Stifel Archives - Green Market Report

Debra BorchardtSeptember 30, 2021
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High Tide Inc. (TSXV: HITI) (Nasdaq: HITI) just hit a milestone when the Canadian cannabis retailer announced that it has opened over 100 stores. High Tide said that its total number of branded retail locations across Canada numbered 101, and the company has 30 stores in Ontario. In addition to those stats, High Tide also noted that it has launched eight organically-built stores in the month of September alone. While this is a laudable event, could Ontario be reaching dispensary saturation and is that a bad thing for cannabis companies?

Competition is the lifeblood of capitalism. It is survival of the fittest. Retailers that don’t hit the mark will lose customers, while those that can deliver the right products at the right prices in an environment shoppers like will be winners. In the cannabis industry, like other more traditional industries, there are only so many consumers for the product. The industry is limited in its ability to advertise and there is some discomfort at trying to woo new cannabis consumers. The stores are left to wait for the new consumers often called the “canna curious” to explore on their own. This has resulted in a plateauing of sales in some areas. Cannabis consumers can only consume so much within a week or month.

Too Much Competition

The Canadian market is beginning to see the effects of market saturation in some areas. Both Fire & Flower (OTC: FFLWF) and High Tide recently mentioned in their earnings announcements that sales were affected by this. Fire & Flower said that its same-store sales decreased 14% for forty-eight (48) stores in operation during the second quarter of 2021 due to a surge in newly licensed retail cannabis stores in Ontario. According to the company, in just three months the number of licenses went from 665 at May 1, 2021 to 981 at July 31, 2021. The company’s sales also dropped despite the reopening of stores to foot traffic due to the pandemic. Fire & Flower also pointed out that competitors had engaged in deep discount pricing. 

On The company’s earnings call, CEO Trevor Fencott said, “We saw this in Alberta where there was a mass licensing. I think the record at the time was 20 licensed a week. And it expanded. It’s got a lot of kind of mom and pops in the queue that, unfortunately, even though there isn’t really a lot of room for single players anymore in the market, they have to kind of launch to market because they’ve signed a lease. And so, they’re coming, come – no matter what, they’re going to launch. And then, you’ve got the overcrowding and then a pairing back as businesses, unfortunately, can’t compete. So, all these things resolve themselves. I doubt they resolve themselves in a quarter, but they eventually do.”

High Tide noted in its recent earnings call that the number of stores open in Ontario rose to over 1,000 roughly 10 times the number open about a year ago. CEO Raj Grover said, “This increased competition has resulted in it taking longer for new stores to ramp up to the point where they are contributing to consolidated EBITDA. The number of retail licenses in Alberta also increased 60% versus a year ago. And during this time, a few value players have arisen which have driven the retail gross margin for cannabis lower.”

Saturation

As the cannabis industry matures, it begins to face the same issues as traditional retail. Some markets in Canada are now dealing with saturation issues. Grover said in the earnings conference call when asked about saturation, “When you compare the populations between Alberta and Ontario, you’ve got 4.3 million people in Alberta versus 15.5 in Ontario, and Alberta already has 700 stores approximately 700 versus Ontario still has about 1,000 but triple the amount of people. So we still feel that there’s good growth ahead in Ontario. I do agree with you that there are certain markets in Ontario, especially in Toronto, where there’s an extreme saturation of stores.” His plan is to go into retail plazas with strong anchor tenants to keep his traffic strong. High Tide has also created a customer loyalty program called the Cabana Club to combat discounters.

Deep Discounts

In addition to those moves, High Tide is creating its own deep discount brand called Cannabis Chop Club. Grover said on the conference call, “We are seeing very aggressive pricing from select value players. They’re not profitable today and intend to clean up the market before raising prices to a level where they can be profitable. Unfortunately, this will be at the demise of many independents and small chains. We will be positioning our own value brand in more value-sensitive markets and neighborhoods under the Cannabis Chop Club name. This will be done on a micro-market basis depending on the competitive dynamics in each area. We have identified markets where launching our own value brand makes sense. So we can keep our retail concepts differentiated and increase our market share in price-sensitive markets.”

The stores will have a smaller footprint, lower building costs and a different assortment of products and accessories. The locations will be targeting value sensitive areas.

