The anticipated consumer market for legal cannabis in Canada will demonstrate a supply deficiency that White Sheep Corp., our Toronto-based cannabis investment company and commercial operator, believes may take as long as four years to stabilize. Estimates, from the RCMP and Deloitte Consulting for the total consumer spend in Canada for cannabis ranges between $3-billion up to $7-billion.
Stoic Advisory reports their assessment of the actual production capacity as of the end of November 2017, to be 120,000 kg., which at an average retail price of $7.50/gram, would supply only $0.9 billion worth of demand. Stoic also estimates that the funded capacity by ACMPR (Access to Cannabis for Medical Purposes Regulations) licensees is 1,400,000 kgs. There is plenty of capacity in the illegitimate, black market which will almost certainly be silently allowed to continue to produce and sell – to fill the gap – while the legitimate channels become established and preferred. Consequently, the gap for legitimate cannabis is real, the question is why, and what can be done to mitigate the gap.
I am a rare industry veteran who has earned two sales licenses under the ACMPR/MMPR (Marijuana for Medical Purposes Regulations), with the dedicated support of exceptional team members. That is, with my prior team at Bedrocan, I am responsible for obtaining over 5% of all the sales licenses issued by HC to date; at Bedrocan #2, it took us 148 days to obtain our sales license from the date we were awarded our cultivation license.
The broad issue is that answering the supply problem with cultivation capacity and additional cultivation licensees only works when the cultivation capacity is approved for sale – it must transition to allowable sales. Applicants and the public markets have been enthused by Health Canada’s accelerated cultivation licensing program, however, cultivation is only a plateau in the process. If history is any indicator, the transition from a cultivation license to a sales license is, and will remain, a slow and onerous process. The lifetime average number of days between cultivation and sales licensing is 363, with an average of 426 days for sales licenses issued to cultivators since the beginning of 2016. (See the length of time it takes for cultivators to acquire their sales license from Health Canada here.) Subsequent approval for production and sale of extracts or other (as yet unapproved) products is even slower.
Here are the real numbers: As of Dec. 19, 2016, there were 35 cultivation licenses in Canada, with only 24 of these granted the legal authority to sell their produce – wholesale or retail. Ten of the eleven not licensed for sales were approved in the last 15 months. All but one the cultivators licensed before the end of 2016 were granted a sales license by the end of February 2018.
Health Canada became acutely aware of the prospective supply problem when highlighted by the Federal Task force and has responded by revising the licensing process and accelerating the number of cultivation licenses issued. In the year and a quarter since Dec. 19, 2016, there were 54 new cultivation licenses granted, however, only 4 of these have graduated to sales licenses. On a calendar basis, Health Canada (“HC”) issued 9 sales licenses in 2017, and so far in calendar 2018, five more cultivation licenses have been escalated to sales licenses. The companies licensed to sell in 2018 are: AB Labs (Invictus IMH.V), MedReleaf (LEAF.TO), Tweed (WEED.TO), Canntrust (TRST.TO) and TerrAscend (TER.CN). These companies are well capitalized veterans of the industry and we should be surprised if they do NOT have the experience and management skill to obtain a sales license.
But, what of these others? All these smaller, marginally capitalized companies? How do they succeed? Why these so-called “delays” in the approval to sell?
Is Health Canada deficient? Woefully inadequate? In my experience, absolutely not. HC does an exceptional job under challenging circumstances dealing with and inspecting inexperienced management entering a newly regulated industry.
The single most significant challenge for these cultivators is poor compliance management and a complete lack of understanding of real success factors required in the cannabis business.
Cannabis is a compliance industry that produces cannabis. It is NOT an agricultural industry that tolerates compliance. Cannabis requires a blend of diligence found equally in the pharma and food manufacturing industries – far more discipline than in most other production businesses.
Moreover, while many growers are good at their tasks, most gained their experience in small and/or illicit operations (basements, garages, the occasional former brewery facility) and do not have the management or technical ability to scale their operations. How do the major companies handle earning a sales license? A look at three successful market leaders:
- Canopy Growth struggled for a few years to build the processes that enabled their Tweed Farms facility to produce a high-quality flower. This is a company with expert leadership, unlimited capital, exceptional facilities, and still, it was difficult – over 2 years to be able to sell cannabis from The Farm. They have learned form the experience at the Farm, and earned a license for the Grasslands facility in 223 days.
- Supreme, a leader in greenhouse grow and an icon in the industry, took 474 days to earn their sales license, and that was for a single 10,000 sq. ft. room supported by a superbly qualified team.
- Finally, Aurora’s success is built on a combination of their 40,000 sq. ft. indoor building in a small Alberta town, the promise of Aurora Sky, (their 800,000 sq. ft greenhouse facility in Edmonton), and wholesale purchases from various other licensees. Aurora was successful in earning a sales license in October 2015 for their Cremona facility with 1,200 sq. ft grow rooms. It took them 245 days under slightly different guidelines. The question is how they will translate their small grow room experience, and scale that into 32,000 sq. ft. individual grow rooms at Aurora Sky. How long will it take Sky to earn its sales license? Can Cannimed’s leadership fill a gap?
So, how will the legal capacity gap be filled? Can the smaller cultivation licensees step up and achieve their sales licenses in a more timely manner? Or will the market need to rely on the larger companies who presumably have the resources and skill to grow their sales capacity?
My point is this: the industry can build all it wants, it can grow all it wants, and it can start to store in the (now unnecessary) vaults all that production capacity, but, in the absence of quality assurance procedures adhered to by every employee of an ACMPR licensee, the company will not be able to sell their product. Note that the migration to oils/extracts/edibles adds a new level of compliance complexity.
Health Canada reports that as of the Ides of March, 2018, there are 485 companies in the cultivation licensing queue. We expect that number to at least double when HC adds “small scale” grows and other new license types. Where will these applicants acquire the leadership, skill and management capability, not to mention capital, to earn the legal right to sell cannabis and cannabis related products? How will these companies sustain their operations while they wait the year or more from investing all that capital into the ground, and then how will they build market share, customers and revenue in a controlled distribution market, that requires (in Ontario), a minimum of five package sizes?
Eventually, I am confident that all of the surviving companies will earn their sales licenses, just in time for a consolidation of the industry. But in the meantime, the companies with inadequate capital and management without their sales license will accumulate inventory – much of it ultimately not able to be sold or processed – and eventually run out of capital. The supply shortage of legal cannabis will remain profound, requiring consumers and the provincial distribution channels to rely on the majors who can demonstrate their leadership and compliance expertise, while silently condoning the illicit market.
Hamish Sutherland is the President & CEO of WhiteSheep Corp.