Let’s now look at how capacity expansion could translate into cannabis companies’ margins. With the expected surge in demand from the recreational sector, producers (MJX) such as Canopy Growth (WEED), MedReleaf (MEDFF), Aphria (APHQF), and Aurora Cannabis (ACBFF) have moved to expand their capacity. By scaling up, producers stand to gain from lower production costs, which should translate into margin expansion.
How high sales growth translates into margins will remain a big area of focus for investors. The above chart shows EBITDA (earnings before interest, tax, depreciation, and amortization) margin estimates for five cannabis producers in fiscal 2019. Except for Canopy Growth, all four producers are estimated to report an EBITDA margin above 30%. Canopy Growth’s margins may be negatively impacted due to its investment activities.
Currently, there is uncertainty on how the margins will play out given the three retail models proposed by different provinces. The three retail models are government/private mix, government only, and private only. However, with economies of scale, a low-cost production setup will drive down per unit cost, which could help a producer remain competitive.
By significantly driving down costs through scale, legal producers could put illegal producers at a disadvantage. Thus, the government could be successful in eliminating the illegal market if that happens.
You may also be interested to read, Analyst Ratings and Price Targets for Major Cannabis Stocks.