The OCS Announces A Margin Change…Is It Too Little, Too Late

Although sales of recreational cannabis in Canada have been increasing, business conditions for licensed retailers have not improved.

Due to the challenging nature of the Canadian cannabis retail market, several retailers have merged or been acquired by other operators. We believe a primary reason for the uptick in merger and acquisition (M&A) activity with Canadian cannabis retailers is related to how these companies are trying to become profitable.

From the strength of the illicit market to the tax structure for legal operators, the cannabis retail market in Canada faces important challenges. In an effort to alleviate some of these challenges, the Ontario Cannabis Store (OCS) says it will be reducing its price margins in an attempt to help cannabis retailers compete with the illicit market.

Last week, the OCS announced the margin change and we are favorable on the development. According to the provincial cannabis distributor, the change will be implemented in September and we are not surprised by the length of the time delay prior to its implementation.

The OCS estimates the change will put $35 million back in the hands of licensed cannabis companies this fiscal year and $60 million in the 2024 fiscal year. Going forward, the provincial cannabis distributor expects these amounts to compound annually and we will monitor how the change benefits Canadian cannabis companies.

At the start of 2019 (shortly after legalization in Canada), the average price for cannabis was $11.78 per gram. In 2021, the average price per gram of cannabis fell to $7.50 and we find the drop in price to be substantial (according to a November report from Deloitte Canada and cannabis research firms Hifyre and BDSA).

According to the November report from Deloitte Canada, Hifyre and BDSA, prices for cannabis 2.0 products have also been squeezed. When vape cartridges were legalized, the average price per gram was $32.02. Around a year later, the average price was closer to $19, a more than 40% decline.

OCS Margins Are Just Part Of The Problem

Most Canadian cannabis producers are not profitable and these firms blame the illicit market, excise taxes and OCS margins for the trend. During the last year, several large scale Canadian Licensed Producers (LPs) have closed facilities and reduced headcount to lower costs and remain viable businesses.

Although we think the OCS’ decision to reduce its price margins is a step in the right direction for the Canadian cannabis industry, we believe it is not enough to combat the pressure that legal cannabis operators have faced. Going forward, we hope to see these companies receive additional support from the Canadian government and will monitor how the process progresses.

Some of the companies that have been especially impacted by the overregulated and overtaxed Canadian cannabis sector include:

1. Canopy Growth Corp. (Nasdaq: CGC) (TSX: WEED)
2. SNDL Inc. (Nasdaq: SNDL)
3. High Tide Inc. (Nasdaq: HITI) (TSX Venture: HITI)
4. Aurora Cannabis (Nasdaq: ACB) (TSX: ACB)
5. HEXO Corp. (Nasdaq: HEXO) (TSX: HEXO)

Too Little Too Late?

Although we are favorable on the OCS’ decision to lower margins, we would be much more excited if the change took immediate effect. September is more than six months away and many Canadian cannabis operators are running on fumes (from a cash and resource standpoint).

By the time the change takes effect, we expect several more Canadian LPs to close facilities and believe we will see much more consolidation. While we are usually a fan of M&A because of the benefits of the combined company, we believe the upcoming M&A cycle will be the result of companies needing to consolidate to survive.

If you are interested in learning more about consolidation in the Canadian cannabis sector, please send an email to support@technical420.com with the subject “Consolidation & Cannabis” to be added to our distribution list.

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Michael Berger is Managing Partner of StoneBridge Partners, LLC and Founder of Technical420.com. Prior to entering the cannabis industry, Michael was an Equity Research Analyst at Raymond James Financial covering the Energy Sector. Michael has been featured in publications such as The Street, Bloomberg, US Money News, and hosts various cannabis events across North America.

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