A supply glutton in the Canadian recreation marijuana market can be the last in everyone's mind right now. The primary concern is currently lack of supply. Marijuana producers can not send enough cannabis to meet the high demand.
Make no mistake about it, but it's a supply glute on the way. The opinions vary when it is going to hit, but it would not be surprising if the Canadian marijuana market is experiencing a surplus by 2020.
The common wisdom is that the major marijuana producers such as Canopy Growth ( NYSE: CGC) and Tilray (NASDAQ: TLRY) claiming the largest market in the industry will be in the best shape when the supply gluten comes in Canada. But a small marijuana stock that has largely flown under the radar Flowr (NASDAQOTH: FLWPF) ̵[ads1]1; could only be better prepared for the upcoming Canadian surrender than the big boys.
Yes, a supply glutton comes
A supply gratuity occurs when there is more than enough supply to meet the demand. Canada has nothing external to this right now, because there is a very high demand for recreational marijuana, and the manufacturers have not yet had the opportunity to grow enough cannabis to meet that demand. But it will definitely change.
In august, my Motley Fool colleague Sean Williams put a great analysis of how much production capacity could be on its way. Sean looked at the forecasts from the top sellers (including Canopy Growth), the two plants (with Tilray in the group – despite its huge market value, the company's capacity is not in the upper echolon) and smaller producers. When summarizing all these projections, Sean achieved a total production capacity of around 3 million kilos per year by 2020.
What about demand? Professional service company Deloitte believes the annual Canadian marijuana demand will be around 600,000 kilos. It is slightly lower than the official demand estimation of 650,000 kilograms per year from the Canadian parliamentary budget manager, serving a function similar to that of the US Congress budget office.
The most optimistic projection for Canadian marijuana requires that I have seen 900,000 kilos per year. This estimate was made by Colorado-based cannabis consulting firm Marijuana Policy Group.
But if you take even the rosiest demand estimate, it will be in comparison with the Sean 2020 capacity projection. Certainly, Canadian marijuana growers may not produce 3 million kilograms of cannabis annually within a couple of years. Expansion may take longer than expected. Smaller players may run out of money. But even though the actual annual capacity expects to be one third of what is being projected (a very unlikely scenario, in my opinion), we still look at a significant supply glutton in Canada.
Most likely to survive and thrive
So with a supply glutton in Canada apparently inevitable, the question is: Which companies are most likely to survive and thrive? And that's where little marijuana producer Flowr comes into the picture.
When the offer exceeds demand, prices fall. This is likely to happen in a few years in the Canadian marijuana market. Companies with low operating costs will better manage a low-cost environment.
In the cannabis industry, the key to achieving low operating costs is high performance per square meter. I recently talked with Flowr founder and chairman Steve Klein, who claimed that "the most important CPI [key performance indicator]" in the industry is dividend per square meter.
Flowr hits most of the major Canadian marijuana producers when it comes to Avling. Its current yield translates at a cost per gram of 2.05 in Canadian dollars, well below Canopy Growths and Tilray's cost per gram. Even better, Flowr believes that it can increase the yield and reduce costs even more.
Small attributes Flowr's success in achieving good results largely to the company's president and co-founder, Tom Flow. Flow claims a solid record in the cannabis industry with a flush-and-drain system of growing that is challenging to use, but generates impressive yields. His expertise helped attract Scotts Miracle-Gro subsidiary Hawthorne Gardening to enter into a research and development alliance with Flowr.
But there is another reason why Flowr could succeed in navigating a utility bill. High quality should be even more important in a commercial market. Flowr's products are all grown in indoor plants and do not require irradiation. The problem with irradiation is that it adversely affects the taste and smell of cannabis. Most of Flowr's competitors irradiate their products to meet Health Canada's safety standards.
Most other Canadian marijuana producers change what Flowr refers to as ultra-premium products. Flowr's plan is to continue to focus on high quality cannabis while innovation in ways to improve returns and reduce costs. This strategy can make it a leg on most peers when the total supply gluten hits.
There are some things that investors should know, though. Flowr only has about 20% of the plant that is operational right now. Klein sa at the company expects to be 100% production by mid 2019. This means that the company's income may be limited for a while.
Also, we have just addressed the Canadian marijuana market. Growth in international markets should help absorb some of the supply gluten that is almost certainly on its way in Canada. Larger companies like Canopy Growth, with its huge cash flow from an investment of Constellation Brands will be in a better position to compete in the world market.
Canopy Growth and Tilray may be the storm in Canada relatively well if they are able to capitalize on international opportunities. But high quality and high performance makes Flowr a small marijuana warehouse to hold on to the radar screen.