At this time last year, there arguably wasn't a hotter or more popular investment opportunity than marijuana stocks. It's not hard to understand why, either, if you simply look at the industry's recent growth trends or Wall Street's sales forecasts.
Between 2014 and 2018, worldwide weed sales more than tripled to $10.9 billion, according to the State of the Legal Cannabis Markets report from Arcview Market Research and BDS Analytics. Furthermore, a variety of Wall Street projections have been calling for roughly a fivefold to 18-fold increase in sales by the end of the next decade. This aggressive growth forecast is what made pot stocks so popular among retail investors, and is a big reason cannabis stocks expanded their production capacity as quickly as they could.
But one year has made a world of difference in the cannabis space.
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Sales expectations fall off a cliff in Canada
The near-exponential initial rise in marijuana sales simply hasn't materialized in Canada, because of a host of regulatory and procedural issues.
For one, regulatory agency Health Canada hasn't been able to effectively tackle a nearly insurmountable number of cultivation, processing, and sales license applications. It entered the year with more than 800 license applications on its desk, which in many instances has meant that brand-name pot growers are waiting months, if not longer than a year, before getting the go-ahead to produce and/or sell their product.
Canada has also been plagued by the slow rollout of physical dispensaries in select provinces. Just as Health Canada oversees grow farm licenses, it's up to each province to regulate the licensing of physical dispensaries. Ontario, for instance, has 14.5 million people but only around two dozen open retail locations. That's about one dispensary for every 604,200 people. That's simply not enough of a brick-and-mortar footprint, which is ultimately driving consumers back to the black market.
These supply challenges are creating an odd scenario to our north. With new product beginning to hit the marketplace, yet few channels present in some provinces to get this product in front of consumers, it's led to oversupply and rapidly falling per-gram prices for some growers.
Image source: Getty Images.
Major pot stocks are beginning to cut production for 2020
The good news, if there is any to be had here, is that these regulatory and procedural issues are fixable. Health Canada, for instance, is now requiring growers to complete their cultivation facilities before submitting their grow license applications. We've also seen Ontario outline the next stage of its retail lottery process, which should roughly triple the existing brick-and-mortar network in the province.
But all of these "fixes" are going to take time to have an effect, which means the real possibility that supply concerns will persist throughout 2020. Because of this, a number of growers have voluntarily, or in one instance forcefully, cut back on expected production.
It began with a corporate update from The Green Organic Dutchman (TGODF +0.00%) on Oct. 18. In that update, the company outlined plans to reduce operating expenses and push toward positive operating cash flow by the second quarter of 2020. Part of this spending-reduction plan includes idling output at the company's flagship Valleyfield property. Though fully capable of 130,000 kilos of peak annual output, Green Organic Dutchman will only keep four grow rooms active at Valleyfield in 2020, with an expected output of 10,000 kilos. When combined with its Ancaster campus, TGOD is on track to yield only 20,000 to 22,000 kilos in 2020, well below its peak yearly run rate of 219,000 kilos.
Then, 11 days later, on Oct. 29, Quebec-based HEXO (HEXO +0.00%) made a similar announcement while delivering its fiscal fourth-quarter operating results. In addition to cutting 200 jobs to better align its expensing with the challenging market environment, HEXO announced that it would idle its Niagara grow farm, which came over with the Newstrike Brands purchase. Previously touting 150,000 kilos of annual peak output, HEXO aims to produce around 80,000 kilos in 2020.
Image source: Getty Images.
Next, it became Aurora Cannabis' (ACB +0.86%) turn last week. The company behind the most popular pot stock in the world announced that it would immediately halt construction on Aurora Nordic 2 in Denmark and Aurora Sun in Canada to reduce near-term expenses. Aurora Nordic 2 was expected to yield at least 120,000 kilos per year, with Aurora Sun producing at least 230,000 kilos annually. Instead, Aurora Cananbis' fiscal first-quarter report notes that just six grow rooms spanning 238,000 square feet will remain in operation. This effectively takes 320,000 kilos to 330,000 kilos of annual run-rate production (basically half of Aurora's annual run-rate output) off the table.
There's also CannTrust Holdings (CTST +0.00%), which currently has its cultivation and sales licenses suspended by Health Canada because of its admission that it grew cannabis in five unlicensed rooms for a period of six months. Health Canada is allowing CannTrust to complete the harvest and processing of plants that are already propagating, but no new cultivation is being allowed in the meantime. As a result, CannTrust has confirmed it'll shed 140 jobs, at least temporarily, until such time as it regains its licenses. For the time being, this means up to 300,000 kilos of peak output are out of commission.
Combined, TGOD, HEXO, Aurora, and CannTrust, along with minor cutbacks at Cronos Group's Peace Naturals campus, might remove as much as 1 million kilos of expected run-rate output next year in Canada – and this could be just the beginning. We haven't heard any talk of production cuts from Canopy Growth, which is the No. 2 global producer by peak estimated output behind Aurora, or Aphria, which finally received licensing for its joint venture Aphria Diamond facility after at least an 18-month wait.
It's great that marijuana companies are being proactive about the dynamic market conditions in Canada and are looking to reduce their costs, but it's also a real shot in the arm that pot stock operating results are going to be ugly, with a capital "U," for quite some time.
