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Growing cannabis supply glut means ‘investors should be bracing for impact’

Photo taken in Portland, United States (GETTY CREATIVE)

Canada’s cannabis producers are harvesting enough pot to satisfy 81 per cent of the total demand projected by Health Canada. The problem is, legal sales in June amounted to just 14 per cent of demand by volume, according to new data from industry researchers TheCannalysts.

Analyst Craig Wiggins warns the disconnect between cannabis being harvested by licenced producers and their actual share of the market is a looming problem for investors and the industry alike.

“Are we going to get to 81 per cent displacement of the illicit market? Because that’s what we are producing now. By the end of October, we should be at 100 percent, which is scary,” Wiggins told Yahoo Finance Canada. “Investors should be bracing for impact.”

He divided Health Canada’s reported sales figures by the agency’s projected overall demand for cannabis (including black market) — 11,171 kilogram-equivalents sold through legal medical and recreational channels in June, versus the market consumption of 77,167 kilograms per month. The answer: 14 per cent market penetration of the black market. Meanwhile, the amount of legal cannabis harvested per month tops 62,671 kilograms and is increasing rapidly.

“Every couch cushion in Smiths Falls must have some weed under it,” Wiggins said, referring to the small Ontario town where cannabis giant Canopy Growth Corp. (WEED.TO)(CGC) has its main facility. “The industry keeps adding more and more production capacity. It’s going to get way worse.”

Canopy Growth reported total sales of 10,549 kilograms equivalents in its most recent quarter, versus 40,960 harvested. Aurora Cannabis Inc. (ACB.TO)(ACB) sold 17,793, and produced 29,034. Tilray Inc. (TLRY) sold 5,588, and produced 11,474.

Anticipated demand from new retail stores and stockpiling inventory ahead of the Canadian release of so-called cannabis 2.0 products (edibles, drinks, vapes and topicals) are the often-cited reasons for rising supply. Wiggins isn’t convinced either will absorb the growing glut of cannabis sitting in company vaults.

“What the data is telling us is 2.0 and more stores aren’t going to solve the problem for the industry on the whole,” he said.

“Forty to 50 per cent of any mature cannabis market is still flower. If you’re not a good flower right now, what makes you think 2.0 is going to save you. That’s only half of your business, if you’re lucky. Granted the margins should be better. But these are companies that weren’t very good at putting dope in a baggie going into advanced manufacturing. It ain’t going to be easy.”

Wiggins expects Health Canada will need to have an action plan in place to deal with bankrupt companies as the industry swings from a cannabis shortage to an oversupply situation that renders lower-grade product held in vaults worthless and pushes down overall prices.

“Think how many companies went out there and built their business model on selling 50,000 kilograms a year at $5 per gram. Then there is a huge glut of supply and they are going to actually sell 25,000 kilograms at $3 per gram,” he said. “That’s part of the iceberg under the water.”

He also notes sales reported by licenced producers are dramatically outpacing actual retail sales as provincial wholesalers ready themselves to stock new stores.

So what happens when licenced producers can no longer rely on large orders based on new store openings, and oversupply weighs on prices?

“Think of it like oil extraction out of the ground. There comes a time when you don’t pump. You leave it in the ground. It might be that companies don’t fully plant their greenhouses,” Wiggins said.

“I’m very bullish on the industry as a whole over a period of time. But in any growth industry, we need to get rid of the losers. Dead weight in any industry makes it very murky. Something has to give.”

Yahoo Finance Canada