At this time last year, investor hopes for the cannabis industry were pretty high. Canada had just become the first industrialized country in the modern era to legalize recreational marijuana in October 2018, derivative pot products looked to be less than a year from hitting dispensary shelves in Canada, and multiple U.S. states were in the process of greenlighting medical cannabis or recreational pot.
However, over the past year, marijuana companies and investors alike have seen their hopes and dreams for the pot industry go up in smoke.
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Canadian marijuana stocks have been a buzzkill in 2019
A combination of regulatory and procedural issues in our neighbor to the north has ensured that legal-channel marijuana has been kept off dispensary shelves. For instance, regulatory agency Health Canada entered 2019 with a reported backlog of more than 800 cultivation, processing, and sales license applications waiting to be reviewed. Given the arduous procedure needed to vet each company and facility, this multiple-month review process has significantly grown in length. In fact, Aphria's joint venture Aphria Diamond facility recently took at least 18 months to gain licensing approval to grow cannabis. It'll be some time before the agency is anywhere close to eliminating this licensing application backlog.
There have also been serious issues with the rollout of physical dispensaries in certain Canadian provinces -- especially Ontario. Canada's most populous province had a mere two dozen open dispensaries a full year after recreational marijuana was legalized, which equates to one retail store for every 604,200 residents in the province. That's nowhere near enough dispensaries to adequately meet consumer demand, and it's having an adverse impact on the industry.
Then there's the real beneficiary of these supply issues: the black market. Statistics Canada recently reported that black market cannabis was 45.4% cheaper than legal-channel marijuana on a per-gram basis during the third quarter. Even with a reasonably low federal excise tax, Canadian pot growers are having a hard time competing with this huge price gap.
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Another Canadian cannabis stock is cutting its production
With Canadian pot stocks facing an odd situation of oversupply in a number of provinces despite the fact that most consumer demand is not being met by legal-channel product, multiple growers have announced production cuts.
It began with The Green Organic Dutchman (TGODF +0.00%) in October. Green Organic Dutchman had told investors earlier in the year that it was on track to eventually hit 219,000 kilos of peak annual output, placing it among Canada's top five growers. However, in a recent corporate update, the company noted its intention to utilize only four grow rooms at its flagship Valleyfield property in 2020, as well as grow rooms at its Ancaster campus. All told, Green Organic Dutchman expects to yield 20,000 to 22,000 kilos next year, which is just 1/10th of its peak potential.
Not long thereafter, Quebec-based HEXO (HEXO +0.00%) announced production cuts. In an effort to better align the company's costs with current market conditions, HEXO has decided to cut 200 jobs, as well as idle its Niagara grow farm, which was acquired with its Newstrike Brands purchase. Despite forecasting 150,000 kilos of peak annual production, HEXO's run-rate output in 2020 is probably going to be closer to 80,000 kilos.
Next up was Aurora Cannabis (ACB +0.30%), the world's most popular pot stock. Also aiming to conserve capital, Aurora plans to utilize only six grow rooms at its flagship Aurora Sun campus in Alberta, and will completely idle its under-construction Aurora Nordic 2 facility in Denmark. These grow farms were expected to generate at least 230,000 and 120,000 kilos for Aurora Cannabis, respectively, once fully operational. Now, Aurora Cannabis' run-rate output by the end of 2020 has been effectively cut in half.
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Then came OrganiGram Holdings (OGI 0.73%), the newest Canadian cannabis stock to cut production. On Monday, Nov. 25, New Brunswick-based OrganiGram announced that it would be halting Phase 4C construction at its Moncton facility. Phase 4C was expected to increase OrganiGram's output by 24,000 kilos at full capacity. Assuming the company achieves full licensing for Phase 4B, it'll be operating with an annual run rate of 89,000 kilos, as opposed to the 113,000 kilos at full capacity that management has touted.
Altogether, and inclusive of CannTrust's cultivation and sales licenses being suspended, around 1 million kilos of peak annual output have been removed from the Canadian marketplace for 2020.
It'll be a while before growers are meeting legal-channel demand
Though removing this production will certainly help reduce costs for pot stocks and partially help to ease supply concerns in key provinces like Ontario, none of the issues facing cannabis stocks are going to disappear overnight.
For instance, Health Canada changed its cultivation licensing application process midyear, which now requires growers to have completed their grow farms prior to submitting their application. This should help eliminate underfunded projects, but it's not going to make the agency's licensing backlog disappear overnight. Long wait times to bring product to market should remain the norm for the foreseeable future.
The rollout of dispensaries in Ontario also isn't a quick fix. Even with a second lottery to assign dispensary licenses that could nearly triple the province's physical footprint, there will still be a significant shortage of storefronts. This suggests the black market will continue to thrive, with the pricing gap between legal and illicit marijuana further driving consumers to black market products.
It's important for investors to realize that the marijuana industry can still be wildly successful. But this success isn't going to come without a hearty helping of growing pains.
