Capacity expansion is in overdrive, and that’s not necessarily a good thing.
These are exciting times for marijuana stock investors. For the first time in history, a developed country stands on the verge of legalizing recreational marijuana. By this coming summer, in either August or September, it appears likely that adults aged 18 and over in Canada will be able to legally purchase cannabis from licensed dispensaries. In doing so, Canada will be opening the door to an additional $5 billion in annual sales, if not more.
The table is clearly set for Canada to succeed. Medical marijuana has been legal in our neighbor to the north since 2001, with Health Canada overseeing the licensing process ever since. In addition to already having key infrastructure in place, the federal government has worked out a two-year tax-sharing agreement with all but one province, paving the way for an orderly launch of recreational weed sales within the next couple of months.
Oversupply concerns are actually getting worse
But while these are exciting times for green-rush investors, they’re also somewhat worrisome. In the wake of an expected recreational legalization, pot stock valuations have headed into the stratosphere. While this has made money for investors, and allowed cannabis companies to raise capital via bought-deal offerings, it’s also led to the growing possibility of a supply glut.
You see, no one has any real clue what demand might look like once Canada gives the green light on adult-use sales. Various government- and province-based reports, along with estimates from Wall Street, have estimated that annual demand could come in around 800,000 kilograms, with perhaps slow but steady growth from there. However, based on fully funded capacity from some of the largest Canadian weed growers, a domestic glut looks increasingly likely.
Just over a month ago, I contended that Canada was headed toward “an epic glut of marijuana.” Since then, those oversupply concerns have only worsened due to ongoing capacity expansion activity. Here’s a brief look at what the six largest growers could now bring to the table annually.
- Canopy Growth Corp. (NASDAQOTH:TWMJF): 400,000 kilograms to 500,000 kilograms (my estimate)
- Aurora Cannabis (NASDAQOTH:ACBFF): 430,000 kilograms
- Aphria: 230,000 kilograms
- MedReleaf (NASDAQOTH:MEDFF): 140,000 kilograms
- OrganiGram Holdings: 113,000 kilograms
- Hydropothecary Corp.: 108,000 kilograms
Mind you, this doesn’t include players like Cronos Group, Supreme Cannabis Company, Sunniva, and Emerald Health Therapeutics (NASDAQOTH:EMHTF). The former three might produce between 30,000 and 50,000 kilograms annually, while Emerald Health has the capacity to eventually push north of 100,000 kilograms.
The supply picture grows murkier
The biggest changes are seen at the top, with Canopy Growth and Aurora Cannabis pushing production ever higher.
Earlier this week, Aurora Cannabis announced that it was acquiring 71 acres of land in Medicine Hat, Alberta, to build the “Aurora Sun” facility. This high-technology hybrid greenhouse should be capable of growing 150,000 kilograms of dried cannabis a year over its 1.2 million-square-foot facility. There will be 850,000 square feet devoted to flowering space, which is larger than its previous flagship project, Aurora Sky. Management anticipates the first planting will commence in the first half of 2019, with completion of the facility in the second half of next year. In short, the 240,000 to 270,000 kilograms Aurora Cannabis guided to just two months ago is now around 430,000 kilograms in fully funded capacity.
Then we have Canopy Growth Corp., which announced on April 13 that BC Tweed, its majority-owned subsidiary, had received growing licenses for two of its British Columbia greenhouses. In total, it now has 2.4 million square feet of licensed grow space, and is on its way to an estimated 5.6 million square feet of capacity. Despite being tightlipped about its annual production capacity, 400,000 to 500,000 kilograms seems reasonable based on its fully funded growing space.
There’s nearly 1.5 million kilograms of annual capacity alone between the top six growers. Once the mid-tier players are added in, along with the dozens of other licensed producers in Canada, we could see annual production hit 2 million to 2.2 million kilograms per year by 2020 or 2021. That would translate into 1.2 million to 1.4 million kilograms in annual oversupply.
The good news is that exporting this oversupply to foreign markets that’ve legalized medical cannabis could abate some or all of this purported marijuana glut. But things could still get worse.
We probably haven’t seen the last wave of capacity expansion
The fact of the matter remains that a number of cannabis growers are just sitting on owned acreage and waiting to pull the trigger on further capacity expansion. Given Aurora Cannabis’ latest move to acquire 71 acres in Alberta, this could be the tipping point that pushes other large and mid-tier players to expand as well.
As an example, MedReleaf recently acquired 164 acres of land in Ontario, 69 acres of which contain the Exeter facility, which it plans to retrofit to grow cannabis. Already with 1 million square feet of capacity from Exeter, MedReleaf has suggested that the adjacent 95 acres could house a 1.5 million-square-foot facility. With “only” 140,000 kilograms in fully funded production, MedReleaf may have little choice but to push forward with this additional facility.
A similar story is seen from Emerald Health Therapeutics. It has a 50-50 strategic partnership with Village Farms International (known as Pure Sunfarms) covering a 1.1 million-square-foot facility being retrofitted for cannabis production, as well as 1 million square feet in wholly owned capacity that’ll also house its headquarters in Richmond, B.C. However, the Pure Sunfarms partnership is also sitting on 3.7 million square feet of land that could be further used for capacity expansion.
Make no mistake about it: This glut could get even worse. And if it does, cannabis prices may suffer, along with margins. This is a major worry that investors absolutely must be aware of if they’re going to put their money to work in marijuana stocks.