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analysis

Last week, Health Canada released its monthly cannabis summary, which showed sales volumes grew substantially from March to April. But work-in-process inventories also rose as finished goods production apparently fell. That raises concerns for subsequent months’ sales. It also amplifies recent fears that some licensed producers (LPs) have cannabis stockpiled that might not get to market, possibly triggering financial writedowns.

For dry cannabis and oils combined, April sales rose 10 per cent to hit 17,049 kg. That constitutes about 22 per cent of national monthly demand, given Health Canada’s estimate for annual demand of 926,000 kg.

Other Health Canada data suggest registered medical users home-grew plants equivalent to roughly three more percentage points. So, altogether, April was likely the first month where legal sources met a quarter of Canada’s demand.

Recreational consumers continued to favour dry cannabis while medical clients preferred oil. But curiously, the biggest sales increases went against type: medical dry grew 25 per cent and recreational oil grew 20 per cent. It seems consumers have acclimatized to the legal industry and begun exploring alternative product formats.

Geographically, the sales growth evidently was concentrated in Ontario. Statistics Canada figures show recreational sales nationally rose $14-million in April, with $12-million coming from Ontario. That was courtesy of the province’s first dozen stores finally opening.

Product-wise, the main growth was in dry cannabis: sales rose 16 per cent to 8,853 kg. That's a great improvement, but legal sales still only meet around one-sixth of estimated dry demand.

Disappointingly, estimated dry finished product processing (9,931 kg) and shipping (8,955 kg) both fell by about one third. The lower output was barely enough to replenish distributors' inventories. That would've limited subsequent sales growth in May.

Oil products saw less change. Sales rose 4 per cent to 8,196 litres, or roughly 39 per cent of oil-related demand. The modest increase implies relatively saturated markets, given that processing, shipping and inventory levels all remained ample.

This implies near-term oil sales growth depends on more stores opening, especially in Ontario and Quebec. Product mix and pricing adjustments might also help. Longer-term growth will come after foods, drinks, vape-ables and topicals becoming legal later this year.

April also saw continued inventory growth, but opinions varied on its implications. Health Canada clearly considers it good, as the department bragged again this week about high inventory-to-sales ratios.

Conversely, some analysts think it’s bad. Bulging inventories imply impending product surpluses, price drops and inventory writedowns.

Furthermore, Bank of Montreal analysts recently suggested that large unfinished inventories might reflect LPs’ difficulties with growing cannabis at industrial scale. Such difficulties might result in “lower yields and quality” than expected and, consequently, writeoffs.

When considering these conflicting inventory interpretations, it helps to distinguish between oil and dry, unfinished and finished.

For oils, inventories grew four times faster for unfinished raw materials (up 32 per cent) than for finished products (up 8 per cent).

That's likely good. Finished products are already plentiful, so there's little need for increased processing. And stockpiled oil soon will be needed for edibles and extracts production.

Dry cannabis is more concerning. Its inventories grew seven times faster for unfinished (28 per cent) than for finished (4 per cent).

Intentional stockpiling seems unlikely here. Current dry product shortages mean producers can sell as much as they can ship, at prices as high as they'll ever get. Voluntarily holding back good-quality flower for eventual edibles production would seem risky.

The inventory growth could instead be due to processing not keeping up with harvesting. This was a problem last fall, and LPs haven’t yet demonstrated sustained improvements in finished goods output.

In this interpretation, unfinished inventories mostly represent processing backlogs. That’s not good, but so long as finished goods remain scarce, prices will stay high. LPs can still avoid writedowns, if they accelerate their processing and shipping.

A more worrisome explanation is that some unfinished inventory might not be worth finishing because of low quality or contamination. It’ll instead need writing-off.

That's certainly possible. Health Canada's cannabis tracking system focuses on quantity: reporting every kilogram of cannabis plant or extract. But it largely ignores quality.

So, “unfinished dry cannabis” might be top-shelf flower. Or low-grade leaves. Or infested material awaiting disposal.

All this implies investors shouldn’t panic over big inventories. But they should note the types of inventories and quiz producers to ensure they can realistically turn those assets into revenues rather than writeoffs.

Michael J. Armstrong is an associate professor in the Goodman School of Business at Brock University.

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