Article by Chris Damas, Growth Op
The cannabis industry began planning for a large recreational market when the Trudeau government made legalization a campaign promise in 2015. On October 16, 2018, the day before recreational cannabis use became legal, there were 129 medical cannabis sales and cultivation licenses given out by Health Canada.
Two years later, the cannabis industry has become a plant growing, oil extracting behemoth, and Health Canada’s sanction of outdoor cultivation is only making the beast larger, with 540 licenses issued and counting. The latest data shows the potential for up to 400 tons of outdoor cannabis to be grown this year, as per BCMI Research, which could supply the whole industry for its entire THC extraction needs, and that’s from 1,344 acres of licensed growing area.
Race to the bottom
Despite the robust growth, the problems in the industry are many, including a “race to the bottom” in the pricing of so-called “large size, value format” whole flower. The heavy DAD (Daily/Almost Daily) user is the big beneficiary — an eighth (of an ounce) of high quality, high THC legal cannabis can now be had for half the price of a fifth of spirit alcohol.
Experienced commodity traders will say the “solution to low prices is low prices.” But the cannabis industry has not followed the classic boom and bust cycle, because the “tail” of the bust, which began in March 2019, threatens to extend abnormally. Although cannabis licensed producers (LP’s) and even provincial cannabis boards repeat the mantra that more supply and lower pricing is required to drive out the black market, why are big LPs so intent on growing more cannabis and producing more derivatives?
Accounting practice incentivizes producers to grow more marijuana than they can sell and process so that lower unit costs and positive gross margins can be reported, fooling investors into giving them more money. Later, the excess inventory is quietly written off and the cycle begins again. There will be no solution until participants see the industry for what it is: a cash-burning machine.
Companies that have never made a gross, let alone net profit continue to raise capital, mainly from professional stock traders, hedge funds and short sellers that anticipate capital raises and then cover their winning bets with new issues from ailing companies.
Short sellers have made a bonanza from the promotion of cannabis and don’t want to see the goose that laid the golden egg eaten for Thanksgiving dinner. They incentivize investment bankers who help weak companies raise money, knowing the pros will be there to flip their stocks one more time.
The more cannabis LP’s produce, the lower reported unit cost and higher gross margin per gram, making financial results more appetizing to potential investors and bankers.
Company losses are then funded by raising money via term loans, revolving credit lines, convertible debentures, highly dilutive unit equity deals with warrant sweeteners and “at-the-money equity programs”, whereby companies can sell stock and raise cash directly from the market, fittingly called ATM’s. The capital allows companies to continue expanding into processing and manufacturing, which means oversupply in vape pens and other cannabis extract-based products is guaranteed down the road.
Fixing the dysfunctional industry
The only way to get a lower cannabis supply and higher prices is for governments to initiate constructive structural changes to the dysfunctional industry they created.