The big day that we've all been waiting for is nearly here in Canada. Following the commencement of recreational cannabis sales on Oct. 17, 2018, and the implementation of regulations regarding marijuana derivatives exactly one year later (Oct. 17, 2019), we're now just days away from these alternative consumption options officially hitting dispensary shelves.
There's obvious excitement surrounding derivatives, such as edibles, vapes, and cannabis-infused beverages, among the investment community. But as you'll see in a moment, it's not all peaches and cream for marijuana stocks. With derivative sales about to kick off anytime now in Canada, here are five things you ought to know.
1. Not everything is getting a green light with this derivative launch
First of all, it's important to recognize that the legalization of derivative products doesn't mean it's a free-for-all when it comes to alternative consumption options. Although consumers will now be able to purchase vapes, edibles, infused beverages, concentrates, topicals, and tinctures, cannabis infused with alcoholic beverages is still a no-no. That means Constellation Brands and Molson Coors Brewing, which are alcohol giants and have infused-beverage partnerships in the cannabis space, will have to focus their attention on nonalcoholic infused products.
Furthermore, the federal government set some concrete guidelines as to what tetrahydrocannabinol (THC) concentrations are allowed in derivatives -- THC being the cannabinoid that gets users high. Edibles are only allowed to have 10 milligrams (mg) of THC in a single serving, while concentrates, topicals, balms, and oils will have limits of 1,000 mg of THC per package.
2. Derivatives are what will drive margins for years to come
Make no mistake about it, derivatives are the future of the cannabis industry. Not only are derivatives likely to speak to a younger generation of consumers, but they deliver significantly juicier margins than traditional dried cannabis flower. There's not a marijuana company out there that isn't devoting a good portion of its portfolio or production to these high-margin consumables.
For example, even though OrganiGram Holdings (NASDAQ:OGI) has been devoting most of its sales to the recreational market -- adult-use consumers typically buy dried flower -- it has quite the array of derivative products waiting to hit dispensary shelves. OrganiGram purchased 15 million Canadian dollars' worth of fully automated equipment that'll help the company produce up to 4 million kilos of chocolate edibles each year. It also has a nano-emulsification technology that it'll be introducing as a powder next year that can be added to beverages. This formulation speeds up the process by which cannabinoids take effect. OrganiGram is even one of four chosen partners for the PAX Labs Era vaping device.
Derivatives are the key to long-term success for OrganiGram and the entire North American pot industry.
3. Supply issues in the derivative space will be persistent
Remember that not-so-great stuff I mentioned? Well, despite hitting dispensary shelves any day now, derivatives are going to face the same supply constraints that have plagued the Canadian marijuana landscape since day one of legalization in October 2018.
Thankfully, Health Canada is unlikely to be as much of a hindrance to derivatives reaching consumers as the regulatory agency has been with dried flower. The agency began the year with an enormous backlog of more than 800 cultivation, processing, and licensing applications, and has struggled to approve companies to grow, process, and sell weed in a timely manner.
The bigger issue here is the slow-stepped rollout of physical dispensaries in certain provinces. Ontario, which is home to 38% of Canada's residents, had a meager two dozen dispensaries open at the one-year anniversary of adult-use weed sales. Even with a second round of dispensary licenses issued, the legal retail landscape in Canada's most lucrative province for marijuana is inadequate. That's what's going to stop companies like Canopy Growth and Aurora Cannabis from succeeding right out of the gate.
4. Pricing pressures may rear their head early on
One of the oddest aspects of the supply issues that have persisted since day one is that they've actually led to the oversupply of product cropping up in select provinces. How's that possible with demand in the legal market nowhere near satisfied? Well, with so few legal channels to sell product (i.e., with an inadequate number of open dispensaries), there's been a bottleneck of supply in select provinces, thereby leading to falling cannabis prices.
It's my suspicion that we're only a few months away from seeing the same exact thing happen to derivative pot products. Remember, it took a couple of months before dried flower product supply had built up adequately in existing dispensaries, and we're liable to see this same casual inventory buildup with derivatives. But without a quick means of licensing more retail stores in provinces like Ontario, the same oversupply pitfall awaits derivatives -- and that's a big problem considering the hefty margins they're expected to provide.
5. Vape-related health concerns could subdue a top-selling consumption option
A fifth and final thing to be aware of is that Canada's derivative launch could be marred by the vape-related health scare that's popped up in the U.S. in recent months.
According to the Centers for Disease Control and Prevention (CDC), 2,291 confirmed or probable cases of e-cigarette, or vaping, product use-associated lung injury (EVALI) were reported, leading to 48 deaths. The CDC believes that vitamin E acetate is the culprit behind EVALI, with a majority of the instances tying into black-market product containing THC. As a result, the CDC cautions that consumers not vape liquids containing THC.
This advice is -- pardon the pun -- a clear blow to Cronos Group (NASDAQ:CRON), which expects to lean on its partnership with Altria Group to become a vape market share leader. When Altria became an equity investor in Cronos, the expectation is that Cronos would lean on Altria's marketing expertise and product development prowess. But with fears over vaping safety clearly apparent, potentially the most lucrative derivative product, vaping, may have a subdued launch in Canada. As such, it's probably a smart idea for all investors to continue to temper their expectations for Cronos Group and the entire pot industry.