The Future of Cannabis Might Not Be a Leaf

The global market for cannabis extracts is projected to grow at a cumulative annual rate of 22% through 2025. Recent survey of California cannabis users shows increasing preference of vapes, edibles, and other derivatives instead of traditional smoking. The effect is especially pronounced among young the youngest and oldest adults surveyed.

Preference for vaporizing over smoking in young adults lines up with the (unfortunate) trend of vaping use among young Americans. Their decrease in tobacco smoking had been a trend for a number of years and only recently has youth nicotine consumption began to increase again with the rise of vape use. For the same reason that nicotine vaping is taking off in popularity, the convenience of cannabis vaping attracts many users not otherwise interested in smoking.

Medicinal users are also leading the shift to vaporizers. Many want the health benefits without the downsides of smoking. Vaping generally avoids the carcinogenic effects that smoking can have on the lungs. An early study found that users who switch from smoking to vaping could see improvements in their breathing and lung health.

It’s not surprising that medicinal users would be more concerned about the downsides of traditional smoking. Any type of burning releases carcinogens and cannabis smoke contains tars and other harmful substances similar to tobacco smoke. In fact, since cannabis smokers inhale more deeply than tobacco smokers, the exposure to toxins is much greater for each breath. Since these harmful effects only apply to burning leaves, any use of extracts in vaporizing, eating edibles, or other extract-consuming activities avoids them.

The production of these extract products requires different expertise from cultivation, so the early leaders in the field might not capture the bulk of the industry growth as user trends change. Mass proliferation of new cannabis production in legal markets can, in fact, be a benefit to extract producers who can negotiate better pricing as the margins on leaf products continues to decline.

Even the biggest producers are starting to feel the squeeze of tightening margins on cannabis production. Canopy Growth (TSX:WEED) (NYSE:CGC) saw their gross margins fall by half during the past year. Over longer terms the declines have been even steeper. In the past six years, the average wholesale cost of cannabis in Colorado has fallen to less than a third of where it began. This is a major hurdle for cultivators but is a huge benefit to extract producers like Halo Labs (NEO:HALO) (OTC:AGEEF).

In addition to saving on wholesale product costs, extract processing is also less sensitive to the quality of the cannabis that it uses. Producers do not have to worry about purchasing the highest quality or most consistent supply because they can control for the differences in their process. These differences become especially beneficial to companies that can buy lower-priced inputs and turn them into premium extracts. The wide variety of strains and cultivars in the market makes it even more important to handle multiple input supplies.

Companies like Halo Labs (NEO:HALO) (OTC:AGEEF) are taking advantage of the cost differential to focus on premium lines of oils, waxes, and their proprietary DabTabs that are not impacted by the declining margins on leaf products. Investment analysts are predicting that the cannabis market may end up looking like alcohol, where producers of premium products capture significant portions of market profits by differentiating themselves and maintaining higher margins. Extract producers face a much higher profit growth curve compared to cultivators, even if much of the investor interest has gone to the former over the past few years. The maturation of legalized cannabis markets will especially benefit those with high-margin differentiated products that do not wind up commoditized as lead products already are.