Grover added, “To be clear, we will not be the one starting a price war but we just won’t sit on our hands and lose market share. We will fight fire with fire when necessary. Given our unique positioning in accessories, our lean operations and national scale of growing loyalty plan and our strong capital markets profile and balance sheet strength, we are well-positioned to continue to lead the market regardless of competitive dynamics. And our new Cannabis Chop Club concept will be another tool we have to keep driving value for shareholders.”

Diminishing Returns

Stifel analysts believe the overexpansion of dispensaries will result in diminishing returns for the market. Andrew Carter wrote in a recent report titled September 2021 Cannabis Update, “We outline an uneven environment in which some areas are past the point of saturation, while others have no access: 21% of Canadians live in areas with one store or more per 10,000 residents, while 25% of Canadians live in areas without a licensed dispensary (defined as five miles from the population center). Expanding legal access is likely to be difficult, with 30% of the addressable market in areas where the Provinces own and operate all retail stores, while municipal restrictions prohibit stores in some areas (most notably Mississauga, Ontario, with over 700,000 residents). For the retail operators, the Canadian market is extremely competitive in some areas, with the average Ontario retailer facing 20 stores within a two mile radius. Absent unlocking underserved areas, continued retail growth will not likely be a tailwind for category growth, given the diminishing returns.”

To be fair, sales are still rising for many. Stifel said that Headset suggested robust growth from the Canadian market as lockdown restrictions are easing.  Stifel cautioned that there are elevated retail inventory levels, continued pricing compression, and increasing category fragmentation in what “we regard as a structurally difficult market for private operators.” Carter wrote, “We count over 200 producers, and the market share outside the top-10 producer has grown to 37% in the latest three months, up 12 ppt from the end of 2020. Through July, we highlight the sequential market share performance across our coverage for the trailing three months: Aurora Cannabis down 145 bps, Canopy Growth down 320 bps, Cronos Group up 34 bps, HEXO down 170 bps, and Tilray down 170 bps.”

Ultimately, Stifel said it has an overall negative bias towards Canadian producers.


Debra BorchardtSeptember 20, 2021
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Stifel analysts W. Andrew Carter, Christopher Growe, and Matthew Smith issued a huge report September 2021 report updating investors on their outlook for the cannabis industry. The group lowered estimates and price targets on several companies. The group also noted they have a negative outlook on the Canadian cannabis industry and Canopy Growth in particular. With regards to the U.S. market, the analysts don’t believe the current administration will change the legality of the industry but believe this is actually a positive thing.

Don’t Expect U.S. Legalization

While the election of a Democratic President in the U.S. had many believing that federal reform was around the corner, Stifel doesn’t think so. The analysts said that they don’t believe this is achievable with this Congress and there is limited potential for modest reform. They wrote, “We believe federal inaction provides the leading U.S. MSO’s (multi-state operators) and our four ancillary cannabis names an extended window for value creation.” The group went on to say, “While this has reduced interest in the sector, we remain enthusiastic about the category’s prospects while federal inaction extends the window for value creation for GrowGeneration, Hydrofarm, Scotts MiracleGro, and WM Technology.”

While Stifel doesn’t think Federal legalization is happening anytime soon, the report was mostly positive for U.S. cannabis companies. The analysts wrote, “Year-to-date, we estimate the North American regulated category grew 45%. The U.S. state-licensed market should benefit from a number of new state systems coming online over the next few years: Connecticut, Montana, New Jersey, New Mexico, New York, South Dakota, and Virginia. Once all of these systems are implemented, the percentage of the U.S. population living in a state with an adult use cannabis commercial system will increase to 44.8%, up from 31% today. We estimate the U.S. state-licensed market will grow to nearly $35 billion in 2023 sales, suggesting 21% CAGR aided by robust underlying growth and new systems coming online.”

Canadian Bummer

Stifel noted that in 2018, Canadian cannabis companies drove investor enthusiasm as the first fully legal developed market. Unfortunately, the market has not met the expectations and competition has been stronger than anticipated. For example, there has been a 100% increase in active licenses since 2020. Some areas in Canada have hit saturation, while others have no access at all. The report wrote, “Expanding legal access is likely to be difficult, with 30% of the addressable market in areas where the Provinces own and operate all retail stores, while municipal restrictions prohibit stores in some areas (most notably Mississauga, Ontario, with over 700,000 residents). For the retail operators, the Canadian market is extremely competitive in some areas, with the average Ontario retailer facing 20 stores within a two-mile radius.”

