The cannabis industry's worst kept secret is that it's done little to diminish black market sales. We are a year into Canadian legalization, and Statistics Canada reports that 60 percent of Canadians are still getting their cannabis from illegal sources. In fact, only 29 percent of cannabis users in the country purchase pot solely from licensed cannabis companies.
That's a hell of a lot of revenue—as much as $4 billion—that cannabis companies are missing out on.
Cannabis Companies vs the Black Market
The problem isn't isolated to Canada. The Californian market for legal weed is dwarfed by the market for illicit weed. This year, sales of legal weed are projected to generate $3.1 billion, while black market weed is forecasted to generate $8.7 billion.
So, for every $1.00 being spent on cannabis in the state of California, only $0.26 is going to licensed and registered cannabis companies.
The persistence of the black market is often cited as a primary reason why pot stocks have been under-performing. Cannabis users can still buy pot cheaper and, in general, more conveniently through illegal means than legal ones.
StatsCan estimates that the average price of cannabis per gram in the legal market is $10.23. Meanwhile, the black market offers an average of $5.59 per gram.
Overabundance of Supply
Black market cannabis has also caused an overproduction issue for cultivators. There's too much dried cannabis flower being harvested and not enough demand to justify it.
For example, Canopy Growth Corporation (TSX:WEED) (NYSE:CGC) recently harvested 40,960 kilograms of cannabis, but only sold 10,549 kgs. Aurora Cannabis Inc. (TSX:ACB) (NYSE:ACB) produced 29,034 kgs, but only sold 17,793 kgs. Both cannabis companies can expect sales to increase, but so will production.
This had led analysts to warn investors to "brace for impact" as the glut of supply means some biomass will inevitably be left in the fields or else destroyed. Consequently, cannabis companies that aren't prepared to weather this oversupply storm will likely fold before things pick up.
Fortunately, black market cannabis sales are declining. As consumers shift their attention to the legal market, cannabis companies can expect to see revenue increases. Still, it will likely be years before illegal sales have a negligible impact on the industry.
HEXO's Plan to Undercut Black Market Prices
In a direct attempt to undercut black market prices, HEXO Corp. (TSX:HEXO) (NYSE:HEXO) is launching a "cannabis value brand."
Known as Original Stash, the brand will be sold in one-ounce increments priced at $4.49 a gram, including taxes. With one ounce equalling 28 grams, the total product will cost $125.70. It's currently available in Quebec but will be rolled out nationwide before long.
“Our aim with Original Stash is to disrupt the illicit market, educate consumers about the value of a regulated and tested product, and drive them to purchase their cannabis legally,” said HEXO Corp’s CEO and co-founder Sebastien St-Louis. “We’re now competing directly with the illicit market and providing consumers with an affordable, controlled, quality product."
St-Louis added that his company is "very bullish" on Original Stash, and says it will be a key part of HEXO's strategy to exceed a 20% market share in the coming years.
This is the best method for converting black market sales to legal sales that any cannabis company has yet to put forward. Original Stash can appeal to the 42% of Canadians who cited price as the most important factor when deciding where to buy cannabis.
It'll be fascinating to see if HEXO's strategy pays off and if other cannabis companies will follow suit in an attempt to raise revenue and potentially alleviate their oversupply problems. Investors should watch how Original Stash performs for signs of how the industry might reclaim some of its earlier, ambitious revenue predictions.
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