The legal cannabis industry is figuratively -- and literally -- budding before our eyes. In just a few short years, it's gone from generating a few billion dollars in legal revenue each year to an industry that, by the end of the next decade, could be cranking out $50 billion to $75 billion in annual sales, according to various Wall Street estimates.
But as is common with nascent industries that are still finding their footing, hiccups are aplenty in the early going.
The Canadian pot industry has more problems than it can count in the early going
Canada, which became the first industrialized country in the world to OK recreational marijuana, has been contending with a persistent supply shortage that looks as if it'll take many quarters to resolve. A combination of mammoth cultivation, processing, and sales application backlogs at Health Canada, mixed with a shortage of compliant packaging solutions, has tied the hands of producers and left unfinished cannabis sitting on the sidelines. Recently announced policy changes at Health Canada may help alleviate some of the application backlog it's been contending with for years, but there's simply no easy fix for the shortage facing dispensaries in our neighbor to the north.
Another problem is that marijuana stocks aren't delivering the green -- at least yet. Most forecasts projected a rapid ramp-up of sales and quick turn to profitability for most pot stocks. But stagnant supply caused by regulatory red tape and packaging shortages has left pretty much all growers running in the red on an operating basis.
The black market is also a concern. Although Canada chose to implement a reasonably low federal excise tax of 10% on recreational cannabis, a number meant to derive enough revenue to cover regulatory enforcement costs for provinces and the federal government, it still overlooks the fact that the black market pays no excise taxes, income taxes, or licensing fees. Thus, the black market continues to thrive, even in markets where weed has been legalized or decriminalized.
And lastly, we've been witnessing the erosion of average selling prices (on a per-gram basis) on dried flower. Much of this decline is due to the start of wholesale shipments to provinces for the recreational market, as well as the absorption of excise taxes by pot growers.
This small-cap cannabis specialist isn't like its peers
But whereas pretty much every grower has seen their per-gram sales price for cannabis decline in recent months, one of Canada's under-the-radar growers announced a rising per-gram price for its cannabis in its fiscal first-quarter operating results last week. Ladies, gentlemen, and investors alike, if you aren't familiar with Flowr Corp. (NASDAQOTH: FLWPF) as of yet, pull up a chair and grab your favorite beverage.
Small-cap grower Flowr is probably off most people's radar because it's not a top-tier producer. It trades on the over-the-counter (OTC) exchange, which means its average daily trading volume can vary, and it receives little coverage from Wall Street. However, this doesn't make Flowr forgettable. In fact, this company is far from it.
Flowr's Kelowna campus in British Columbia is currently being developed to support at least 50,000 kilos of ultra-premium-quality cannabis per year when operating at full capacity. The first part of the Kelowna campus (K1) is expected to be completed in the third quarter of this year, with the K2 expansion forecast to provide four times the capacity of K1 when it comes online. Producing 50,000 kilos may not even place Flowr in the top 15 growers in Canada by peak output, but there's little denying that its use of genetics and focus on quality are paying off.
According to figures from management, Flowr aims to yield 300 grams per square foot, which is roughly triple the industry average, and as far as I can tell tops in the industry. Flowr should be able to do more with its square footage than any other marijuana grower, which I would expect to lead to above-average margins.
More important, in the company's first-quarter results, we saw a 9% increase in average selling prices per gram of dried cannabis (7.70 Canadian dollars vs. CA$7.08 in Q4 2018) from the sequential fourth quarter. As pretty much the only grower with rising average per-gram pricing, it demonstrates just how strong the demand is for ultra-premium cannabis. At the same time, there's virtually no chance of a supply glut for the ultra-premium cannabis segment, meaning this pricing power for Flowr shouldn't be fleeting.
To build on this point, something else to consider is that the ultra-premium pot buyer isn't necessarily part of traditional cannabis culture. Rather, ultra-premium consumers tend to be more affluent, making them less likely to change their buying habits if the Canadian or global economy weakens, and they're more about the experience than being part of "the cannabis movement."
Flowr's portfolio is growing, and it may soon be on the move
Of course, there's more to Flowr than just 50,000 kilos of ultra-premium cannabis.
For starters, there's the Flowr Forest, which includes 150,000 square feet of outdoor growing space adjacent to its primary campus, as well as 42 planned greenhouses, each of which would span 4,500 square feet (189,000 square feet in aggregate). When fully licensed, much of this outdoor-grown marijuana will likely be used for extraction purposes to create premium-quality derivative products, such as oils. Don't forget, by this coming October, we should see Health Canada waving the green flag on new consumption options, which could open the door for premium-quality edibles and beverages.
The Kelowna campus also features a research-and-development center that'll be staffed by employees of Flowr and Scotts Miracle-Gro (NYSE: SMG) subsidiary Hawthorne Gardening. Scotts Miracle-Gro's cannabis-focused subsidiary provides nutrients, lighting, soil, and pest-prevention solutions to the medical cannabis industry throughout North America, and Flowr will be angling to examine how these components can be used, with genetics, to maximize flower quality. With Flowr expected to conservatively produce 300 grams per square foot, Scotts Miracle-Gro and Flowr aim to boost yield to as much as 450 grams per square foot with their ongoing research.
Finally, the company's days on the OTC exchange may be numbered, with a move to the Nasdaq being viewed as something of a given. As stated in Flowr's first-quarter operating results press release:
A listing on the Nasdaq Stock Exchange should substantially improve visibility and daily trading volume, lessening volatility. It may also open avenues to additional partnerships beyond just Scotts Miracle-Gro.
Flowr may be a tiny tot, but it looks to be separating itself from the pack in the early stages of recreational legalization in Canada.
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