Margins on pot production remain hazy and unclear to investors
|Toronto Star 14 Nov 2017 at 13:27|
WINNIPEGâ€”If thereâ€™s one thing thatâ€™s still hazy in Canadaâ€™s nascent marijuana market, itâ€™s how wide the margins are on that dime bag.
With less than nine months left before recreational cannabis becomes legal in the country,Â analysts and investors are still unclear who the big winners and losers will be.
Some publicly traded pot companies donâ€™t report how much a gram of dried bud costs them to make and if they do, the numbers arenâ€™t uniformly calculated. Moreover, producer margins could start to shrink as provinces start to purchase pot wholesale.
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Selling prices â€świll certainly cut in half perhaps from what they are now, and cost of production will matter,â€ť said Mike Gorenstein, chief executive officer of Toronto-based Cronos Group Inc. â€śItâ€™s not going to be 80- or 90-per-cent margins forever.â€ť
The pending margin squeeze comes as investor optimism over recreational sales has sent valuations soaring. Canopy GrowthÂ Corp., the countryâ€™s first marijuana unicorn with a market cap of more than $3 billion, has seen its share price rise more than 80 per cent in the past 12 months, while Aurora Cannabis Inc. more than doubled. MedReleafÂ Corp. is up more than 90 per cent since its June debut.
Medical marijuana is currently sold direct to consumers for about $7 to $12 a gram, depending on quality. Prices for recreational pot could probably drop to C$4.50 to C$5 as provinces such as Ontario and Alberta plan to purchase marijuana wholesale,Â said Jason Zandberg, an analyst with PI Financial in Vancouver.
What the price drop will do to margins is nebulous because there isnâ€™t an industry standard for reporting production costs,Â said Vahan Ajamian, an analyst at Beacon Securities Ltd. in Toronto. For example, itâ€™s difficult to determine whether Canopy Growthâ€™s reported costs of $2.78 a gram are being calculated the same way as MedReleafâ€™s $1.46.
Companies will probably disclose even less information about their costs of production in the coming months as producers competing for supply contracts will want to maintain a competitive edge, Zandberg of PI Financial said. Itâ€™s difficult to look at an earnings statement and try to extrapolate which companies will be successful in five years when looking at cash flow, earnings and price-to-earnings ratios, he said.
Some producers are focusing on lowering costs in order to help maintain robust margins.
Leamington, Ont.-based Aphria Inc.â€™s cash costs per gram were 95 cents last quarter and further cost efficiencies are pending so the company will be â€śin the driverâ€™s seatâ€ť in terms of lowering the selling price without sacrificing margins, CEO Vic Neufeld said in an interview.
Companies are also looking to geographic diversity to make up for price declines in Canada.
â€śIf a particular province sets wholesale prices too low, thatâ€™s OK, we have options,â€ť said Aurora Cannabis executive vice-president Cam Battley, noting global demand exceeds supply and the company owns a medical distributor in the European Union and is paid a premium for its products in Germany. â€śWeâ€™re in a sense inoculated against anything we donâ€™t like.â€ť
Canopy Growth expects provinces to purchase bulk products at a price â€śpretty closeâ€ť to the current average in the medical market, said CEO Bruce Linton.
While there will be some short-term pressure, the companyÂ has multiple markets, including medical and international, and is focused on different forms of marijuana that can eventually be sold at a higher margin, such as infused beverages, he said.
â€śThis is a transitional thing,â€ť Linton said by phone. â€śOver time, we can maintain our margins creating evolved products.â€ť
Large producers that have established and expanded their operations to lower their costs will continue to do well along with smaller craft growers that can sell their products at a higher price, Cronos Groupâ€™s Gorenstein said.
Companies that are still trying to raise capital to expand their operations may have a tough time competing. There will come a point when supply meets demand, and â€śthere will be a very rapid price compression,â€ť he said.
If margins shrink, companies that will be successful will need to make up the difference on volumes, said Chris Damas, editor of the BCMI Report.