Plenty of Canadian cannabis consumers continue to tap into the illegal market as the legal cannabis industry ramps up its supply chain and producers prepare for the fast-approaching day when they can offer new product categories like edibles and extracts, according to an analysis by S&P Global Market Intelligence.
Cannabis obtained through legal sources in the second quarter of 2019 totaled 49.2%, up from 21.7% from the year-ago period, prior to Canadian legalization in October 2018, according to a Canadian government survey released in August. The illegal market provided 46.1% of the cannabis obtained by Canadian consumers, down from 51.0% in the year-ago period. The competition between the more established illegal market and the fledgling legal cannabis market continues a trend seen in the first quarter of 2019.
Smoking remains the most common way for Canadians to consume cannabis, though the country is prepping "legalization 2.0," when products like cannabis-infused edibles, extracts and topicals become legal. Canada's government expects a gradual rollout of new products starting no earlier than December, though the expanded categories will likely drive an overall boost to the retail market and pull more consumers into legal channels, experts said.
"In the long run, this is the future of the market," Kristoffer Inton, director of equity research, basic materials at Morningstar, said in an interview.
This expanded market will likely take until January 2020 to hit critical mass, but has the potential to expand the profitability of the cannabis sector, Stifel analyst W. Andrew Carter said in an interview. The change will likely put a dent in the amount of cannabis sourced from the illegal market, Carter said.
The cannabis market worldwide is expected to grow 40% by 2023 from $150 billion in 2018, including both legal and illicit sources, according to a Euromonitor International report.
Overall cannabis usage is growing in Canada. The portion of Canadians who reported using cannabis in the previous three months increased to 16.1% in the second quarter, a slight bump above the 15.6% from the year-ago period. Canada and its territorial capitals saw about 4.9 million people report cannabis use in the past three months for the second quarter, an increase from the approximately 4.7 million who reported doing so a year earlier.
The portion of Canadians trying cannabis for the first time at 11% was up from the year-ago figure of 5%, but down from 12% in the first quarter.

For the first quarter of 2019, five of Canada's biggest cannabis firms reported a combined C$117.3 million in recreational cannabis sales to Canada's legal market. The supply chain for recreational cannabis in Canada is still developing and will play a key role in boosting retail sales, Inton said.
Ontario and Quebec, Canada's two most populous provinces, have one cannabis store for every 595,000 and 495,000 people, respectively, Canopy Growth Corp. CEO Mark Anthony Nicholas Zekulin said during an Aug. 15 investor call. According to government data, 16.8% of Ontario and 10.3% of Quebec reported using cannabis in the second quarter.
By comparison, California has one store per 10,000 people, Zekulin said during the call.
The stark difference between store concentration shows a need for more retail locations to expand the distribution of recreational cannabis in Canada, Inton of Morningstar said.
In the meantime, the cannabis sector is dealing with a backdrop of negative investor sentiment, damaged credibility and limited near-term catalysts, Carter, the Stifel analyst, said in a Sept. 15 report.
"We see more risk for negative headlines in Canada given delays in retail store openings, potential delays by Health Canada in approving second wave products (edibles, vapes), and we believe global consumer companies have little incentive to take stakes in large Canadian [licensed producers] at this point instead waiting for the category to play out," Carter said in a Sept. 15 report.
