For opportunistic and growth-oriented investors, the legalization of marijuana in Canada is the greatest thing since sliced bread. It gives investors the opportunity to get in on the ground floor, so to speak, of an industry with multibillion-dollar potential.
For added context, a report released earlier this year by Arcview Market Research and BDS Analytics calls for 38% global sales growth in legal weed in 2019 to $16.9 billion. Meanwhile, Wall Street investment bank Cowen Group is even more aggressive with its estimate of $75 billion in global sales by 2030. With big bucks flowing into this industry, the thesis among investors is that there are bound to be big winners.
However, recently released sales data from Canada appears to show that the initial buzz of recreational weed sales is wearing off.
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Canada's recreational buzz is fading
According to the monthly published retail trade sales data by Statistics Canada, here's how much revenue cannabis stores have rung up since adult-use sales began on Oct. 17, 2018 (expressed in U.S. dollars at a conversion rate of $1 to 1.34 Canadian dollars):
- October 2018: $32.03 million
- November 2018: $39.6 million
- December 2018: $41.58 million
- January 2019: $39.7 million
No, your eyes aren't deceiving you. That is indeed a sequential monthly sales decline of 4.5% in January for cannabis store sales, and an aggregate of only $152.91 million in sales since legalization became official in October. Expected to generate up to $6 billion in sales for Canada by 2022, recreational weed sales are on pace for less than $500 million in total revenue on an annualized basis through the first 3.5 months of sales data.
How on Earth could the most popular industry on the planet right now be face-planting so hard out of the gate in Canada? Let's take a closer look.
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Here's why weed sales are flat in Canada
If you want a single scapegoat for Canada's early-stage pot problems, you're out of luck. Instead, it's a combination of factors that's making life difficult for pot stocks and investors.
For starters, pretty much all marijuana stocks are still in the process of expanding their capacity to meet demand. The outlays for capacity expansion were often in the hundreds of millions of dollars for major growers (i.e., those with 100,000 kilos or more of forecasted annual peak yield). This meant that these growers weren't going to commit this much capital until they knew for certain that the Cannabis Act would become law. This didn't happen until, arguably, December 2017 or January 2018, leading to a mad rush to construct greenhouses last year. This late start to capacity ramp-up means full production isn't expected for up to 24 more months.
Second, the cannabis supply chain wasn't prepared, either. Reports suggest that a packaging shortage has left store-ready and unprocessed cannabis waiting in the wings. Health Canada laid out a laundry list of packaging, warning, and labeling requirements that growers and retailers would have to follow in order to get their products onto dispensary shelves. But meeting these requirements is apparently easier said than done.
Third, and perhaps most importantly, we've witnessed a mammoth cultivation license application and sales permit application backlog at Health Canada. Through March 15, 159 licenses (cultivation, processing, distribution, and sales) had been issued. However, there were around 840 license applications (mostly for cultivation) waiting in the backlog for approval or rejection as of January 2019. It takes Canada's regulatory body quite a bit of time to review these applications, and it's meant that even some of the largest names in the industry are waiting for the OK to grow, harvest, process, ship, or sell their marijuana.
Check out the latest earnings call transcripts for the companies we cover.
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Opportunity or peril?
With companies needing time to clear all three of these hurdles, the big question is whether this lull in sales represents real opportunity for investors or if it's a warning to a bursting bubble.
In terms of opportunity, I view this as the perfect time for KushCo Holdings (KSHB) to shine. For those who might be unfamiliar with the company, KushCo supplies packaging and branding solutions for more than 5,000 growers worldwide. It's certainly not the only packaging-solutions company for the cannabis industry, but it's probably the best known. KushCo should be able to use its industry expertise to abate some of the backlog the Canadian supply chain is contending with. Again, this isn't going to happen overnight, but at roughly 2.5 times 2020 sales, KushCo is beginning to look awfully inexpensive considering the growth potential of the global industry.
On the other hand, this lull in sales growth is a bit worrisome for Aurora Cannabis (ACB -1.15%), which, in its October-through-December quarter, supplied about 20% of the marijuana purchased throughout Canada. Aurora is expected to be operating at an annual run rate of more than 150,000 kilos as of the end of this month, but it doesn't appear as if the supply chain is capable of supporting a major uptick in production (at least not yet). But the worry here is that, at a $9 billion market cap, Aurora is valued at quite the premium. If marijuana sales growth remains slower than expected, it's pot stocks like Aurora Cannabis that'll take it on the chin.
Hopefully February's data will show improvement -- but keep in mind that "hope" isn't a recommended investing strategy.
