How the Cannabis Industry Ended Up in a Downturn

How the Cannabis Industry Ended Up in a Downturn
Photo by Sharon McCutcheon

It has become very apparent that the cannabis industry has a major problem on its hands; from disappointing earnings reported by the major players, to the huge round of employee layoffs. The writing is very much on the wall. Cannabis could be facing a pretty severe slump.  

One of the most telling warning signs that something is amiss in the cannabis industry was last month’s announcement from CannTrust.  In the wake of its massive unregulated pot scandal, the Ontario giant reported that it would be laying off up to 140 employees.  The company is currently dealing with the fallout of the scandal, and is working to reacquire its production and sales licenses that were suspended by Health Canada.  According to chairman Robert Marcovitch, “reducing the Company’s current operating expenses supports our financial sustainability, and places us in the best position to fully resume production upon the reinstatement of our licenses. We look forward to rehiring at that time.”

Licensed producer Hexo Corp. announced that they, too, would be laying off 200 employees. The company would also shutting down several facilities in the process. The decision was due to unpredictability in the market, as well as a desire to drive down costs.

Canada is not the only region facing issues.  The cannabis industry in California has been reeling over the last few months.  Earlier in November, both CannaCraft, a Sonoma County-based retailer, and Grupo Flor, a vertically integrated cultivator and retailer out of Monterey County, announced that they would be laying off staff as well.  CannaCraft pointed both to the lack of growth in California’s legal market and to issues with regulations, stating that “we believe appropriate action by regulators and continued efforts by licensed companies to provide a clean, high-quality product ultimately will drive long-term growth for the regulated industry,”

What’s Causing The Downturn?

Singling out one defining factor is temping, but the industry has been hit from multiple angles. To make matters worse, many of these factors are out of the industry’s control. How quickly they can correct themselves remains to be seen.

Disappointing Industry Sales Numbers

One of the biggest issues has been the schism between expectations and reality.  This is especially true in Canada, where last year’s legalization was supposed to unleash a torrent of legal sales.  

Alberta has fared quite well, but Ontario and British Columbia have suffered due to a slow retail rollout process.

There’s also the discrepancy between legal and black market prices. This is especially true in Canada and states likes California.  The high price of flower is driving customers away from legal retail outlets, cutting into their sales and driving profits down.  

The proof is in the numbers, which have been down across the board. Many of the industry’s major players have seen their stocks tumble over recent months.  Canopy Growth, one of the worlds largest companies and a major licensed producer in Canada, has reported rapidly falling revenue.  Aurora and Hexo Corp. have also reported similarly dismal revenue, far below what both companies initially expected.

Lack Of Institutional Investment

The issue isn’t so much a lack of investment, but where that investment is coming from.  Many institutions still fear investing in cannabis, thanks in large part to its status as a Schedule 1 drug in America.  The industry is overwhelmingly dominated by retail investors, many of whom have been quick to ditch their stocks at the first sign of trouble.  According to Nicholas Vita, CEO of Columbia Care Inc., “until the larger institutional investors in the U.S. begin to look at the sector from a long-term perspective, I think you’re going to see a lot of volatility”.

Regulations And Taxes

Some of the blame can be laid on the industry itself, but current regulations haven’t helped.  In Canada, government has been facing criticism since the rollout of legalization regarding what many view as heavy-handed regulations, such as those placed on the country’s licensed producers.  

At the retail level, a lack of permits being issued by a number of provinces has created a situation where purchasing legal flower can be a headache.  Ontario and Quebec, the two most populous provinces in the country, still don’t have nearly enough retail outlets to serve their populations.  Ontario still has well under 100 stores serving a provincial population of over 14 million people. Quebec has just 23 stores serving a population of over 8 million.  

All of this has helped contribute to an environment with lower overall sales.

High state tax rates are having a serious impact on legal cannabis businesses in some US jurisdictions.  The effect is particularly profound in California, which not only has some of the highest cannabis taxes in the country, but is actually planning on increasing them in 2020.  Combined with the fact that these businesses still can’t write off federal taxes thanks to cannabis’s status as an illegal drug, many of these companies have seen their tax rates skyrocket.

Scandals

Last, but certainly not least, have been the scandals that have plagued cannabis over the past year.  The fact that CannTrust, one of the Canada’s largest cannabis companies, was caught flagrantly violating federal regulations is something that’s tarnished the image of the industry.  Add in the rash of respiratory-related deaths thanks to black market vape products, and it’s easy to see why some investors have opted to jump ship.

2020 is on the horizon. Investors will be watching closely to see if the industry can be turned around.

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