Marijuana Earnings Reveal Troubling Trend in Canadian Cannabis

February 13, 2019

By Chloe Aiello

It's a big week in cannabis earnings ー Aurora Cannabis reported Monday and Canopy Growth will report Thursday ー but Paul Rosen, CEO of cannabis private equity firm Tidal Royalty, said he's noticing a concerning trend.

"All the companies are facing gross margin compression because there are excise taxes, there's a massive marketing spend as we go to recreational cannabis, and there's also increased packaging costs. So I think you're going to see a trend line here, which is revenue and capacity going up, but gross margin is going down," Rosen told Cheddar Wednesday.

Aurora Cannabis ($ACB), which Rosen called "a proxy for what other large marijuana producers will look like when we go recreational," reported its second quarter earnings on Monday, and saw a quadrupling of revenue and an increase in market share. But the higher cost and lower price point of producing recreational marijuana, which Canada legalized in October, contributed to margin compression that sent Aurora shares briefly tumbling after the bell on Monday.

"Sales up, production capacity up, but gross margin [is] down and losses up," Rosen said. "So it really depends on whether you are an optimist or a pessimist. The pessimists can find plenty to pick through here to cause some concern and the optimists can certainly find a lot of reasons for excitement."

Analysts see a similar trend for Canopy Growth ($CGC), as well. According to estimates from analysts surveyed by Thomson Reuters, Canopy Growth is expected to report CAD$81 million in Canadian dollars in revenue ー almost quadruple what it reported last year at this time ー and a 40 percent profit margin, which is about a 17 percent slide year-over-year.

Rosen said investors should consider margin compression when considering investing in Canadian cannabis producers in the future.

"The question is, is the drop in gross margin a temporary phenomenon as we deploy a tremendous amount of capital in the recreational market or is it a trend line that is going to repeat quarter after quarter? And that's really I think one of the most central questions for all investors to consider as they go forward and consider these stocks," Rosen said.

Despite a tremendous amount of enthusiasm from both providers and consumers, Canada's budding adult-use market got off to a rocky start amid a series of operational snags, including licensing bottlenecks, supply shortages, and delayed and shifting retail stipulations. For consumers, that meant intermittently bare dispensary shelves and a shortage of specific strains of flower, but as Aurora's results showed, for cannabis producers navigating new packaging requirements and taxes, it proved costly.

For full interview click here.