Despite a solid outlook for the Canadian cannabis market and producers who have raised almost $1 billion over the past few months, Stifel analysts delivered a sobering report on the industry. 

We believe it will be increasingly difficult to profitably capture growth in the Canadian market with “strengthened balance sheets” across the sector likely facilitating continued irrational deployment of capital with limited prospects of a shakeout driving the market towards rationality. 

Good News For Canada

First, the good prognostications got the Canadian cannabis market. Stifel worked with Headset data to create its latest report. Headset covers roughly 65% of the Canadian sales market and is a good indicator of the overall health of the industry. Sales in January 2021 were up 106% over 2020, but down 1% from December 2020. This is leading the analysts to forecast that the market will reach over C$4 billion in 2021 sales. The analysts also estimate sales in the adult-use market will double over the next two years reaching C$6 billion before slowing to a high-teens rate of growth.

The analysts also suggested that the second wave of new products hitting the markets will be a boost to the industry. Vapes, edibles, and beverages are new to the Canadian consumer. However, packaging restrictions and THC caps are issues that could prove challenging to producers. Flower, as usual, is the big category leader, unfortunately for producers prices for flower continue to fall. “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.”

Lead analyst W. Andrew Carter wrote, “Despite our robust outlook, we outline an increasingly competitive environment and uneven performance by Canadian producers. Latest Headset trends suggest robust growth for HEXO (HEXO.CN; C$8.85; Hold) providing support for our recently revised estimates ahead of F2Q21 on March 18th, softer trends from Aphria (APHA.CN; C$23.01; Hold) suggesting risk to our F3Q21 estimates, January market share gains for Canopy Growth (NASDAQ: CGC); C$42.06; Sell) driven by discount brand Tweed. but also outperformance in Ontario with the company likely placing significant focus on this key customer, and continued declines from Aurora Cannabis (ACB.CN; C$13.25; Sell).”

Canadian Capital Raising Is On Fire

Remember the bear market of 2019? Tight capital? Cannabis companies struggling to find anyone willing to invest? Those days are over. Stifel wrote, “Between ATM issuances, warrant exchanges, and equity offerings, Canadian producers have raised roughly $1 billion in the past few months. Offerings completed by Canadian producers have been on relatively unattractive terms burdened with significant warrant coverage. Aurora Cannabis (ACB.CN; C$13.25; Sell) has completed two equity offerings since early November raising over $300 million issuing 36 million shares (23% dilution) with attached warrants suggesting another potential 9% dilution.”

The analysts went on to say, “The shares of Sundial Growers (SNDL; $1.30; NC) were caught up in the “GameStop Saga” to which the company furthered its long-term prospects by announcing a $100 million unit deal including close-to-the-money five-year warrants, followed by a $74.5 million unit including close-to-the money warrants, and then raising another $89 million exchanging the issued warrants for newly issued close-to-the money five years warrants. And the company utilized roughly $225 million of its outstanding ATM amid the volatility suggesting nearly $500 million in capital raised on market volatility.” Within the Stifel report, it is worth noting that Sundial was listed as having a sales decline of 17% through January 2021 for three months trailing in four provinces. That number improved (?) to a decline of 12.5% by the end of February 2021 for three months trailing. 

Fortunes have changed dramatically. The analysts noted that companies struggling with meeting debt covenants just months ago now have hundreds of millions of dollars “with limited organizational investment remaining to compete in the Canadian market, and we have been surprised some institutions have favored renegotiating debt over pursuing value creation through recourse options.” 

Any category shakeout will have to be driven by provinces and consumers through differentiated capabilities and brands, and Canadian market restrictions makes building brands extremely difficult at this stage of the market’s development.

Cheap Weed Wins

The Stifel report also highlighted that 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 of 2020. “Against increased competition at the producer level, we find the total inventory at the provincial/wholesale level has gone from 76 days in March 2020 to 56 days in October 2020, though that increased to 68 days in November.” Producers are seeing their profits decline as discounted cannabis brands are commanding a large size of the shipments. That combined with higher excise taxes on the percentage of gross sales has combined to cut into profits.

The analysts noted that Canopy Growth has been aggressively cutting prices in order to protect market share. “We believe Canopy’s outlook for 9% pricing compression over the next year is optimistic within the context of the current market.”