Expected Canada marijuana supply issues could be a ‘buzz kill’ for the stock prices of companies such as Canopy Growth Corporation (TSE:WEED) and Aphria Inc. (TSE:APH)
David Bar | May 4, 2017 | SmallCapPower: With legalization just over a year away, and legal sales commencing around the beginning of 2019, the question of whether companies will be able to produce enough marijuana to meet demand obviously comes to light. If current producers cannot generate the supply to feed the expected demand, people will inevitably turn to the black market for their needs, and this could affect Canadian marijuana stocks such as Aphria Inc. (TSX: APH) and Canopy Growth Corporation (TSX: WEED) in the next year or two.
Related: For Our Complete Coverage On Canadian Marijuana Stocks Click Here.
As I had stated in my past article, the expected participation rate for the recreational market is forecast to mature around 28%, and including the medicinal market demand for marijuana is expected at approximately 1.61mm kilograms by 2023. With 2023 being a long way off, this number is highly suspect as no matter how good your research is, forecasting into the future creates a large amount of uncertainty. With that in mind, let’s bring it back a couple of years to 2020, when I have forecasted the participation rate to be 23%. Even at this participation level (just 3% higher than the current black market users, according to a study by Deloitte) this generates a substantial demand of 1.2mm kilograms! Even within the first year of legalization demand is expected to be 896,984 kilograms at an 18% participation rate (Figure 1, below). This demonstrates a large supply gap.
Right now, as is shown in Figure 2 below, public companies only have approximately 574,350 kilograms of capacity in the pipeline to come online by 2020 (in Canada as CanniMed Therapeutics Inc. (TSX: CMED) has capacity potential in Michigan). That is still a large deficit, and although there are currently 43 licensed producers in Canada, the publicly-traded companies below account for more than half of those licenses (Cronos Group has four private company investments whose capacities are included below, and Canopy Growth has six of the licenses). As the private companies do not have access to the kind of funding that public companies do, you can almost bet that they do not have the funds to build the needed capacity.
What’s the issue?
This poses a serious problem for Health Canada, the Liberal Government and all licensed producers. Whenever supply is outstripped by demand, generally prices rise in order to balance how many people can afford the product or are willing to pay the its premium. However, this absolutely cannot happen in the marijuana market. If prices rise as a result of a shortage, people will just go right back to the black market where they can get similar product at a much lower price, effectively creating the exact situation the government is trying to eliminate.
As is illustrated above, this puts pressure on the provincial governments to effectively maintain a constant price, regardless of supply and demand dynamics, which will affect the licensed producers’ profit margins. It all isn’t helped by the fact that Health Canada is the only certifying body, and is doing something that absolutely cannot be rushed or have its process expedited, as that be irresponsible.
What does it all mean for the industry?
Unfortunately it means that, inevitably, people will still be purchasing large quantities of marijuana from the black market for the foreseeable future, even after legalization. However, it also means that there is a substantial opportunity for current producers to increase their capacity, but also a space for new entrants once they receive their licenses.
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David Bar is an MBA Candidate at the DeGroote School of Business. With an interest in the mining and marijuana industries, he hopes to work in the investment industry focusing in these sectors.
Disclaimer: The author has holdings in some marijuana companies (Aurora Cannabis, Cannabix Technologies, Supreme Pharmaceuticals, Maple Leaf Green World).
Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.
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