Investors Panic as Cannabis Shortages Plague Industry

Pot stocks like Canopy Growth Corp (TSX:WEED)(NYSE:CGC) are getting hit hard as supply chain troubles continue. Buy the dip or stay away?

| More on:
Red siren flashing

Image source: Getty Images.

We’re more than a month into the legal cannabis era, and supply shortages are still plaguing the industry. According to industry insiders, cannabis stores are still low on product, and some have been temporarily forced to shut down because they don’t expect to re-stock for weeks.

The cannabis industry was widely criticized for how it handled legalization, with some saying that the supply shortages could have been avoided. Aurora Cannabis’s (TSX:ACB)(NYSE:ACB) CEO Terry Booth was quick to counter this by saying that everyone saw the shortages coming, but the fact that they continue to plague stores to this day remains a major concern. Some have speculated that shortages are the main culprit for a cannabis “panic sell-off” that started on October 17, the day legalization hit.

The big question is how all of this will affect cannabis stocks in the long term. To answer it, we need to look at why the shortages occurred, and how long it will take to achieve some semblance of normalcy.

Reasons for the shortages

There are a number of theories circulating to explain why cannabis shortages are occurring.

According to Khurram Malik of Biome Grow, regulations and tight timelines were the main culprits for the shortages. The federal government put strict quality requirements on producers mere months ahead of legalization, which resulted in companies having to change course to meet the new guidelines … so that theory goes.

Another theory holds that the federal government took too long to approve licences. With many producers waiting months to hear if they’d be licensed, they had only a few weeks ahead of legalization to ready their supply. This theory might explain why the supply of cannabis was short in the beginning, but it doesn’t seem to explain why supply still hasn’t caught up with demand. According to some projections, it will be years until the cannabis supply stabilizes, which doesn’t square with the idea that this is all because producers had too little time to get ready.

Investors getting antsy

At this point, it’s hard to say exactly what’s going on with cannabis supply chains. What’s undeniable is the effect it’s been having on investors. Broadly, cannabis stocks have been getting pummeled since the week of legalization. One high-profile example is Canopy Growth (TSX:WEED)(NYSE:CGC), which has fallen 36% from its October high. Although the cannabis sell-off was initially attributed to profit taking by early shareholders, it has gone on long enough that one has to wonder if a more fundamental cause is behind it. Given that supply shortages are now driving cannabis customers back to black market vendors, it’s hard not to wonder if that might be the cause.

Effects on earnings

On the surface, supply shortages look like bad news for the cannabis industry. However, whether that is really the case depends on the underlying cause. If the theory that government regulations caused the shortages is wrong, and it’s simply massive demand that caused the problem, then cannabis companies should be seeing significantly increased sales. However, they are “losing” revenue compared to what they would be generating had they been fully prepared. In the end, we’ll need to wait for 2019 to see how the earnings picture turns out.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Andrew Button has no position in any of the stocks mentioned.

More on Investing