Credit ratings agency DBRS Ltd. has issued an initial non-investment grade credit rating for the Canadian cannabis industry, warning that many licensed producers will fail as the sector develops.

In a report released Monday, DBRS said that despite having negligible to low levels of debt, the largest licensed producers in the cannabis industry “exhibit characteristics consistent with the low, non-investment-grade range of the credit ratings spectrum.” The credit ratings agency issued a B-range rating, which is typically reserved for fund portfolios that are “considered to be of a highly speculative credit quality.”

“For now, cannabis is still a relatively small-scale subsector within the context of the consumer products industry and the economy in general. Much is to be determined regarding consumer reception, competitive behaviour, regulation, taxation and international market potential,” the report said, adding that there are a wide range of outcomes in terms of financial performance for companies within the industry, translating to “high credit risk while the industry established itself.”

DBRS estimates that sales in the Canadian cannabis market will be between $4 billion and $6 billion annually, less than other consumer product categories including tobacco and alcohol, which had sales of $20.4 billion and $22.5 billion last year, respectively.

Still, there is room for improvement when it comes to the credit rating for the cannabis industry, particularly when it comes to the leading licensed producers, and DBRS expects there will be gains to come as the industry develops.

“DBRS believes the credit risk profile of the cannabis industry could improve significantly and rapidly as the industry settles, data becomes available and the behaviours of consumers, competitors and regulators is more known,” the report said.

Licensed producers with “strong brands, good geographic and product diversification and scale” could eventually see their rating improve to the BB-range or the BBB-range, a rating that is reserved for fund portfolios considered to be of an “adequate credit quality.” DBRS also believes that companies will likely have to expand internationally in order to attain an investment-grade rating.

But while while some cannabis companies will thrive in the post-legalization market, there are many that won’t survive.

“Although the development of the sector may benefit all (licensed producers), not all will perform equally and many will fail,” the report said.

Key factors that will be analyzed in separating the improved companies from the ones with potential to fail include brand strength, market position, nature of product offering, geographic diversification, size, and operating efficiencies, DBRS said.

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