- BMO downgrades Sundial to “perform” on signs suggesting lower LP-to-LP pricing and demand;
- HEXO’s $16.9-million inventory writedown due to decline in cannabis prices;
- Cannabis 2.0 products could offset falling dried flower prices in early 2020;
As wholesale pot prices inch lower and unfinished inventories pile up, some licensed producers (LPs) reveal inventory writedowns are taking bites out of revenues as the Canadian cannabis industry struggles to shake off sector-wide sluggishness.
With a flurry of LP financial reports expected over the coming weeks, the degree to which Canada’s nascent cannabis industry is reeling from product returns and lower business-to-business (B2B) prices will be further clarified as provincial wholesalers prepare warehouses to accommodate newly legalized concentrated products that are expected to increase revenues in 2020.
On Wednesday, BMO downgraded Alberta-based Sundial Growers Inc. to “perform” from “outperform” due to “recent developments” that suggest lower LP-to-LP demand and pricing.
“We believe a number of data points have recently emerged suggesting there is now less demand and lower pricing in the LP-to-LP market, which represents the majority of Sundial’s current revenues,” BMO said in a report.
Earlier this week, HEXO Corp., one of the country’s major LPs, revealed a $16.9-million writedown of inventory that the company bought in fiscal 2019 but was unable to sell at a profit due to decline in cannabis prices. This accounted for 30 per cent of its $56.7-million loss for its fourth quarter 2019. This was due to price compression in the market after the Gatineau, Que.-based grower bought a considerable amount of cannabis from other LPs to meet what was expected to be strong retail demand.
But the number of licensed stores to open in the first year of recreational cannabis legalization was lower than expected and wholesale prices fell as overall production ramped up.
“Purchasing that product was before we had full visibility on store count, and so quite frankly, in hindsight, purchasing that product was a mistake,” the company’s chief executive told analysts on a conference call.
Prior to reporting net revenue at $15.4-million for the three-month period ended July 31, HEXO cut its revenue guidance by 40 per cent. This was largely due to the return of $2.9-million worth of wholesale product and an additional $3.8-million impairment charge due to the company’s expectation for additional product to be returned.
“Until there is better visibility into HEXO's ability to ‘rightsize’ its operations to reaccelerate revenue growth and improve margins, we remain on the sidelines,” said BMO Capital Markets in a report.
“We note pricing in the LP-to-LP market had been very high earlier this year (upwards of $8/g) given the supply shortages back then. We believe a number of the larger LPs had purchased third-party product at these price levels.”
Several analysts downgraded HEXO this week, citing lower selling prices as one of the reasons.
In a separate report, BMO calculated the amount of unfinished inventories held by LPs continued to grow to 339,000 kilograms in August, up 11.5 per cent from July, noting that provinces have become more selective with their purchases to ensure retail products are better aligned with consumer demand.
RBC Capital Markets also viewed HEXO’s financial results negatively “given the pricing, margin, product return dynamics, and soft guidance relative to the Street.”
Jefferies Equity Research noted in a report that gross margins dropped 16 per cent sequentially, with the benefits of scaling up unable to offset price compression while the build-up of inventory suggests the LP cannot yet sell the product.
The Supreme Cannabis Company Inc., which sells to other LPs, said in a September report that it reduced its selling price estimate for premium flower by 2 per cent in the three-month period ended June 30 “to account for greater expected volatility in the wholesale market,” while it also lowered its estimated selling prices for premium cannabis trim by 15 per cent.
Harvest One Cannabis Inc., a relatively small Vancouver-based LP, logged a $181,000 write-down of inventory in fiscal 2019 “that did not meet the quality standards for dried flower sale and revalued as extraction grade cannabis” in a financial report.