Amid cannabis boom, cost data leave an­a­lysts dazed and con­fused

The Globe and Mail (Atlantic Edition) - - OPINION - JEN SKERRITT

If there’s one thing that’s still hazy in Canada’s nascent mar­i­juana mar­ket, it’s how wide the mar­gins are on that dime bag.

With less than nine months left be­fore recre­ational cannabis be­comes le­gal in the coun­try, an­a­lysts and in­vestors are still un­clear who the big win­ners and losers will be. Some pub­licly traded pot com­pa­nies don’t re­port how much a gram of dried bud costs them to make and if they do, the num­bers aren’t uni­formly cal­cu­lated. More­over, pro­ducer mar­gins could start to shrink as prov­inces start to pur­chase pot whole­sale.

Sell­ing prices “will cer­tainly cut in half per­haps from what they are now, and cost of pro­duc­tion will mat­ter,” said Mike Goren­stein, chief ex­ec­u­tive of­fi­cer of Toronto-based Cronos Group Inc. “It’s not go­ing to be 80- or 90-per-cent mar­gins for­ever.”

The pend­ing mar­gin squeeze comes as in­vestor op­ti­mism over recre­ational sales has sent val­u­a­tions soar­ing. Canopy Growth Corp., the coun­try’s first mar­i­juana uni­corn with a mar­ket cap of more than $3-bil­lion, has seen its share price rise more than 70 per cent in the past 12 months, while Aurora Cannabis Inc. more than dou­bled. MedRe­leaf Corp. is up more than 70 per cent since its June de­but.

On Tues­day, shares of MedRe­leaf fell as much as 15 per cent to $15.67 in Toronto, while Canopy de­clined 5.4 per cent and Aphria Inc. fell 5.6 per cent. Aurora Cannabis gained as much as 16 per cent to $6.90, touch­ing the high­est in­tra­day price on record.

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 $4.50 to $5 as prov­inces such as On­tario and Al­berta plan to pur­chase mar­i­juana whole­sale, said Jason Zand­berg, an an­a­lyst with PI Fi­nan­cial in Van­cou­ver.

What the price drop will do to mar­gins is neb­u­lous be­cause there isn’t an in­dus­try stan­dard for re­port­ing pro­duc­tion costs, said Va­han Ajamian, an an­a­lyst at Bea­con Se­cu­ri­ties Ltd. in Toronto. For ex­am­ple, it’s dif­fi­cult to de­ter­mine whether Canopy Growth’s re­ported costs of $2.78 a gram are be­ing cal­cu­lated the same way as MedRe­leaf’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, PI Fi­nan­cial’s Mr. Zand­berg said. It’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’s cash costs per gram were 95 cents last quar­ter and fur­ther cost ef­fi­cien­cies are pend­ing so the com­pany will be “in the driver’s seat” 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.

“If a par­tic­u­lar prov­ince sets whole­sale prices too low, that’s okay, we have op­tions,” 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. “We’re in a sense in­oc­u­lated against any­thing we don’t like.”

Canopy ex­pects prov­inces to pur­chase bulk prod­ucts at a price “pretty close” to the cur­rent av­er­age in the med­i­cal mar­ket, CEO Bruce Lin­ton said. While there will be some short-term pres­sure, the com­pany 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.

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 Group’s Mr. 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 “there will be a very rapid price com­pres­sion,” he said.

SEAN KIL­PATRICK/THE CANA­DIAN PRESS

An em­ployee in­spects mar­i­juana plants at Tweed in Smiths Falls, Ont., in Jan­uary, 2016. An­a­lysts and in­vestors are still un­sure how le­gal­iza­tion will af­fect pro­ducer mar­gins.

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