Why HEXO’s writedown on ‘cannabis trim’ could be another bad sign for the industry
Quebec licensed producer HEXO Corp. has been forced to write down the value of its inventory of cannabis trim by $2.4 million, another potential warning sign for an industry struggling with oversupply and large producer stockpiles.
HEXO cited “new and available third-party information” that resulted in a price adjustment of the fair market value for trim for the decision, which was disclosed as it restated its financial statements for the period ending Oct. 31, 2019.
Unlike the cannabis flower, which contains high levels of THC, trim is essentially a byproduct of cultivation that consists of the leaves and stems that have trace-levels of THC.
The perfect analogy for flower versus trim, is steak versus sausages
While it cannot be rolled into a joint, trim can be combined with dried flower to extract marijuana oil, giving it some value to producers.
“The perfect analogy for flower versus trim, is steak versus sausages. Trim is just the byproduct — all the stuff that doesn’t look good but can still be used, just like parts of a cow you might use to turn into sausages or burgers,” said Brayden Sutton, chairman of Nevada-based cannabis company 1933 Industries Inc., and the former executive vice-president of Aurora Cannabis Inc.
Sutton says in general, the ratio of THC in flower to that of trim is 20 to 1 (though that varies by strain), meaning that it would take 20 times more trim in weight to extract what you would get from flower.
“Trim is useful to companies, and it’s a whole other market. You can take a big garbage bag full of weed trim, put it into an extractor and pull the essential oil out of it,” he said.
But there could be too much cannabis trim on the Canadian market right now, a potential issue for companies when it comes to future impairment charges.
Health Canada data shows that as of September 2019, there was 316,000 kilograms of dried cannabis inventory, far surpassing domestic sales figures. It is, however, unclear, how much of that inventory is trim versus flower.
“A lot of producers were accumulating this byproduct for cannabis 2.0. There’s so much of it. I think trim will decline in value faster than flower, and it will be the first subject to impairment,” believes Andrew Uddell, managing director of The Cannalysts, an independent cannabis research firm. “And then the economics comes into play. If you’re storing tons of low-value products, it might not make sense to store them at all.”
Licensed producers value all parts of the plant as “biological assets,” and assess their fair value based on what they think the future per gram price might be. As prices start declining, companies may have to take writedowns on that fair value. If producers are holding more cannabis trim than flower, and trim prices decline more quickly, the impairment issue could be compounded.
In a recent note to clients, Bank of Montreal cannabis analyst Tamy Chen alluded to this specific issue of an oversupply of cannabis trim, saying that piling trim could further exacerbate inventory impairment issues on the balance sheets of some LPs over the next few quarters — especially those that have already been hit by price declines of dried flower and product returns.
“We have heard anecdotally from a number of other industry participants that trim represents a meaningful amount of industry inventory. For some cannabis genetics, the ratio of trim to flower could be as high as 1 to 1,” Chen wrote.
“We believe most LPs intend to extract this trim to produce rec 2.0 products but we note there are limitations that may make some trim no longer extraction-grade (low potency, degradation of quality over time, pesticides etc.),” she added.
Sutton says one of the biggest problems when assessing Canadian licensed producers is that most of them do not disclose how much trim they are storing, versus flower. “They don’t break it down,” he said.
“Trim can only last for about a year, and when it’s not good anymore, when you can’t use it, you’re forced to write that down.”
HEXO’s writedown comes in addition to $26 million of inventory impairments and sales provisions disclosed in its most recent earnings, compounding financial issues for the company that has seen its revenue slip and cash balance erode over the last six months.
The company’s stock price has dropped almost 25 per cent since reporting earnings in mid-December, though it rose three per cent Thursday to close at US$1.64.