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The Canadian Marijuana Industry Is a Disaster, and Aphria Just Confirmed It

Roughly one year ago, the cannabis industry could do no wrong. Canada had just become the first industrialized country in the world to give cannabis the green light in the modern era, and it was widely believed that, by the turn of the decade, marijuana stocks would be seeing green (i.e., become profitable).

Furthermore, there was excitement about the upcoming launch of "Cannabis 2.0." This is a fancy way of describing the launch of derivative products, such as edibles, infused beverages, vapes, topicals, and concentrates, which weren't legal between Oct. 17, 2018, the official launch date of adult-use sales, and Oct. 17, 2019, which is when regulations concerning derivatives went into effect.

A cannabis leaf laid within the outline of the Canadian flag's red maple leaf, with rolled joints and a cannabis bud to the left of the flag.

Image source: Getty Images.

But as you're probably aware, the grass has not been greener on the other side of legalization. In fact, things are downright awful in the Canadian pot space at the moment. Since the end of the first quarter, pretty much every major marijuana stock has seen 50% or more of its valuation wiped away. In many instances, we've also witnessed a serious deterioration in operating forecasts or industry fundamentals.

What's to blame for this disastrous performance? While cannabis growers can take a small portion of the blame for slow-stepping their initial round of cultivation expansion, most of the problems tie back to regulatory agency Health Canada.

Health Canada means well, but is a main source of supply problems

On the one hand, there is no modern era precedence to an industrialized country waving the green flag on cannabis, so Health Canada is nothing more than a guinea pig that's trying to figure out what does and doesn't work.

Further, Health Canada's tight oversight is certainly needed to ward out any illicit activity. For instance, if Health Canada hadn't been thoroughly reviewing its licensed producers, it may not have discovered that CannTrust was producing illicit marijuana in five unlicensed rooms for a period of six months. In other words, Health Canada's strict regulatory approach does have its perks.

However, the agency has also been a nuisance in the supply department. It entered the year with a cultivation, processing, and sales license application backlog that topped 800. With so many applications to review, the length of time it took to get the go-ahead to plant and/or sell marijuana grew substantially.

How do we know this? Just ask Aphria (NYSE: APHA).

An up-close view of a flowering cannabis plant in a large indoor grow farm.

Image source: Getty Images.

Aphria exposes Health Canada for the obstacle it truly is

Aphria is a top five, maybe even top three grower, with peak annual output forecast at 255,000 kilos. Unlike industry giants Canopy Growth and Aurora Cannabis, which have 10 and 15 grow farms, respectively, Aphria plans to produce this 255,000 kilos from a very small number of farms:

  • Aphria Diamond: This joint venture project will account for 140,000 kilos per year.
  • Aphria One: This is the company's organically constructed cultivation farm that's capable of 110,000 kilos per year.
  • Broken Coast Cannabis: Broken Coast was acquired by Aphria in early 2018 and should produce about 5,000 kilos annually.

The Aphria Diamond joint venture is of particular interest, given that it was formed with Double Diamond Farms in January 2018. Double Diamond already had existing vegetable-growing greenhouses, meaning that the duo would simply need to retrofit those greenhouses for cannabis production. This is a means to save time and money, rather than building a greenhouse from the ground up. As such, Aphria expected little trouble in getting cultivation licensing approval for Aphria Diamond.

Somewhere between this January 2018 joint venture announcement and the publication of Aphria's quarterly management discussions and analysis on April 14, 2018, Aphria filed the appropriate licensing paperwork with Health Canada. This past week, on Nov. 1, 2019, it received its approval to begin planting. It took somewhere between 18 and 21 months for Health Canada to review and approve an application of an existing greenhouse project that simply needed a retrofit. That's a problem. 

It's also worth noting that, as of May 2018, the average sales license application was taking 341 days to approve. Since May 2018, the number of sales applications has significantly increased.

A Canadian flag with a cannabis leaf replacing the maple leaf, and the words, Sold Out, stamped across the flag.

Image source: Getty Images.

Health Canada makes changes, but the backlog remains

Earlier this year, Health Canada did announce a change to its cultivation license application process that was designed to reduce its backlog and expedite its review process. Rather than allowing growers to submit cultivation applications anytime they chose to, the agency now requires that grow farms be completed and ready for inspection prior to submitting the application. In theory, this should remove a number of underfunded operations.

However, it still doesn't explain how a large-scale company like Aphria, with preexisting greenhouses that simply needed to be retrofit, took 18 to 21 months to get a simple cultivation license from Health Canada.

The length of time Aphria took to get the green light to cultivate at its joint venture property also suggests that what backlog remains at Health Canada is going to take a significant amount of time to work through. That's worrisome, because there are a number of massive projects (ahem, Aurora Cannabis) that are awaiting approval from the agency.

And while this supply is being kept off the market, Canada's illicit producers are thriving. The per-gram price difference between legal and black-market marijuana ballooned to 45% in the third quarter, with one Wall Street estimate suggesting that illicit growers will gobble up 71% of all weed sales in Canada this year.

While all of Canada's cannabis problems are fixable, the one that needs attention, first and foremost, is Health Canada.

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Sean Williams owns shares of CannTrust Holdings Inc. The Motley Fool recommends CannTrust Holdings. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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