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How Big Will the Canadian Recreational Marijuana Market Be? Colorado Could Give a Clue

Keith Speights, The Motley Fool

Mark your calendars for June 7, 2018.

That's the date scheduled for Canada's Senate to vote on bill C-45, legislation that would make the recreational use of marijuana legal throughout the country. The Senate already cleared one key hurdle in March, with a 44-29 vote to allow the bill to advance to committee review.

But the key question for the burgeoning cannabis industry is just how big the Canadian recreational marijuana market will actually be. Colorado's results from legalizing recreational marijuana could provide a clue to the answer.

Canadian maple leaf cutout next to marijuana buds and pack of marijuana cigarettes.

Image source: Getty Images.

Rocky Mountain highs

The Colorado Department of Revenue (CDOR) recently released the latest marijuana sales reports for the state. And there are some new Rocky Mountain highs.

Retail marijuana sales in Colorado for the first three months of 2018 totaled $280.5 million. In addition, CDOR reported $88.1 million in medical marijuana sales during the period. The combined total of $365.7 million meant that 2018 is on track to be the best year for marijuana sales in the state ever. 

Marijuana sales have steadily increased in Colorado since the recreational market opened in 2014. Last year, total marijuana sales topped $1.5 billion, up 15% from 2016. However, the rate of growth has been slowing down as expected.

The first quarter usually isn't the peak period for marijuana sales in the state. Sales are typically highest in July, August, and September. Based on the great start this year, Colorado should see total marijuana sales around $1.6 billion for full-year 2018.

Applying Colorado's results to Canada

Could Canada's experience with legalizing recreational marijuana mirror Colorado's? Maybe. There are some similar dynamics at work. Both Canada and Colorado allowed legal use of medical marijuana for several years before moving to legalize recreational use of the drug. Marijuana legalization enjoys public support in both areas.

How big might the marijuana market be in Canada if we applied Colorado's results? The population of Colorado in 2017 stood at 5.6 million, while Canada's population is around 36.3 million. That makes Canada's population roughly 6.5 times larger than Colorado's.

As we saw earlier, Colorado is probably on track to record total marijuana sales of $1.6 billion this year. If we assume that Canada's marijuana market will be larger than Colorado's at the same scale as their difference in population sizes, Canada could be in store for a marijuana market of $10.4 billion annually. That's a much greater number than some other estimates.

Canada's Parliamentary Budget Officer (PBO) projected that marijuana sales would be between CA$4.2 billion and CA$6.2 billion. The midpoint of that range amounts to around $4 billion in U.S. dollars. Professional services firm Deloitte estimated that the Canadian marijuana market could be between CA$4.9 billion to CA$8.7 billion. The midpoint of Deloitte's range is roughly $5.3 billion in U.S. dollars.

There are a couple of things to note, though. First, both the PBO and Deloitte estimates focused on the recreational marijuana market. The Colorado figure used also included medical marijuana sales. Second, and more important, the PBO and Deloitte projections focused on the initial marijuana market size. 

Total marijuana sales in Colorado's first year of allowing legal use of recreational marijuana approached US$684 million. It took some time for wrinkles to be worked out. That's probably to be expected in Canada, also. If we based our projection off of Colorado's first year of recreational marijuana, Canada's marijuana market would be closer to US$4.5 billion -- right in line with the PBO and Deloitte estimates.

The key thing to understand is that's just the beginning. If Canada's market evolves like Colorado's has, the country could easily be looking at total annual marijuana sales of more than US$10 billion (or close to CA$13 billion) within a few years.

From the marijuana market to the stock market

What does all of this mean for Canadian marijuana stocks? For one thing, they should soon enjoy tremendous sales growth assuming legalization of recreational marijuana proceeds as planned. However, it also means that these stocks' valuations aren't dependent only on the Canadian market.

The largest Canadian marijuana grower right now is Canopy Growth (NASDAQOTH: TWMJF), which has a market cap of around US$5 billion. Aurora Cannabis (NASDAQOTH: ACBFF) has a market cap of close to US$3.3 billion. The Canadian marijuana market size -- even using higher estimates for a few years down the road -- won't be large enough to justify these valuations.

Does that mean these stocks are way overpriced right now? Not necessarily. Canopy Growth and Aurora aren't just targeting the Canadian marijuana market. Both companies are going after large international markets as well, especially Germany. That's why Canopy, Aurora, and others are ramping up production capacity well above what's needed to supply the Canadian market.

The global medical marijuana market could be eight times greater than the Canadian marijuana market. That changes the outlook for the growth potential for Canopy Growth, Aurora Cannabis, and their peers. 

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Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.