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HIGHLIGHTS
  1. LP adult-use cannabis sales to provinces dropped by half in July - BMO calculation
  2. Growth acceleration for LP sales not likely until Q2 2020
  3. Wholesale and retail recreational dried flower prices expected to fall in Q1 2020

The amount of cannabis that licensed producers (LPs) sold to provincial wholesalers dropped by half in July, raising concerns that products will be returned and inventory value will fall, BMO Capital Markets said, adding it has lowered its price targets for growers.

BMO said in a report that it does not anticipate growth to accelerate until the second quarter of 2020 when more stores are expected to open in Ontario – Canada’s biggest consumer market – and the next wave of products reach consumers.

Using monthly data from Statistics Canada, BMO calculates that LPs sold 9,125 kilograms of recreational cannabis to provinces, down 50 per cent from 17,879 kg in June, the biggest monthly volume of sales since adult-use marijuana was legalized in October 2018, according to BMO data.

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“We are concerned about the continuing trend of inventory build-up at both the provincial distributor level (37,000 kg at July end vs. 14,000 kg at January end) and LP level (300,000 kg at July end vs. 123,000 kg at January end) while consumer purchases of legal rec cannabis have grown modestly (from 6,000 kg in January to 11,000 kg in July),” BMO said.

StatsCan data show total finished inventory of recreational dried flower held by LPs rose in July, versus June, as well as sales, but that finished inventory held by distributors and retailers fell slightly.

BMO calculated StatsCan’s end-consumer purchases and inventory held by provinces to see the volumes sold by LPs to the provinces in July.

Wholesale prices for recreational flower are forecast to start declining in the first quarter of 2020, due to elevated inventory held by provinces that, combined with retailers, will likely need to markdown prices to increase sales.

This monthly drop in LP sales combined with slower-than-expected retail cannabis store openings, particularly in Ontario, have caused BMO to downwardly revise annual revenues and lower its target prices. It forecast LP sales dropped roughly 20 per cent to 31,122 kg in the calendar third quarter. BMO forecasts this will grow modestly in the final three months of 2019 to 33,000 kg and reach 47,190 kg by the second quarter of next year.

The move comes at a time of scrutiny towards Canada’s newest industry, with the value of publicly traded cannabis companies hovering around 2017 lows as LP revenues are not as strong as expected while many of the companies continue to invest in production capabilities.

“The magnitude of the sell-in decline in July (down 50 per cent month/month) is significant and if this trend continues into August and September, there would be further downside to our estimates and Street numbers, particularly for LPs with sizable rec market shares (Aurora and Canopy),” BMO said in a report.

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The bank expects LPs that grow in large-scale facilities, such as Aphria Inc., Aurora, Canopy and Tilray, will be flat to down sequentially until more retail stores opens. LPs that grow in smaller-scale and primarily indoor facilities, such as The Cronos Group, Sundial Growers and The Supreme Cannabis Inc., are forecast to increase their market share as their flower products are expected to have quality differentiation versus the over-saturated “midrange” flower segment, BMO said.

While a portion of the inventories are being held in preparation for the legalization of new concentrated products such as edibles and vaporizers later this month, with new products not expected to be on store shelves until early 2020, the rate of licensed retail store openings in provinces such as Ontario have been gradual.

“We believe that unless retail store roll-outs meaningfully accelerate soon and LPs can produce differentiated flower and Rec 2.0 cannabis products that are better aligned with rec consumer demand, there would be an increasing risk of product returns, inventory writedowns and industry rationalization,” BMO stated.

Aurora Cannabis Inc., which recently indicated near-term recreational cannabis sales have “plateaued” as provincial wholesalers work through their large inventories, and Canopy Growth Corp. harvested a total of 70,000 kg in the previous quarter, BMO said.

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