With regards to the U.S. listed Canadian producers, Stifel said that it thinks the costs of capturing category growth are increasing. To be fair, sales continue to grow with Canadian adult-use sales expected to reach $7 billion by 2023. Recovery from pandemic closures and a continuation to pull consumers out of the illicit market all bode well for the industry. However, Stifel tempered the positive comments with issues regarding regulatory changes and underserved markets.

“We caution that the difficult Canadian market will likely serve as a headwind for profitably participating in the market’s growth as there is a long lead time before increased consumption will be able to drive shipments higher,” wrote the analysts. “Retailer inventories continued their decline from 1Q21, but they remain elevated, with Alberta, Ontario, and Saskatchewan all ahead of levels at the end of 4Q20.” Three companies now own essentially 35% of the Canadian market – Canopy Growth, Tilray, and Hexo.

Stifel had some tough love for Canopy Growth. The analysts wrote, “We believe Canopy is actively eroding its position within an inflexible commitment to Canadian market leadership despite the significant resources needed to achieve this endeavor with no consistent evidence validating the ability to achieve market leadership.” Stifel is keeping its Sell rating for Canopy and lowering the price target to C$15, which was lately trading at C$17.70 while the U.S. stock was lately selling at $13. The analysts also pointed out that since the company fired its founder Bruce Linton, results have been underwhelming. They think a personnel change is needed.

Stifel has a Hold rating on Hexo and lowered its price target to C$2.85 even though revenue is growing. The company cited a complex capital structure for Hexo that could weigh on investor interest. Stifel thinks Tilray is best positioned for market leadership, but lowered the price target to C$11.50 from C$14 and maintained the Hold rating.

Hydroponic Concerns

The analysts said they were taking a cautious approach towards the hydroponic category, which they cited for slowing growth due to oversupply issues. However, weather, fire, and construction delays could solve that problem. The report said, “Hydroponics benefits from the irrational deployment of capital toward plant touching opportunities with a myriad of funded “CocaCola of cannabis” pitches. But the hydroponics subsector has been largely insulated from this dynamic. Fresh category skepticism is likely to keep this insulation intact, and we believe each company should sport a stronger position for executing additional M&A. Of the three, we favor GrowGeneration with the dramatic underperformance relative to peers in the face of better positioning to contend with and capitalize on more challenging category dynamics.”

Stifel Updates

The analysts made the following changes:

“We are lowering our near-term estimates for Aurora Cannabis (ACB.CN), Canopy Growth (WEED.CN), Cronos Group, Hydrofarm (HYFM), the Scotts Miracle-Gro Company (SMG), and Tilray (TLRY). Our revisions stem from our more cautious approach to hydroponics category growth (HYFM, SMG) and uninspiring Canadian POS trends (ACB, WEED, TLRY). We are
increasing our estimate slightly for GrowGeneration (GRWG) for the latest acquisitions (two stores), and we are updating our HEXO estimates for the addition of Redecan and 48North. Our ratings remain intact, but we are lowering our target prices for Aurora Cannabis, Canopy Growth, Cronos Group, HEXO, Hydrofarm, ScottsMiracle-Gro, and Tilray. We recently initiated coverage of WM Technology (MAPS) with a Buy rating and $19 target price. While our WM Technology outlook remains intact, we approach our F4Q21 estimates with incremental caution, given slowing category growth, particularly in California, which represents over 60% of the company’s sales.”

 

 

 

 


Debra BorchardtJuly 27, 2021
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Cannabis consumption rose during the height of the COVID crisis as anxiety and lockdowns prompted many to increase the amount consumed. According to a new survey by Stifel, it doesn’t look like consumers are going to return to pre-pandemic levels of use. This is good news for cannabis companies. The survey also determined that cannabis remains a resilient category despite increasing options for discretionary spending as people ease out of COVID restrictions. The research firm surveyed both U.S. and Canadian cannabis consumers and said it reinforced its opinion that the U.S. landscape looks positive while suggesting a mixed outlook for Canada.

