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4 Ways "Cannabis 2.0" Will Be an Early Disappointment in Canada

By Sean Williams - Feb 13, 2020 at 7:51AM

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The launch of high-margin edibles, vapes, and infused beverages isn't going according to plan.

The stage appeared to be set in 2019 for marijuana stocks to thrive, but this didn't prove to be the case. When the year ended, most cannabis stocks had logged big-time losses for the year, with Canadian pot stocks leading the way to the downside. A combination of supply concerns and a resilient black-market presence have made it very difficult for Canadian growers to thrive.

But throughout 2019, the launch of derivative pot products, such as vape, edibles, infused beverages, concentrates, and topicals, was viewed as the light at the end of the tunnel. Affably known as "Cannabis 2.0," these alternative pot products offer substantially higher margins than traditional dried flower, making them a must-have for any grower's portfolio.

A large cannabis dispensary sign in front of a retail store.

Image source: Getty Images.

Sorry, folks, but the launch of derivatives hasn't gone as planned

However, little has been heard about the sale of derivative cannabis products following their launch in mid-December. Although we'll have to wait a few months to receive accurate sales data from Statistics Canada, it looks safe to say that Cannabis 2.0 has been a disappointment, at least in the early going.

Why? Look no further than the following four reasons.

1. Ontario's licensing woes

Perhaps the most damning issue for the entire Canadian pot industry has been Ontario's inability to license dispensaries. Until the end of 2019, Ontario's retail licenses were awarded via a lottery system, with a meager 24 stores open as of the one-year anniversary of adult-use sales commencing (sales began Oct. 17, 2018). This is a problem considering that Ontario is home to 38% of Canada's population, and it could likely house up to 1,000 retail stores. As a result of too few open dispensaries, supply bottlenecks have ensued.

The good news is that Ontario has abandoned its lottery system in favor of a more traditional licensing process where applications will be received, vetted, and awarded on a regular basis. The hope is that Canada's most populous province will award around 20 dispensaries per month, beginning in April, ultimately pushing the retail store count up to 250 by the end of 2020.

The issue is that this ramp-up will take time. In the meanwhile, Ontario's dispensary count remains low, thereby significantly limiting access to higher-margin Cannabis 2.0 products to roughly two-fifths of the country.

A bearded man in sunglasses who's exhaling vape smoke while outside.

Image source: Getty Images.

2. Alberta's ban on vapes

Another problem for the Cannabis 2.0 movement is that the most popular derivative of all, vapes, has been temporarily banned in Alberta, a province of almost 4.4 million people, or 11.6% of Canada's population.

According to a government spokesperson in Alberta, regulators have no plans to allow vaping products onto dispensary shelves before it completes the Tobacco and Smoking Reduction Act review. This was expected to be completed by the end of 2019, with the results leading to amendments of the Tobacco Act by the spring of 2020. 

In particular, physicians are concerned about the health effects associated with vaping. This comes after more than 2,700 confirmed cases of vape-related lung illnesses in the U.S., and 60 deaths, since this past summer. 

Quite a few Canadian pot stocks are banking heavily on vapes to drive their business. Cronos Group (CRON -0.88%), as an example, received a $1.8 billion equity investment from tobacco giant Altria Group last March. The expectation has long been that Altria would use its expertise in marketing smokable products, as well as its connection with Juul as an equity holder, to aid Cronos in its launch and marketing of vape products throughout Canada. However, with health concerns cropping up in the U.S., and Alberta regulators taking a cautious approach, Cronos is likely to see a weaker-than-expected uptake of vapes in the early going.

A cannabis leaf floating atop carbonation in a glass, with other cannabis leaves to the right of the glass.

Image source: Getty Images.

3. Funding/operational issues with certain growers

A third issue is that a number of growers -- even brand-name pot stocks -- aren't truly ready to meet Cannabis 2.0 demand.

In some respects, the reason for this is entirely procedural. Canopy Growth (CGC -5.96%), for example, stated in January that it was withholding the launch of its suite of infused beverage products. Canopy is expected to be a major player in the infused beverage arena given that Constellation Brands holds a greater than 35% stake in the company and is the perfect partner to provide its expertise on a beverage launch. However, Canopy simply hasn't had enough time to complete its beverage production line since receiving its licenses in November. As such, the company's beverage product launch will be later than anticipated.

The other factor here may have to do with funding. Although investors haven't heard of any specific instances where Cannabis 2.0 product launches were delayed by funding concerns, there's no denying that quite a few cannabis stocks are in need of financing to ensure they're around for the long haul. Examples might include Aurora Cannabis (ACB -3.62%) and HEXO, both of which have instituted significant cost cuts in recent months.

A suspicious-looking young man in a blue hoodie who's holding a potted cannabis plant.

Image source: Getty Images.

4. Taxation

Lastly, go ahead and place at least some of the blame on taxation. Although Canada's tax rate on legal marijuana is significantly lower than in a number of recreationally legal U.S. states, the fact remains that any notable level of taxation on legal pot products, whether it's traditional flower or derivatives, makes it difficult for those products to compete with black-market pricing.

"Too high a level of taxation at the inception of a legal consumer system can be a disincentive for consumers to make that move from black market to legal market," according to Aurora Cannabis' now-former Chief Corporate Officer Cam Battley, via Reuters. Mind you, Aurora has a multitude of problems, including financing concerns, an ugly balance sheet that's buried under goodwill, and has been hampered badly by Ontario's slow retail store rollout. But before his departure, Battley made a great point that competing with black-market producers becomes less likely if tax rates are too high.

With supply still problematic, and the price for Cannabis 2.0 products significantly higher than black market marijuana (including taxes), it would be no surprise if the black market continued to hold significant market share in Canada and pressured early stage derivative sales.

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