Quantcast
Featured Image

The marijuana industry is blossoming before our eyes, with the cannabis movement taking its biggest steps forward in history in 2018 .

Last year, following years of promises from Prime Minister Justin Trudeau, Canada officially legalized recreational cannabis. In doing so, the country rolled out the green carpet for a multibillion-dollar industry and, more importantly, demonstrated once and for all that marijuana is a legitimate business. Now, with the country acting as both global ambassador and guinea pig, all eyes are on Canada to see exactly how legalization pans out.

Cannabis buds next to an index card that says yes, lying atop dozens of miniature Canadian flags.

Image source: Getty Images.

Cannabis supply is constrained, and it's visibly hurting sales

Earlier this week, Ottawa-based Statistics Canada, the government agency responsible for producing statistics on the Canadian economy, resources, and society, announced cannabis sales for the first full month in the post-legalization environment. Following the $32.3 million (43.1 million Canadian dollars) that consumers spent on pot in the two weeks following its legalization on Oct. 17, 2018, the agency reports that sales rose by 26% to $40.8 million (CA$54.4 million) in November.

But on an extrapolated basis, what was purchased in November only works out to $490 million in full-year sales. That's a far cry from the $5 billion-plus that industry analysts and Canadian regulators have called for in intermediate peak annual sales.

Statistics Canada, as well as most dispensaries that have been interviewed by Canadian news media outlets, caution that the initial data isn't representative of the full potential of the pot industry. That's because supply constraints are hindering the ability of retail and online stores to meet demand. This supply shortage is occurring on three fronts:

1. Growers are still ramping up production

Marijuana growers are still in the midst of expanding their capacity. Aurora Cannabis (NYSE: ACB) , for instance, likely slots in as the country's largest grower by peak production. While the company conservatively estimates it'll yield "at least 500,000 kilograms," I believe Aurora Cannabis could easily produce around 700,000 kilograms annually by 2021 or 2022. But as of the beginning of 2019, Aurora Cannabis was only producing at an annual run rate of 100,000 kilograms. The company expects to hit 150,000 kilograms on an annual run-rate basis by March 31. It's going to take time -- especially with Aurora working on numerous organically built, retrofitted, and acquisition-based greenhouses -- to get its operations up to spec.

The same could be said for other top-tier growers. OrganiGram Holdings  expects to produce 113,000 kilograms when its Moncton, New Brunswick, facility is fully operational, but is currently only producing 36,000 kilograms on an annual run-rate basis. Aphria 's management team has estimated 255,000 kilograms of peak annual yield. Right now, however, it's only producing about 35,000 kilograms annually.  It'll be some time before Canadian growers are able to meet domestic demand.

The Canadian flag with a cannabis leaf at the center, and a large sold out stamp across the leaf and flag.

Image source: Getty Images.

2. Regulatory red tape at Health Canada

The second reason for the supply shortage can be tied to the country's regulatory agency tasked with overseeing the industry, Health Canada.

According to data from Marijua na Business Daily  in May 2018, Health Canada had a backlog of more than 500 cultivation license applications to review and either approve or deny. These applications often sit around for months, or perhaps longer than a year, before the agency has time to make its decision. Without this license, finished greenhouses will sit idle.

Additionally, Marijuana Business Daily noted in May that the average sales permit was taking 341 days between filing and approval. That's nearly a full year that growers are having to wait just to be given the OK to sell harvested cannabis. Health Canada simply doesn't have the means to work through its application backlog with any expediency, which is liable to constrain supply into perhaps 2020.

3. Provincial delays

And part of the blame can be placed on the provinces themselves . Just as Health Canada is in charge of regulating cultivation license and sales permit approvals, individual provinces are overseeing the rollout of cannabis in terms of how the product can be sold -- i.e., whether or not online sales are allowed, and if government-run or private stores operate dispensaries.

For example, in Ontario, Canada's most populous province and the region expected to see the highest amount of cannabis sales, a network of 25 dispensaries isn't expected to open until April. In the meantime, Ontario residents have no other choice but to purchase cannabis from the online store. This limits the ability of Ontario to meet the immediate demands of its residents.

Permitting and red tape are just as much of an issue at the provincial level as at the federal level.

A suspicious-looking young man in a blue hoodie smirking and holding a potted cannabis plant.

Image source: Getty Images.

Don't overlook the black market

Although Canadians can expect a steady ramp-up in production from growers, and more cultivation licenses and sales permits to be approved in the months ahead, it doesn't mean that all consumers will necessarily be turning to legal channels to buy their marijuana. If anything, this supply shortage has been the perfect opportunity for black market growers to dig in their heels and claim substantial market share in the cannabis space.

One of the biggest issues for legal channels is going to be competing with the illicit market on price. Even with Trudeau backing a low excise tax rate of 10%, black market consumers won't owe this tax. And illicit producers won't pay federal income tax, nor will they twiddle their thumbs waiting for a cultivation license or sales permit from Health Canada.

It's evident from the early sales figures that the legal marijuana market will be huge. But it's also feasible to expect the black market to hang on to more of its share than initially expected following this shortage. In other words, it might be time for marijuana stock investors to reduce their expectations a bit.

10 stocks we like better than Aurora Cannabis Inc.
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has quadrupled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Aurora Cannabis Inc. wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of November 14, 2018

Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends OrganiGram Holdings. The Motley Fool has a disclosure policy .



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of NASDAQ, Inc.

Related Articles