Cannabis Market Update: Q3 2023 in Review

Cannabis Act review provides little support for companies

Canadian cannabis companies enjoyed strong investor attention post-legalization, but in the years since then they've had to deal with various struggles, including sky-high taxes and industry-related fees.

Licensed producers were let down again on March 28, when Canada's 2023/2024 federal budget was released with no meaningful changes for cannabis taxes. A 2.3 percent regulatory fee, which doesn't apply to sales of tobacco and alcohol, and a decade-old excise tax that can go as high as 36 percent in some provinces, are among the factors making it difficult for companies in the sector to turn a profit. Rather than reducing excise taxes, the new budget states that they can now be paid quarterly, which doesn’t help when the money isn’t there.

Meanwhile, despite the fact that unpaid fees have swelled to C$200 million, the Canada Revenue Agency (CRA) has been unforgiving in its attempts to collect. On June 29, the agency threatened to enter defunct cannabis company Tantalus Labs’ facilities and destroy its entire inventory over unpaid debts — the company had entered bankruptcy proceedings after it was unable to pay estimated debts of C$14 million, C$4.4 million of which was owed to the CRA. A judge allowed Tantalus to sell off its inventory instead, and the insolvent entity was later purchased by Atlantic Cultivation.

These troubles spilled into Q3, with Fire & Flower and Aleafia Health filing for bankruptcy protection. Fire & Flower was auctioned off to FIKA Cannabis on September 15, and Aleafia Health announced a successful bid by Red White & Bloom Brands (CSE:RWB) on October 12. Cannabis business owners say without any relief, more closures are likely.

So, could help be on the way? On October 10, after over a year of reviewing the Cannabis Act, the Canadian government released its findings in its What We Heard report. However, according to Nawan Butt, portfolio manager at Purpose Investments, it unfortunately doesn’t offer much hope for cannabis companies.

“I don't think there is much within the regulator's purview that can change the outcome for investors in Canada. And that generally comes down to the fact that Canadian companies have mostly been bloated and not well operated, and (have) too many regulatory fines put on them for them to be the best versions of themselves," he told INN.

"At this point, where we've seen hundreds of millions of dollars — if not billions — written off in the Canadian industry, it's very hard to get bullish from an investor's point of view.”

While the Canadian government has pledged to have a second panel of economic advisors review the Cannabis Act from a business perspective, market participants will have to wait for that review to be complete.

For now, some provinces are stepping up to offer support to cannabis companies. In July, Ontario announced it would reduce its markup rate on all cannabis products, and that same month Manitoba did away with its social responsibility tax, retroactive to January 1, 2022, in an effort to help shop owners reinvest in their businesses.

US takes baby step toward cannabis reform

On September 27, the US took a potentially major step toward cannabis reform.

After seven previous attempts, the SAFER Banking Act finally made it to the Senate floor — if it progresses, it could open up financial services to cannabis firms. As it stands, many cannabis retailers and adjacent plant-touching businesses struggle to find the funding necessary to get their businesses off the ground.

The development came on the heels of the Department of Health and Human Services' August 30 recommendation that the Drug Enforcement Administration (DEA) reschedule cannabis from a Schedule I drug to Schedule III.

On both occasions, the market responded with short-lived jumps in cannabis company share prices. Still, lasting change hasn’t been observed, and events like the dismissal of Kevin McCarthy from his position as House speaker and the escalating conflict in Gaza have tabled any discussions of a vote on the act. Meanwhile, the DEA is conducting its own review of the data it's been given by the Department of Health and Human Services.

Gennaro Santoro, senior director of strategy at EY-Parthenon and a member of the Americas Cannabis Center of Excellence, believes one sector in particular may be poised to benefit if and when reform takes place: cannabis testing.

“As the market continues to grow and … retail sales increase, more testing will be required,” he commented to INN. He also pointed to events like California’s new standardized cannabis testing methods and recent claims of misleading labels regarding THC potency in Canada as creating more testing needs.

In addition, he noted that changing consumer demands are creating new testing requirements. “A lot of newer customers may like edibles, for example. Some of those new product categories are actually kind of tricky to test. They have to have new tests created for you to be able to get the right information. They also require you to test it when the plant is grown, when it’s processed and in the finished product. So inherently more demand for testing comes from these new products versus just normal dried flower," Santoro explained.

US-based cannabis companies head north

In the meantime, US-based cannabis companies are finding innovative ways to offer opportunities to investors and increase their market share — for example, listing north of the border on the Toronto Stock Exchange (TSX).

One example is Terrascend (TSX:TSND,OTCQX:TSNDF), which underwent a restructuring to meet TSX requirements and officially commenced trading on the exchange on July 4. The move prompted major financial institutions Morgan Stanley (NYSE:MS) and BNY Mellon to remove bans on providing services like account administration, tax support and the collection and distribution of dividends. It could also inspire more institutional investment.

But will Terrascend's success on the TSX prompt other US-based cannabis companies to follow suit?

“We quite like the path that they have set forward,” said Butt. “Our immediate thought was that this (would) be replicated by others, just because it makes a lot of sense. It brings a lot of liquidity volume to the stock, as well as access to the stock, because the TSX has much easier access for investors than the Canadian (Securities) Exchange.”

As it stands, Curaleaf (CSE:CURA,OTCQX:CURLF) announced its TSX application on October 10.

Investor takeaway

Although the cannabis industry continues to incrementally move forward, patience is needed.

“My outlook hasn't changed a lot (since Q2)," Rami El-Cheikh, head of EY's Americas Cannabis Center of Excellence, told INN. “There's still a lot of uncertainty in the market, there (are) still a lot of unprofitable businesses in this space. So I don't see any substantial changes in the short term (and) my outlook, unfortunately, remains bleak."

For his part, Santoro emphasized that change has been slow to come to the cannabis sector, and it will continue to be slow. “There's optimism, but nothing happens quickly,” he said.