The survey confirmed that price is more important to Canadians than to U.S. cannabis shoppers. It also learned that regular cannabis consumers continue to prefer flower, while new cannabis consumers prefer edibles, beverages, and topicals. Another key item in the survey said location is the most important element for store loyalty. “We believe these three categories have the potential to drive mainstream conversion given the accessibility, discretion, ease of use, and familiarity with Headset data suggesting stronger branding power for these segments versus inhalables.” 

No Post Pandemic Change

The Stifel survey found that post-COVID, 65% of consumers said they expect to maintain consumption with 17% suggesting increased consumption. “We believe increasing incidence and consumption by existing consumers will be consistent category tailwinds, but the Canadian market’s growth is predicated on the ongoing conversion of the illicit market through expanding retail access and product availability.” The report also noted that the edibles market in Canada has been difficult for producers and believes that the category won’t be fully successful without regulatory changes. 

The category is fairly new, but producers face strict regulatory requirements. There are limits on THC levels and packaging limitations make it hard to build brand awareness. Edible also can’t resemble any type of candy that could appeal to children, which has boosted the illicit market.

Bargain Shoppers

Canadian consumers are more price sensitive than US consumers. Stifel said that price and quantity were the top two priorities in each survey with Canadians putting a much higher importance on price (31-37% vs 25-28%) versus US consumers significantly outpacing the next highest priority (10-15% vs 3-5%). The survey found that 30% of Canadian consumers suggested price was the number one determining factor in choosing a retail location. “We believe this underscores the Canadian producers’ difficulty in profitably capitalizing on Canadian cannabis category growth. Novelty and brand were the least important priorities for Canadian consumers. Headset trends outline significant turnover for the top ten brands with seven of the current top 10 brands discount or deep discount offerings.”

Location, Location, Location.

Stifel said that location is the number one determining factor in where Canadians purchase cannabis. The survey revealed that 83% of consumers typically buy from the same location, highlighting strong customer loyalty. “We see the results as supporting well-capitalized and well-established operators able to expand quickly and secure desirable locations, especially in Ontario. Store proximity, price, product selection, and technology were among other factors in order of importance driving purchasing decisions.” 

Beyond the survey, the analysts took a look at active store licenses (both on an absolute and per capita basis) and other accessibility metrics by province and region of the Greater Toronto Area (GTA). They found that some areas were past the point of saturation and others had extremely limited access; thus, have room to accommodate many more stores. That could mean that companies may consolidate poorly performing stores and invest more heavily in better locations. 

In Closing

“While we continue to outline a negative overall approach to the most senior Canadian producers, LPs have the ability to invest behind R&D and commercialize products in the Canadian market. The US MSOs have the ability to leverage growing infrastructure to commercialize emerging product concepts.”


Debra BorchardtMarch 8, 2021
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Despite a solid outlook for the Canadian cannabis market and producers who have raised almost $1 billion over the past few months, Stifel analysts delivered a sobering report on the industry. 

We believe it will be increasingly difficult to profitably capture growth in the Canadian market with “strengthened balance sheets” across the sector likely facilitating continued irrational deployment of capital with limited prospects of a shakeout driving the market towards rationality. 

Good News For Canada

First, the good prognostications for the Canadian cannabis market. Stifel worked with Headset data to create its latest report. Headset covers roughly 65% of the Canadian sales market and is a good indicator of the overall health of the industry. Sales in January 2021 were up 106% over 2020, but down 1% from December 2020. This is leading the analysts to forecast that the market will reach over C$4 billion in 2021 sales. The analysts also estimate sales in the adult-use market will double over the next two years reaching C$6 billion before slowing to a high-teens rate of growth.

The analysts also suggested that the second wave of new products hitting the markets will be a boost to the industry. Vapes, edibles, and beverages are new to the Canadian consumer. However, packaging restrictions and THC caps are issues that could prove challenging to producers. Flower, as usual, is the big category leader, unfortunately for producers prices for flower continue to fall. “The deep discount segment represented 46% of dried flower category sales in the three months ending in January, growing 28% over the last three months.”

