Canadian Cannabis Firms Addressing Illegal Markets

Real Money [April 1, 2020]

These companies initially seemed to believe that regulators and law enforcement would drive out the illicit market dealers. That hasn’t happened.

The promise of legalization was that it would end the black market for cannabis. The theory was that cannabis consumers would prefer a civilized trip to the dispensary where they could buy well-defined products versus buying from a dealer with little information as to the cannabis purchased.

The problem is that legalization advocates didn’t account for the high taxation driving customers away from legitimate vendors. At the end of the day cheap prices won consumers over lovely dispensaries selling cannabis in fancy packages. Cannabis companies initially seemed to believe that regulators and law enforcement would drive out the illicit market dealers, but that hasn’t happened either.

Jonathan Rubin of Cannabis Benchmarks said, “Canadian cultivators and retailers have already been struggling ahead of the pandemic, as they compete directly with lower priced and more accessible illicit markets. The same goes for ancillary businesses – including processing, packaging, distribution, delivery, and maintenance – that rely on continuous business operation to keep afloat.” He noted the change in March prices as follows: The simple average (non-volume weighted) price decreased $26 to $1,565 per pound, with 68% of transactions (one standard deviation) in the $799 to $2,330 per pound range. The average reported deal size increased to 2.2 pounds. In grams, the Spot price was $2.99 and the simple average price was $3.45.

Looking at the most recent quarterly earnings, it looks like the companies have taken matters into their own hands. No, they aren’t busting illegal operators. Instead, they are creating value products and lowering prices. The companies might have other problems within the filings, but this is just looking at the comments regarding pricing and value brands.

Dropping Prices

For example, Hexo Corp. (HEXO) stated, “We have launched Original Stash, a value brand that is designed to combat the illegal market and increase our overall market share. Original Stash is focused on frequent Canadian cannabis consumers, who want quality cannabis, but are conscious of legal market premiums.” The company said that Original Stash will be offered in 28 gram (1 oz) quantities at black market prices.

That move is being felt in the company earnings as gross adult-use revenue per gram equivalent decreased to $3.49 in the second quarter of 2020 from $4.35 as Original Stash became more popular. The adult-use net revenue per gram equivalent decreased to $2.47 in the second quarter from $3.24 in Q12020.

Approximately 72% of the Original Stash volume sold was to the SQDC which consequently contributed an additional $7,499 (an increase of 61%) of the company’s sales this period from the first quarter fiscal 2020. During the period the company’s sales to the OCS and ALGC decreased by 33% and 40% respectively, while sales to the BCLDB increased 224%.

Cronos Group (CRON) also recognized the issue in its earnings release. The company said in a statement, “We also face competition from illegal dispensaries and the illegal market that are unlicensed and unregulated, and that are selling cannabis and cannabis products, including products with higher concentrations of active ingredients, using flavors or other additives or engaging in advertising and promotional activities that we may not engage in. As these illegal market participants do not comply with the regulations governing the cannabis industry, their operations may also have significantly lower costs.”

In a sign that the company isn’t getting any help from the authorities, Cronos said that “Any inability or unwillingness of the Canadian federal or provincial law enforcement authorities to enforce existing laws prohibiting the unlicensed cultivation and sale of cannabis and cannabis-based products could result in the perpetuation of the illegal market for cannabis”

Zenabis Global (ZBISF) said it believes that persistent competition from the low-cost illicit market, as well as new supply from competitor LPs as their facilities reach full production, is likely to result in declines in the wholesale price of cannabis in 2020 and beyond.

Zenabis said it was able to realize increases in revenue even with downward pressures on pricing in the adult-use recreational market as well, due to lower per gram revenue from wholesale bulk sales as a result of increasing demand for its products, and the expansion of sales of value-added products such as pre-rolls.

Looking Ahead

Other cannabis companies have begun creating value brands that sit in a portfolio alongside craft, premium cannabis brands. Canopy Growth (CGC) offers its twd.28 which will be priced at $4 per gram, with a THC (tetrahydrocannabinol) potency level of 13 to 25. Tilray’s (TLRY) bargain brands is called “The Batch,” while Aurora Cannabis is producing “The Daily Special.”

It’s a smart move by the big players as the prices don’t seem to be going higher. Despite the pandemic, Cannabis Benchmarks reported that for April forward wholesale prices fell $25 to $1,375 per pound.


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