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HIGHLIGHTS
  1. Small store numbers, strong black market, surplus expectations to challenge LP growth: RBC
  2. Alberta now has 301 retail cannabis licence holders
  3. RBC lowers target prices for seven Canadian licensed producers

Only 12 per cent of recreational pot purchased in Canada came from licensed retail stores in the second quarter of 2019, RBC Capital Markets said, as retail prices remain far above those on the black market.

The lack of licensed retail stores, strong illicit market, expectations for a supply surplus as inventories build, and vaping health concerns will make near- to medium-term growth challenging for licensed producers (LPs), said RBC Dominion Securities Inc. analyst Douglas Miehm and senior associate Savneet Uppal in a report on Wednesday. The bank subsequently lowered prices targets for seven major producers on expectations for impeded growth.

These outlooks underscore growth prospects for Canadian LPs, who are struggling to secure additional capital as they strive to increase production capacity.

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“We estimate that LPs have shipped nearly twice as much product to provincial wholesalers as the latter have sold to end users. Thus, we believe the single-largest bottleneck limiting legal cannabis consumption is the lack of storefronts in Ontario and Quebec,” the report said.

“While incremental store openings in these two provinces should drive a step-function increase in sales, we believe the pace and absolute number of locations will remain too low over 2020 to drive meaningful conversion of the illicit market.

Alberta granted its 301st retail cannabis licence this week, as it by far has more legal pot shops than any other province. Its population, however, is roughly a third of in Ontario, Canada’s biggest consumer market.

After the legal industry started last year with a supply deficit, RBC now sees oversupply on the horizon, following a considerable build in inventories and increased harvest sizes.

“We believe there is a growing amount of cannabis that consumers do not want, setting the stage for oversupply,” RBC said.

“Health Canada data suggests that LPs and distributors/retailers have several months of inventory on hand, which without a meaningful uptick in demand could lead to product returns, pricing pressure at the wholesale level, and limited follow-on provincial orders for all industry participants.”

Earlier this week, BMO Capital Markets said the amount of cannabis that LPs sold to provincial wholesalers dropped by half in July, raising concerns products will be returned and inventory values will fall, and causing it to lower its price targets for growers.

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On Wednesday, The Green Organic Dutchman Holdings Ltd. said it was “reviewing financing alternatives” needed to complete construction at two of its facilities, due to “changing market conditions” that have made financing “unavailable on acceptable terms within the timeframes required,” the company said.

Additionally, the “vaping crisis” of deaths and illnesses largely from illicit vaporizers in the United States, will likely reduce sales when new vape products are soon permitted to be sold in stores as consumers are likely to take a cautious approach, and regulators could even delay the launch set for December.

“Interestingly, the price per gram sold appears to have increased since the onset of legalization. This is consistent with price hikes seen on some of the best-selling products in different provinces, according to our Elements data,” the report said.

Meanwhile, prices on Canada’s illicit market declined after recreational pot was legalized in October 2018, with the discount to licensed retail prices widening to around $4.72 per gram from $3.31.

“With illicit users flagging price as a growing deterrent towards migration into the legal market – and that effect now looking more pronounced – we believe legal demand is likely to remain limited,” RBC said.

“The data also indicate that with increasing pricing spread, illicit consumption has increased on a relative basis and the main driving force appears to be pricing vs. accessibility or quality/variety. We also believe this trend will worsen as value-added formats are launched.”

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Michael Armstrong, associate professor in the Goodman School of Business at Brock University, viewed the estimate that only 12 per cent of recreational pot consumed in Canada comes from the legal market as too low, suggesting it would imply that national consumption is nearly double Health Canada’s estimate.

“I expect retail pricing to become important nationally sometime next year. Currently, it’s probably only an issue in provinces with ample stores, and even then mostly for oils,” Mr. Armstrong said.

“But once the basic ingredients of store counts and supplies are taken care of, the price of legal dry cannabis will need to drop. Quebec has a big head start on this.”

Price targets lowered for seven licensed producers

RBC lowered price targets for LPs, due to the Canadian recreational market issues noted in its report with several companies also expected to be impacted by a more muted uptake of vape products, which are likely to first be launched in retail stores in December or January 2020. Also a source of pressure for several LPs is slower growth of international revenues.

Canopy Growth Corp.: Price target dropped to $41 versus $50 previously.

Aurora Cannabis Inc.: Price target dropped to $7 from $8 previously.

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Tilray, Inc.: Price target US$31 versus US$45 previously.

HEXO Corp.: Price target $6.50 versus $10 previously. This was the only LP that RBC downgraded to “perform” compared with prior “outperform” status, on challenging industry dynamics and the departure last Friday of the company’s chief financial officer.

OrganiGram Holdings: Price target $8.50 versus $10 previously.

Sundial Growers: Price target US$13 versus US$16 previously.

CannTrust: Price target $2.50 versus $5 previously.

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