Canada Is Headed Toward an Epic Glut of Marijuana

In recent years, no industry has grown more impressively than that of legal cannabis. Depending on your preferred source, the legal weed industry is probably growing by 25% to 35% on an annualized basis over the intermediate term, with sales estimates varying from almost $25 billion in North America by 2021 (ArcView) to as much as $50 billion in the United States alone by 2026 (Cowen & Co.).

The public's sentiment toward marijuana is also improving -- at least in the U.S. No shortage of polls over the past year have shown that Americans overwhelmingly favor the idea of legalizing recreational weed, and have even stronger feelings toward legalizing medical cannabis.

Yet it's Canada that's led the way as the premier cannabis market. Having already legalized medical marijuana back in 2001, the country appears to be on the verge of green-lighting the sale of recreational pot to adults by this coming summer. Its Senate is slated to vote on the measure on June 7, with passage and the expected signing of the bill paving the way for adult-use sales to commence in August or September. This could, in all likelihood, add $5 billion a year or more in sales to the industry.

Canada could be headed toward a marijuana glut of epic proportions

As you might imagine, Canadian cannabis growers have been angling to get as much of the medicinal cannabis and recreational market as they possibly can, though recreational sales will account for a significantly larger share of total sales. Organic expansion, strategic partnerships, and acquisitions have been occurring at a blistering pace. In fact, four of the five largest marijuana acquisitions of all-time have occurred within a four-month span.

Unfortunately, this rush to grow capacity as quickly as balance sheets will allow could be setting Canada up for an overabundance of cannabis of epic proportions. Even though no one has any real idea how much marijuana Canadians will demand, there's no shortage of guesstimates.

A recent online report from Grizzle figured countrywide demand at around 800,000 kilograms per year. Meanwhile, uOttawa estimates the annual Canadian consumption at 770,000 kilograms, while a 2017 report from the Office of the Parliamentary Budget Officer projected 655,000 kilograms in purely recreational demand. This was at a time when medical cannabis producers were delivering around 80,000 kilograms a year. Everything is a guess at this point, and most folks probably have their preferred source, but the relative consensus is that 730,000 kilograms to 800,000 kilograms is where the annual demand floor lies.

That's a lot of cannabis...

How does that stack up against annual production estimates for growers? Let's take a look.

Canopy Growth Corp. (NASDAQOTH: TWMJF) will likely be the largest producer in Canada. It already has seven facilities operating on 665,000 square feet of growing space, and it's constructing or developing 3.4 million square feet of growing capacity in British Columbia. Though it hasn't offered any production estimates, it could conservatively be generating north of 300,000 kilograms per year, if not 350,000 kilograms by 2020.

Aurora Cannabis' (NASDAQOTH: ACBFF) latest operating results guided toward 240,000 to 270,000 kilograms of annual production. Most will come from Aurora Sky and its Danish Aurora Nordic project, which are expected to yield more than 100,000 kilograms and 120,000 kilograms, respectively. Aurora Cannabis' acquisition of CanniMed Therapeutics, the costliest pot buyout in history, should also add 19,000 kilograms in annual cannabis capacity.

Not far behind Aurora is Aphria (NASDAQOTH: APHQF), which should yield around 230,000 kilograms of dried cannabis a year. Its four-phase organic project should yield 100,000 kilograms, while a strategic partnership with Double Diamond Farms will add another 120,000 kilograms. Aphria's acquisition of Broken Coast Cannabis tacks on another 10,500 kilograms a year.

After going public last year, MedReleaf's (NASDAQOTH: MEDFF) expansion at Bradford, Ontario, plus its existing Markham facility, will combine for 35,000 kilograms a year. More recently, its acquisition of 164 acres of property, 69 of which had an existing facility (the Exeter Facility) that'll be retrofitted to grow cannabis, should add another 105,000 kilograms. In total, MedReleaf can produce 140,000 kilograms a year.

Earlier this week, OrganiGram Holdings (NASDAQOTH: OGRMF) revised its production guidance upward after higher yields proved sustainable. Having once expected its Moncton location to produce 65,000 kilograms, OrganiGram now believes it's capable of 113,000 kilograms a year, once its expansion is complete in April 2020.

Like Canopy Growth, Supreme Cannabis Co. hasn't provided an in-depth production forecast. Instead, it's been working on forging supply agreements, often around 1,000 kilograms a year. Still, Supreme Cannabis Co.'s 342,000-square-foot 7 Acres property could easily produce between 30,000 kilograms and 50,000 kilograms per year.

Royalty company Cannabis Wheaton Income Corp. (NASDAQOTH: CBWTF) is a bit of a wildcard given that it isn't a producer. As a middleman, it supplies up-front capital to growers looking to expand in exchange for low-cost weed that it can turn around and sell for a profit. The company expects 230,000 kilograms in delivery that it can turn around and sell at market prices by 2019. Discounting what could be coming from partnerships with the names mentioned above, Cannabis Wheaton still probably brings 150,000 kilograms or more to market from small- and medium-sized growers.

Sunniva recently signed a deal with Canopy Growth to supply the world's largest pot stock by market cap with 90,000 kilograms of capacity per year, for two years. Sunniva's 700,000-square-foot facility should be capable of conservatively producing 60,000 kilograms to 70,000 kilograms a year when ramped up.

Emerald Health Therapeutics (NASDAQOTH: EMHTF) hasn't offered any specific production guidance, but is constructing 1 million square feet of capacity that'll house its headquarters, as well as retrofitting a 1.1-million-square-foot facility with Village Farms International that had been used for tomatoes. If Emerald Health options its entire land lease, it could control 5.8 million square feet of growing capacity. Even without this option, the company could sport close to 200,000 kilograms of capacity within two years, by my best guess.

Marijuana prices could plunge, and smaller players may go broke

In total, 91 growing licenses have been issued by Health Canada, and this quick snapshot of a few of the players above accounts for only about 20% of those licenses (not counting Cannabis Wheaton and its licensed partners). Combined, just this small snippet of growers are capable of 1,500,000 kilograms of capacity by 2020, give or take perhaps 100,000 kilograms. That's more than double the consensus guess for demand in Canada, and it doesn't even take into account around five dozen additional licensed growers not mentioned here.

The wildcard is what foreign markets might bring to the table. Canadian growers are among a very small group of countries with the OK to ship dried cannabis to countries that've legalized medical cannabis. According to a report by Targo Consulting, seven countries -- Germany, Croatia, the Czech Republic, Argentina, Chile, Peru, and Australia -- could demand about 193,000 kilograms of cannabis for medical purposes annually. A softening stance in Europe toward medical pot could push this figure even higher, but it's unlikely to absorb what could be 600,000 to 1,000,000 kilograms in oversupply by the turn of the decade from Canadian markets.

Where would this excess cannabis go? Certainly not the U.S., as President Trump made clear when he coerced Israel to shut down its medical marijuana exporting ambitions (most of which would have been headed to the U.S.). Plus, with Attorney General Jeff Session at the helm, expansion of the industry is going to be nearly impossible.

This potential glut of cannabis could decimate margins in Canada and put poorly funded or smaller operations out of business. Similar to how Walmart throws its weight around to put mom-and-pop shops out of business, larger operations are geared to survive in a low-margin environment. The excess cannabis used to flood the market could be perfect for driving out competition and eventually leading to higher prices once fewer players remain.

Needless to say, there appears to be a need for a lot of industry consolidation if supply is ever to come close to meeting demand.

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