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Amid Shortages, Black-Market Marijuana Is Thriving in Canada

By Sean Williams - Nov 10, 2018 at 4:41PM

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It's time to tone down your expectations for pot stocks.

Roughly three and a half weeks ago, the biggest day in Canadian cannabis history came and went. On Oct. 17, Canada became the second country in the world, other than Uruguay, and the first industrialized nation, to legalize recreational marijuana.

Giving adult-use weed the green light in Canada is expected to result in a surge in demand, sales, and profitability for marijuana stocks to our north. Although estimates vary pretty wildly, as we'd expect to see from an industry with very little legal precedence, legal pot could generate $5 billion or more in annual sales within a couple of years. These pie-in-the-sky revenue figures have been more than enough to entice investors to pile into pot stocks.

A Canadian flag with a cannabis leaf instead of a maple leaf and the words, Sold Out, stamped across the flag.

Image source: Getty Images.

Cannabis shortages are constraining the legal Canadian weed industry

But what many regulators failed to foresee is that the Canadian weed industry wasn't going to go from 0 to 60 mph overnight. Despite provinces' projections that they'd have more than enough marijuana to meet demand, cannabis shortages began almost immediately.

According to Rolling Stone, one licensed dispensary in Winnipeg wound up shutting down after just a few hours because it ran out of product. Manitoba itself has cautioned consumers that it could be months before a full complement of products are back on dispensary shelves.

Meanwhile, USA Today reported shortly after legalization that Quebec's government-run dispensaries saw far more consumer demand than anticipated. On the first day alone, the Societe Quebecoise du Cannabis (SDQC), which manages sales in Quebec, registered more than 12,500 in-store transactions and approximately 30,000 online orders. Many of the SDQC's online products were removed from the website because they were out of stock and expected to remain out of stock for a while. Said the SDQC in a statement, "Given the craze created by the legalization of cannabis and the scarcity of products across Canada, the SQDC expects significant short-term supply challenges for the branches."

A suspicious young man in a blue hoodie holding a potted cannabis plant.

Image source: Getty Images.

Marijuana stocks' pain is the black market's gain

On the other side of the coin, the pain the market is experiencing from shortages has turned into a significant opportunity for the black market in numerous provinces. In particular, the Waterloo Region Record notes that black-market marijuana is thriving in Ontario.

According to the online publication, illicit websites are selling cannabis for as little as $3 Canadian per gram, which is about a quarter of what the product is going for at the supply-strapped Ontario Cannabis Store (OCS). Supply shortages have a natural tendency to pull prices higher, whereas an abundant supply of black-market marijuana has allowed the price for cannabis to remain exceptionally low.

Black-market growers and retailers have been willing to pull out all the stops to make a sale during this transition into a legal environment. Aside from offering marijuana at a notable discount to legal channels, illicit websites have offered expedited delivery within 48 hours. By comparison, government orders processed through legal channels typically take two weeks to fill and deliver. And, of course, illicit channels don't charge a 10% excise tax, nor do they owe income tax to the federal government, thereby adding to their ability to keep their per-gram prices substantially lower than legal growers.

The Waterloo Region Record also suggests that illicit producers have shifted away from traditional retail operations and toward mail orders. Doing so has made it more difficult for law enforcement to track these operations. Further, black-market producers have switched to money orders and even bitcoin-based transactions to enhance their anonymity. 

A professionally dressed woman critically analyzing information in a financial newspaper.

Image source: Getty Images.

It's time to adjust your expectations for pot stocks

With demand high (pardon the pun) and supply insufficient to meet those demands, it's becoming more likely that Wall Street and investors will need to tone down sales expectations out of the gate for most marijuana stocks.

Recently, Wall Street investment firm GMP Securities did just that with Canopy Growth Corp. ( CGC ), Cronos Group ( CRON ), and CannTrust Holdings ( CNTTQ ). GMP Securities wound up reducing its market-share forecast for Canopy Growth from 33% to 20% given its choice to sell just one strain of cannabis at OCS, rather than its full complement of products. As for Cronos Group and CannTrust, GMP cut its sales expectation forecast to 100 kilograms for each company from prior forecasts of 1,800 kilograms and 1,000 kilograms, respectively. 

This reduction in near-term output may not sound like a big deal. After all, Canopy Growth, Cronos, and CannTrust are on track for approximately 500,000, 140,000, and 113,000 kilograms of peak annual production when at full capacity, making all three top-10 producers. But it does have some importance on the operating results for these companies.

With recreational pot now legal, Wall Street and investors are going to be looking for tangible results moving forward. This near-term reduction in yield from shortages suggests that sales will be far less than expected, while net losses could widen. Remember, companies such as Canopy, Cronos, and CannTrust are all busy expanding their production capacity, marketing their products, building their brands, hiring new workers, and/or making acquisitions. These are costly ventures that are likely to push these (and other) marijuana stocks into the red on an operating basis.

While it remains to be seen just how much of a long-term impact the black market will have on legal marijuana in Canada, it's pretty clear that illicit growers aren't going down without a fight.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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