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Supply Shortages, Regulatory Hurdles to Keep Marijuana Stocks Depressed

The recent rout in Canada’s marijuana stocks has left many investors wondering if that was an end to the pot party that, according to some forecasters, had just started.

The reality in the market is quite different than what many speculative investors were hoping for after the legalization of recreational cannabis use in Canada.  

Since the country legalized recreational pot on Oct. 17, marijuana shares have been under pressure on concerns about high valuations, supply shortages, and limited distribution networks in the country.

In Ontario, Canada’s largest province, the supply distribution is in total chaos. The province has decided to sell marijuana only online. But its newly created online channel, Ontario Cannabis Store, is unable to supply orders on time. In some cases, it’s taking more than two weeks for the order to arrive.

As I’ve warned in my earlier articles, the legalization-triggered rally wouldn’t last long, as there is many a slip between the cup and the lip!

First, not all companies in the marijuana space will succeed at the execution stage, which requires producers to have an efficient system of production, packaging, delivery, and marketing. Aphria (TSX:APH) CEO Vic Neufeld predicted the supply shortages on the company’s earnings call last month.

Citing supply-chain issues, labour shortages, and delays in getting licences and excise stamps from the government, Neufeld said Aphria would be unable to meet demand in the first two to three months after legalization. The company was forced to destroy almost 14,000 plants worth $979,000 in the last quarter due to a lack of qualified greenhouse workers.

Another concern hitting marijuana stocks quite hard is the fear that if supply bottlenecks continue and the government fails to create a smooth system to transfer demand from black market to legal channels, then investors won’t be able to justify high valuations they have attached to these pot stocks.

Aphria trades at a 12-month trailing multiple of 85, and Aurora Cannabis trades at 60, even after the recent pullback in their share prices.

“The extremely limited distribution network in many provinces, fulfillment challenges in Ontario, inventory shortage in Quebec and LPs coping with limited availability of excise stamps may take several months to be resolved,” according to GMP Securities analyst Martin Landry. “It becomes increasingly clear that recreational cannabis sales in 2018 will be much lower than previously expected.”

Bottom line

I believe the downward move that started soon after the legalization of pot in Canada has still more room to run. The report card of the past two weeks suggests that it will take a lot of time before companies and the regulators could work out a system where marijuana demand is met through the legal channels. That means a long wait for investors who were hoping a quick sale boom for some top marijuana companies.

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Fool contributor Haris Anwar has no position in the companies mentioned.

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