Lead analyst W. Andrew Carter wrote, “Despite our robust outlook, we outline an increasingly competitive environment and uneven performance by Canadian producers. Latest Headset trends suggest robust growth for HEXO (HEXO.CN; C$8.85; Hold) providing support for our recently revised estimates ahead of F2Q21 on March 18th, softer trends from Aphria (APHA.CN; C$23.01; Hold) suggesting risk to our F3Q21 estimates, January market share gains for Canopy Growth (NASDAQ: CGC); C$42.06; Sell) driven by discount brand Tweed. but also outperformance in Ontario with the company likely placing significant focus on this key customer, and continued declines from Aurora Cannabis (ACB.CN; C$13.25; Sell).”

Canadian Capital Raising Is On Fire

Remember the bear market of 2019? Tight capital? Cannabis companies struggling to find anyone willing to invest? Those days are over. Stifel wrote, “Between ATM issuances, warrant exchanges, and equity offerings, Canadian producers have raised roughly $1 billion in the past few months. Offerings completed by Canadian producers have been on relatively unattractive terms burdened with significant warrant coverage. Aurora Cannabis (ACB.CN; C$13.25; Sell) has completed two equity offerings since early November raising over $300 million issuing 36 million shares (23% dilution) with attached warrants suggesting another potential 9% dilution.”

The analysts went on to say, “The shares of Sundial Growers (SNDL; $1.30; NC) were caught up in the “GameStop Saga” to which the company furthered its long-term prospects by announcing a $100 million unit deal including close-to-the-money five-year warrants, followed by a $74.5 million unit including close-to-the money warrants, and then raising another $89 million exchanging the issued warrants for newly issued close-to-the money five years warrants. And the company utilized roughly $225 million of its outstanding ATM amid the volatility suggesting nearly $500 million in capital raised on market volatility.” Within the Stifel report, it is worth noting that Sundial was listed as having a sales decline of 17% through January 2021 for three months trailing in four provinces. That number improved (?) to a decline of 12.5% by the end of February 2021 for three months trailing. 

Fortunes have changed dramatically. The analysts noted that companies struggling with meeting debt covenants just months ago now have hundreds of millions of dollars “with limited organizational investment remaining to compete in the Canadian market, and we have been surprised some institutions have favored renegotiating debt over pursuing value creation through recourse options.” 

Any category shakeout will have to be driven by provinces and consumers through differentiated capabilities and brands, and Canadian market restrictions makes building brands extremely difficult at this stage of the market’s development.

Cheap Weed Wins

The Stifel report also highlighted that the average price-per-gram of dried flower in Headset measured channels had fallen to C$6.76 in January from C$9.27 in March of 2020. “Against increased competition at the producer level, we find the total inventory at the provincial/wholesale level has gone from 76 days in March 2020 to 56 days in October 2020, though that increased to 68 days in November.” Producers are seeing their profits decline as discounted cannabis brands are commanding a large size of the shipments. That combined with higher excise taxes on the percentage of gross sales has combined to cut into profits.

The analysts noted that Canopy Growth has been aggressively cutting prices in order to protect market share. “We believe Canopy’s outlook for 9% pricing compression over the next year is optimistic within the context of the current market.”


Debra BorchardtDecember 17, 2020
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Stifel analyst Andrew Carter has downgraded Aphria (NASDAQ: APHA) from Buy to Hold and upgraded Tilray (NASDAQ: TLRY) from Sell to Hold following the announcement of the company’s merger. In the merger agreement, Aphria shareholders will receive 0.8381 shares of Tilray’s for each Aphria stock they own. Aphria will own about 62% of the combined company, however, the merged company will supposedly be known under the Tilray name and would trade with the TLRY stock ticker.

He said that the merger with Tilray offers compelling long-term potential but limited near-term upside. He raised the target price from C$8.25 to C$9.90 for Aphria based on the company’s 62% of the new combined company.

“We are taking a positive approach to this merger given the long-term potential. But pursuing this merger attracts scrutiny,” he wrote in his note. “Aphria has successfully achieved a leadership position in the Canadian adult-use market organically, and we question the opportunity cost of capital/management bandwidth for undertaking this acquisition. We believe the shares are likely to remain in a holding pattern over the near-term as investors gain confidence with the combined platform’s long-term potential. Against the incremental contribution, we are reducing our revenue estimates for the distribution business assuming the 1Q21 run-rate of C$82 million as the appropriate run-rate going forward. With our outlook suggesting discount will be a more fulsome percentage of sales, our estimates consider a higher level of excise taxes pressuring both net sales and EBITDA.”

