Last year, the marijuana industry made history... many times over. But nothing took precedence over Canada becoming the first industrialized country in the world to legalize recreational cannabis, with sales commencing on Oct. 17, 2018. Even though Canada substantially trails the U.S. in terms of aggregate annual legal weed sales, it's setting an example among industrialized countries that the legalization of marijuana is possible.
Now, the biggest date of 2019 is rapidly approaching. And wouldn't you know it, it's Oct. 17, once again.
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Why Oct. 17 is a big date for the pot industry (again)
Four weeks from today, laws governing the rollout of derivatives will officially go into effect in Canada. A derivative is an alternative cannabis consumption product that's not already been approved.
Over the past 11 months and change, Canada has allowed for the sale of dried cannabis flower, cannabis oil, and sublingual sprays. Meanwhile, edibles, nonalcoholic cannabis-infused beverages, vapes, concentrates, and topicals, weren't legal. This sort of two-step legalization process was done to allow the industry to find its footing, as well as give regulators time to adjust to cannabis becoming legal for adult purchase. But on Oct. 17, regulations now governing dried cannabis will apply to derivative products as well.
However, investors and Canadian consumers should understand that derivative pot products aren't going to be showing up in dispensaries on Oct. 17. Much in the same way that it took dried cannabis flower brands weeks to begin populating dispensary store shelves, it'll probably be the same story for derivative products. Regulatory agency Health Canada has cautioned that derivative supply won't hit the market until mid-December, with it taking weeks or months thereafter for supply to be adequate to meet demand.
This, of course, is really big news for marijuana stocks, because derivative cannabis products are a considerably higher margin product for the industry, relative to dried flower. In select U.S. states (ahem, Oregon), we've witnessed the oversupply and commoditization of dried flower, leading to weaker margins for pot businesses. We're highly unlikely to see oversupply and pricing concerns from derivatives anytime soon.
A point that is sometimes lost on this derivative launch is that these are products which speak to a younger generation of cannabis users. Not only are derivatives more attractive in the respect that they may not need to be smoked, but they're going to attract potentially long-term customers to the industry.
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Growers go all-out for derivative production
Considering the importance of derivatives to cannabis stock margins, it's not surprising to find that growers have been laser-focused on derivative production for a good portion of 2019.
Some growers, such as OrganiGram Holdings (OGI 1.07%), have chosen to set up a variety of in-house derivative options. During the company's fiscal third quarter, OrganiGram announced that it'd be investing 15 million Canadian dollars into a line of fully automated equipment necessary to produce up to 4 million kilos of chocolate edibles per year. This coincides with OrganiGram's 56,000-square-foot phase 5 expansion which, among other things, is targeted at extra space for derivative production and processing.
The company has also developed a nano-emulsification technology that can speed up the onset of the effects of cannabinoids. This product will first be introduced as a powder that can be added to beverages, but OrganiGram is also actively looking for a partner to help it develop an infused beverage product containing this proprietary technology.
Cronos Group (CRON -1.87%), and its investment partner Altria, are also eager to see the green flag wave on derivatives. Cronos Group's peak annual output of nearly 120,000 kilos per year may not even be enough to place this brand-name pot stock among the top-10 growers. But that's OK with Cronos, as it's placed its attention almost entirely on derivative cannabis products.
For instance, Cronos and Altria will be working together to roll out an assortment of vape products. Altria is well-versed in the adult smoking market and should prove helpful in assisting Cronos Group's marketing efforts and product launches (regarding vapes). Beyond vaping, Cronos Group will be leaning on its partnership with Ginkgo Bioworks to produce targeted cannabinoids at commercial scale, as well as other third-party extraction service providers.
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Speaking of extraction services, there may not be a smarter way of playing the derivatives craze than with third-party extraction providers. As an example, MediPharm Labs (MEDIF -2.46%) only commenced its extraction operations during the fourth quarter. Despite this, MediPharm managed to turn a nominal operating profit of $0.01 per share in the second quarter. The company's sales and profitability are set to soar as growers scramble for derivative exposure. Yet, MediPharm's sales and profits should remain highly predictable with the company locking in contracts for an extended period of time. Soon enough, the company's annual extraction capacity will hit 500,000 kilos.
The one thing to remember about the upcoming marijuana derivatives launch
While, on one hand, the launch of derivative products should be lauded by investors, there's another side to this launch that everyone should be aware of.
As I alluded to earlier, Health Canada has cautioned that alternative consumption products aren't going to immediately hit dispensary shelves once the green flag waves on Oct. 17. Rather, it's going to take time before any sort of supply is built up in the marketplace, with a presumptive two-month gap between when derivative regulations going into effect and when derivative products will begin showing up in licensed stores.
But here's the thing: Product showing up in stores doesn't mean that the supply will be sufficient to meet demand. Similar to what we've been witnessing in the dried flower market, supply issues exist that are likely going to make it difficult for derivative products to find their way into dispensaries, at least in the early going.
Don't get me wrong, I expect derivatives to push sales and margins higher for cannabis stocks across the board. However, I think it's going to be multiple quarters before Health Canada resolves a number of supply issues, resulting in what could be weaker-than-expected sales in the months to come.
Make no mistake: Derivatives are the future of the cannabis industry. Just understand that the future isn't going to happen overnight. Give this industry, and the rollout of derivatives, proper time to mature, and you won't be disappointed.
