.

You see, despite the fact that pot is federally legal in Canada, the industry is still highly regulated and, for a long time, there weren’t enough licensed retailers to fill the demand. And even in areas where there are enough dispensaries, there is another factor that could keep consumers away from the legal stores: price.

The blunt reality is that, while cannabis companies are trying hard to differentiate their products, pot still has many commodity-like features. That means, when people decide where to buy weed, price could be a major determining factor.

That is, if the black market offers pot at a lower price than the legal dispensaries do, consumers will have an incentive to go with the less expensive option.

As a matter of fact, a survey by Statistics Canada revealed that 59% of respondents were still purchasing weed from illegal sources. (Source: “Illegal cannabis getting even cheaper, as legal gets costlier, StatsCan says,” CBC, July 10, 2019.)

Unsurprisingly, a main reason behind their decision was cost: the average price of legal pot was CA$10.65 per gram, while the average price of black-market pot was CA$5.93 per gram.

Some might even say that the illicit market is the biggest winner of marijuana legalization.

To give you an idea, legal pot sales in the first year of legalization in Canada were expected to be just CA$1.0 billion. The black market, on the other hand, was expected to be responsible for CA$5.0 to CA$7.0 billion of pot sales in Canada in the same period. (Source: “Frustration and pride in Canada after a year of legal pot,” The Associated Press, October 16, 2019.)

It’s not that pot users don’t want to support the legal weed industry in Canada, it’s just that the price difference has been too substantial for them to do so.

In Canada, there is certainly a lot to be done to bring pot sales from the black market to the legal market.

Mike Serr, chair of the drug advisory committee of the Canadian Association of Chiefs of Police, said “We haven’t disrupted the black market significantly at this point, but that was to be expected.” (Source: “‘Vibrant’ black market persists as legal pot marks its first full year in Canada,” CBC, October 17, 2019.)

“If there is a strong, vibrant dark market out there selling illegal drugs, people will go to that and we need to direct them to the legal market.”

But what about new users? Now that pot is legal, more consumers would try the substance, right?

Well, again, data from Statistics Canada might surprise you.

Before legalization, the agency’s survey results said about 4.9 million Canadians aged 15 and older reported using pot in the previous three months. One year later, the number was unchanged. (Source: “National Cannabis Survey, second quarter 2019,” Statistics Canada, August 15, 2019.)

One could interpret this as bad news for the Canadian pot industry. First-time pot users who don’t know any black-market vendors are likely going to go to a legal dispensary first.

But the number of new users seems rather limited, and even though legal marijuana companies have been trying very hard—some posting solid growth rates—a substantial part of the Canadian market still belongs to illegal vendors.

However, that also means there is a big opportunity ahead: if pot companies can compete with the illegal operators, they might be able to capture a sizable share of a new market.

The Next Big Thing for Pot Stocks in 2020?

The obvious solution for cannabis companies is to sell their products at lower prices. If people could buy legal pot for about the same price as black-market pot, it’s likely we would see more consumers going to the legal stores.

But it’s not that easy for pot companies to simply lower their prices. The industry is just starting out, and many companies are spending a lot of money on land, equipment, employees, obtaining the necessary licenses needed to operate, etc.

Plus, every time a Canadian licensed pot producer delivers its products to a purchaser, it has to pay a federal excise duty. (Source: “Excise duty framework for cannabis,” Government of Canada, last accessed January 28, 2020.)

Despite all this, we are actually starting to see some legal cannabis products being offered at similar prices as the black-market ones.

In October 2019, HEXO Corp (NYSE:HEXO), a Canadian pot company, announced a new value brand called “Original Stash.” (Source: “HEXO Launches Cannabis Value Brand, Original Stash, with 1 oz Product at $4.49 a Gram Including Taxes,” GlobeNewswire, October 16, 2019.)

The product, first launched in the province of Quebec, costs CA$125.70 per ounce (28 grams) including sales taxes.

Simple calculation shows that, to consumers, Original Stash has an all-in price of just CA$4.49 per gram. That’s competitive even compared to black-market pot.

In fact, competing with illegally produced pot is exactly what the company plans to do.

“Our aim with Original Stash is to disrupt the illicit market, educate consumers about the value of a regulated and tested product, and drive them to purchase their cannabis legally,” said HEXO’s co-founder and chief executive officer Sebastien St-Louis.

“We’re now competing directly with the illicit market and providing consumers with an affordable, controlled, quality product. Moreover, we are giving consumers the option of less packaging in a 1 oz format, which we know is a priority for so many.” (Source: Ibid.)

Then, in late November, HEXO announced that it was also launching the new value brand in Ontario, the most populous province in Canada. (Source: “HEXO’s Value Brand Original Stash Available in Ontario,” GlobeNewswire, November 28, 2019.)

In Ontario,  consumers can now purchase the company’s Original Stash dried cannabis flower at CA$140.00 per ounce, including taxes. That translates to an all-in price of just CA$5.00 per gram.

Consumers seem to like the product. On Lift & Co, Canada’s first web site for users to publish cannabis product reviews, Original Stash’s first product, “OS. 210,” received an overall rating of 4.5 out of five stars. (Source: “OS.210,” Lift & Co, last accessed January 27, 2020.)

In my opinion, the introduction of low-priced pot is a big thing for the Canadian pot industry. Seeing that HEXO’s Original Stash product line has been well received, other companies might follow suit and release their own value-oriented products.

And once legal cannabis stores put those low-priced products on their shelves, they might be able to attract customers who were previously shopping in the black market.

Analyst Take

Put it all together and you see that capturing a market that was previously dominated by illegal operators could be a big deal for pot companies.

Sure, pot stocks have been around for a few years, but with the introduction of lower-priced products, legal operators now have a chance to enter a market that’s estimated to be worth billions of dollars.

Given the size of pot companies at the moment, cracking off a few percentages of the black market could result in a huge boost to their finances.

And that just might become the next big thing for pot stocks in 2020.