Tilray’s price target was raised to $9.20 from $5. He wrote, “We believe Tilray offers a difficult case for standalone value creation with Tilray not showcasing, in our view, an enduring right-to-win for new market opportunities particularly in the U.S. with the increasing competitiveness of the Canadian market likely challenging the company’s ability to offer a profitable template for investors. We believe Tilray is contending with underappreciated liabilities and liquidity needs that would otherwise challenge the company’s ability to drive investor enthusiasm. But this merger provides Tilray shareholders participation in a platform offering truly impressive growth potential with the initial announcement suggesting a 23% premium to Tilray’s December 15th closing price.”

Carter believes the combined company will generate $890 million in combined 2021 net revenue with cannabis sales approaching $500 million with the combined portfolio offering mid-teens revenue growth and a combined margin profile comparing well with traditional consumer assets (~20% EBITDA margin).

“While we believe the combined platform will offer investors an impressive growth profile and a well-positioned vehicle for capitalizing on the growth of the global cannabis category, we believe the prevailing valuation fully considers the platform’s potential with the focus now on successfully completing a complex integration,” he said in his research report.

 


William SumnerJune 6, 2018
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Will the nationwide legalization of cannabis in the United States lead to falling cannabis prices? According to a recent report published by the financial services company Stifel Financial Corp., the answer is yes. Published on May 30, 2018, the report details various market pressures and predictions regarding how the legal cannabis market will over the next several years.

According to the report, there is a strong possibility for price compression in the cannabis market, particularly dried cannabis, for several reasons. The first reason is that the highly attractive economics of cannabis will lead to an influx of actors hoping to cash in on the industry, which will lead to oversupply; citing Canada as an example.

Set to legalize adult sales of cannabis this summer, Canada is set to face an oversupply in the coming years. Another report, issued by BMO Capital Markets, found that although the Canadian cannabis market only needs about 11 million square feet of grow space to support demand, the top three growers are already on their way to having approximately 8 million square feet themselves.

When you figure in all of the other cannabis cultivators in Canada, it is easy to see how the market could become saturated. Likewise, permissive licensing structures in the United States has led to an abundance of cannabis cultivators. The most significant barrier to entry as a cultivator is capital; and with deep-pocketed investors flooding the market, capital is readily available to those that seek it.

Additionally, lower prices will emerge as a necessity to encourage users to abandon the black market in favor of the legal cannabis market. Daily cannabis users, which are predicted to account for the majority of national cannabis sales, are sensitive to price. According to an analysis by the Canadian Parliamentary Budget Office, only 61% of daily users would be willing to pay a 20% premium for legal cannabis products compared to the illicit market.

For cannabis operators, this means having to make a choice between maximizing profitability or volume. Profit maximization would most likely occur through the creation of value-added cannabis products; such as extracts and edibles. Using Colorado, Washington, and Oregon as a model; the Stifel report predicts that the national market would initially favor volume over profitability.

Once again drawing from Colorado, the report predicts that a national cannabis industry would most likely see cannabis sell for a wholesale price of $2.00 per gram and a retail price for $3.50 per gram for medicinal and $5.50 for recreational. Dried cannabis would be hit the hardest, while value-added cannabis products would retain a slightly higher price. Currently, the Cannabis Wholesale Benchmarks has cannabis priced at $1,247 per pound for the spot index in June. Cannabis calculates 448 grams per pound putting the current price at $2.78 and so its forecasted drop would be roughly 28% from today’s prices.

In the BMO report the wholesale price of cannabis, at least in Canada, is predicted to be much higher. Wholesale prices for dried cannabis are predicted to hover around C$4.00, while oil/gel capsules would go for C$6.00 per gram, and value-added formats would sell for approximately C$15.00 per gram.

With regards to cannabis taxation, the Stifel report favors the Canadian tax model, which includes a 10% ad valorem tax with a C$1.00 minimum and the ability for provinces and localities to impose their own taxes. Using a similar 10% ad valorem tax, along with a 10% tax imposed by the states, and a 5% local tax; it is estimated that the United States could generate up to approximately $12 billion in cannabis taxes annually.


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