CIBC warns shrinking orders from pot shops could hurt producer revenues

A woman smokes a blunt at the 4/20 marijuana holiday in Civic Center Park in downtown Denver, April 20, 2013. REUTERS/Rick Wilking (UNITED STATES - Tags: HEALTH SOCIETY POLITICS)

Cannabis producer revenues could take a hit as pot shops shift from big initial orders fuelled by fears of shortages to smaller inventory purchases prioritizing brands consumers actually want to buy.

That’s what CIBC analyst John Zamparo is hearing from management teams at large producers in the sector, and the reason behind his revised estimates and reduced price targets for shares of Canopy Growth Corp. (WEED.TO)(CGC), Cronos Group Inc. (CRON.TO)(CRON), HEXO Corp. (HEXO.TO)(HEXO) and Sundial Growers Inc. (SNDL)

“The ongoing dearth of retail stores, particularly in Ontario, has caused reduced expectations across the industry. However, the more immediate impact to cannabis producer revenues involves ordering patterns,” Zamparo wrote in a research note. “Recent inventory purchases have normalized in size as retailers wish to remain nimble and prioritize brands that are popular among consumers.”

While retail cannabis sales have grown by double digits month-over-month since March (through to July, the latest month for which data is available), he expects modest calendar third-revenue growth from licenced producers to reflect this initial inventory build-up, and subsequent lower re-ordering patterns.

Zamparo lowered his estimates for Canopy Growth and Sundial for their upcoming quarters. He increased estimates for Cronos based on the earlier closing of a deal with Redwood Holding Group LLC.

He lowered his price targets for shares of Canopy Growth to $45 from $50, Cronos to $20 from $25, HEXO to $7.50 from $8.50, and Suntial to $8 from $11. All ratings remain the same.

Concern about shrinking orders from established cannabis stores has been largely overshadowed by the persistent shortage of brick-and-mortar retailers, particularly in Canada’s biggest province.

Zamparo’s comments echo a similar warning from Craig Wiggins of the cannabis industry research group TheCannalysts. He said many licenced producers have grown accustomed to supplying large initial orders to new stores as they open for business.

“It’s not sustainable, even with cannabis 2.0 products and more new stores,” Wiggins told Yahoo Finance Canada in an interview last week.

Wiggins also noted that producers are currently harvesting enough cannabis to satisfy 81 per cent of the total annual demand projected by Health Canada when legal sales account for only 14 per cent of demand by volume. The situation, he predicts, will lead to price compression and glut of cannabis sitting in producer vaults.

“When you’re in an oversupply situation, prices come down,” he said. “Plain and simple.”

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