As the U.S. cannabis market continues to heat up with incredible expansion possibilities, the Canadian cannabis companies may be facing industry limits. Sales have been increasing in the Canadian market, but analysts suggest that the increased expenses to operate, more competition and reduced prices for the products, will result in the inevitable lack of growth. This will undoubtedly hurt the Canadian focused cannabis companies.
Canada certainly enjoyed that first to market advantage as the country legalized adult-use cannabis before any other country. The companies were able to establish bank accounts and the stock markets were able to list cannabis company shares. While some industry insiders cautioned that the market would ultimately be limited, most didn't care to listen and pushed ahead with enormous grow facilities that are now being taken off the market.
The Good News
Stifel wrote in its report, which was based on data from Headset, that it expected sales in January to have increased 106% over 2019's January sales and to have dropped 1% sequentially from December. This is a stronger start to 2021 than expected. Stifel believes sales will hit C$4 billion in 2021, which is a 61% increase over 2019. The analysts also wrote, "We estimate sales in the Canadian adult use market will double over the next two years reaching C$6 billion in annual sales before the category slows to a high-teens rate of growth. We believe the market has a long-runway for growth with continued conversion of the illicit market alongside continued mainstreaming of the category."
The lure of these billions have allowed Canadian cannabis companies to raise lots and lots of money. Producers have raised roughly $1 billion in the past few months, having said that, the deals have had somewhat unattractive terms that came with significant warrant coverage. Still, the companies have raised money even though there may be limited places to use that investment.
Another positive is that the Canadian market will be enjoying a rollout of second wave products, which Headset noted accounted for 24.7% of sales in January. The second wave products include beverages, concentrates, edibles, topicals and vapes. The first wave products which included dried flower, pre-rolls, oils and capsules grew by 7.7% sequentially in January. The new products grew 22% sequentially. Products like vapes and edibles have captured market share in the U.S. of 25% and 12%, respectively. So there is a lot of room for these products to grow in popularity in Canada.
The Bad News
Here are the reasons Stifel is cautioning about upcoming headwinds. The first is the growing number of participants in the industry. Stifel wrote: "Since March, the number of producers with a product in Headset measured channels (Alberta, British Columbia, Ontario physical stores, Saskatchewan) has grown from roughly 70 to nearly 150 in the latest data with Health Canada issuing over 500 production licenses." The report also pointed out that in some provinces, the market is saturated with stores, living little room for expansion.
Discount pricing is also an issue. The average price-per-gram of dried flower in Headset measured channels had fallen to C$6.76 in January from C$9.27 in March. "The deep discount segment represented 46% of dried flower category sales in the three months ending in January, growing 28% over the last three months," wrote the analysts. The super premium brands only increased in sales by 2%. More competition at lower prices will make it harder to be profitable.
What This Means For Canadian Companies
Stifel has a sell rating on Canopy Growth (CGC) . The report said that Headset trends suggested "Canopy's sales grew 9% sequentially, just below the market, with a stronger performance in January buoyed by sales in Ontario. But the growth is driven primarily by discount offering Twd. with sales of all other brands down 11% including a 20% decline from second wave platform." The discounting on products may have protected the company's market share, but Stifel believes Canopy's outlook for 9% pricing compression over the next year is optimistic.
The company also has a sell rating on Aurora Cannabis (ACB) , which seems warranted as the Headset data is pointing to sales dropping 8% over the last three months. Stifel said that the decline was heavily weighted to flower including sales of the Whistler brand which the company touted as a priority during the September earning call. "The company has undertaken significant actions to transition the company focusing on premium offerings. But executing this transition will at best take time, likely suggesting continued risk to our fundamental outlook which requires Aurora's adult use business to resume growing in line with the Canadian market," Stifel analysts said in the report.
Things look a little better for Hexo (HEXO) , which will report earnings on March 18. Stifel recently increased its estimates for HEXO, and said it currently expects fiscal second-quarter revenue to grow 10% sequentially. On the downside, the analysts believe the company's ambitions for beverages to achieve over 10% market share of the Canadian category are "ambitious and extremely difficult within the confines of the current regulations." If Hexo receives approval for its plan to buy Zenabis (ZBISF) , that would be a great move since Zenabis' Namaste brand is the second largest PAX partner.
Cronos Group seemed to be the one company in the group that has taken a lighter touch to the Canadian market. Having said that, Headset data showed the company's Spinach brand was now the twelfth largest brand with total sales just ahead of Aurora's San Rafael and Canopy Growth's Tweed brand. Cronos has focused more on global markets, which may serve it well as Canada faces market limitations.
Despite the market disruptions of Covid, many producers managed to weather the storm. Lockdowns in Ontario certainly impacted many companies, but those problems seem to be easing. The real problem is what the market will look like in a couple of years. While sales continue to go higher in the next months as more stores are added, at some point there will be no room for expansion. There are only so many cannabis consumers in Canada and they are fewer than those in the U.S.