Fundamental bottom in Canada cannabis industry? Signs point to ‘no’

By Mike Regan and Craig Behnke , Equity Research Analyst

It was not a good earnings week for Canadian cannabis companies. Canopy Growth announced price cuts and wrote down significant amounts of inventory, while Aurora Cannabis pulled back its expansion plans.

Have we hit bottom in Canada cannabis?

Probably not.

Writing down inventory to the average reported by Health Canada in August (4.7 months), as Canopy did, is not enough to call a bottom on pricing or the financing woes facing the Canadian operators.

This was a period during which Canopy saw significant price declines, including:

  • 16% in the average price per gram for business-to-business sales, to CA$6.32.
  • 7% decline in price per gram to consumers, to CA$10.90.

The company also reported write-downs of CA$14 million because of price cuts.

On the earnings conference call, Canopy CEO Mark Zekulin said that “four to five months of inventory is the ideal length of period for dry flower to ensure we have continuity of availability.”

Canopy’s finished inventory at Sept. 30 stood at 5.1 months using the revenue run rate for the quarter ending that month and 3.8 months using the new lowered consensus revenue of CA$103 million for the quarter ending December.

Fundamentally, the price needs to drop, the supply expansion needs to slow and distribution needs to catch up to soak up the excess inventory and provide some price stability.

In its Nov. 14 fiscal first quarter 2020 earnings announcement, Aurora Cannabis indicated it will reduce capacity capital expenditures by CA$190 million to “better match near-term capacity expansion with anticipated demand.” As part of this, the company plans to plant more higher-potency, lower-yield cannabis strains.

Those are the first steps to better match consumer demand, but it’s likely not enough. We believe industry capacity expansions need to be reduced further, distribution points must increase significantly and derivative products of cannabis 2.0 need to expand consumer demand.

Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19
Dried Flower (kg)
Unfinished Inventory 96,822 99,007 111,693 117,483 120,660 143,773 182,910 222,499 263,333 292,292 328,187
Finished Inventory 18,481 18,724 18,940 20,319 23,154 30,746 31,288 39,921 48,918 57,542 60,872
Sales 6,346 7,285 7,600 7,307 6,683 7,626 8,874 9,524 9,976 11,692 12,917
Unfinished Months of Inventory 15.3x 13.6x 14.7x 16.1x 18.1x 18.9x 20.6x 23.4x 26.4x 25.0x 25.4x
Finished Months of Inventory 2.9x 2.6x 2.5x 2.8x 3.5x 4.0x 3.5x 4.2x 4.9x 4.9x 4.7x

Source: Health Canada