Canopy bets big on cannabis beverages as drinks struggle to gain traction in U.S.

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Starting this month, Canopy Growth Corp. will learn the answer to an important question: Are people actually going to want to drink cannabis?

The Smiths Falls, Ont., producer is making a larger bet on cannabis beverages than its peers, rolling out 13 products after building a 125,000-square-foot bottling facility that can churn out more than five million drinks a month. Canopy also has the backing of alcohol beverage maker Constellation Brands Inc., after the New York-based company invested $5-billion in 2018. Incoming Canopy chief executive David Klein also spent 14 years at Constellation.

Beverages are just one new form of cannabis product coming to market since federal regulations governing edibles and topicals came into force in October, a year after recreational marijuana use was legalized in Canada. But beverages have struggled to gain popularity in the few states in the U.S. where they are legal, making up a tiny percentage of overall cannabis sales. Research firm BDS Analytics pegs beverages at 6 per cent of all ingestible cannabis products purchased from U.S. dispensaries.

One of the obstacles has been taste. Beverage makers have attempted to mask the pungent flavour of cannabis with loads of sugar, and the products have a reputation for tasting somewhat foul. “The perception is the reality,” said Paul Weaver, Canopy’s director of innovation in Toronto. “They don’t taste good.”

Mr. Weaver, naturally, said Canopy’s products are better. The company created a distilled, largely flavourless cannabis liquid to serve as a base for its portfolio of beverages. Canopy will sell three distilled cannabis products designed to be combined with a non-alcoholic mixer, along with a range of cannabis sparkling waters, a ginger ale and a higher-dose carbonated drink.

Another misstep in the United States is that beverages have been marketed toward existing cannabis users and typically contain heavy doses of tetrahydrocannabinol (THC), the compound that produces a high, which is unappealing for novice consumers. In Canada, regulations limit THC content in edibles to 10 milligrams a package, whereas U.S. beverages can be loaded with many multiples of that.

Canopy’s market research also showed that existing cannabis users were only slightly more likely to try beverages. The bigger opportunity is to win over those who are curious about cannabis, Mr. Weaver said, adding the familiar beverage format could entice them. As such, only one of Canopy’s single-serve beverages contains a full 10 milligrams of THC. The rest contain between two and 2.5 milligrams.

“It’s not surprising that the cannabis beverage category has been pretty small in America,” he said. “We would argue that’s because of a poor product design and misunderstanding who your core consumer could be.”

Still, others in the industry are skeptical about beverages. “I definitely believe that Canopy has put a lot of time, effort and money into making a better beverage,” said Alex Blumenstein, founder of cannabis incubator Leaf Forward in Toronto. “But do I think it’s going to be a major share of the market? No.”

Even with an improved product, beverages still face a number of obstacles. The lack of retail cannabis stores, particularly in Ontario, is hurting legal cannabis sales, and the ability of existing outlets to accommodate beverages is unclear. “If operators have limited capital to build out these stores, they might not necessarily put it towards dedicated floor space for refrigeration,” CIBC analyst John Zamparo said.

Beverages that contain cannabidiol (CBD), a component of cannabis that does not produce a high, may present a bigger opportunity to bring in new customers, according to Mr. Zamparo. “There’s much less stigma around it,” he said. Cannabis producers have positioned CBD as a wellness product, even though the science to support health benefits, such as pain and anxiety relief, is still limited.

Canopy is launching two CBD-only sparkling waters under the brand name Quatreau. Canopy is also focusing on CBD sports drinks, and purchased a majority stake in BioSteel Sports Nutrition Inc. in October, which makes recovery beverages for athletes.

But Mr. Zamparo said the sales prospects are still limited unless CBD-only beverages are some day permitted to be sold in places such as pharmacies. “Potential consumers might not want to visit a traditional cannabis store, even though they’re quite nice,” he said.

Owen Bennett, an analyst with Jefferies Financial Group, wrote in a note in December that Canopy’s commitment to beverages, particularly given Constellation’s involvement, means the company could be unwilling to shift focus and resources to other products if beverages underwhelm expectations.

Canopy has misfired before, too; in its 2019 third quarter ended Sept. 30, the company took a $32.7-million revenue adjustment stemming from cannabis oil and gel cap products that were returned unsold or had their prices slashed. The company blamed the issue on the lack of retail stores, not the quality of its products.

The same issue could play out as beverages and other edibles hit the market, Mr. Blumenstein said. A number of other companies, including Hexo Corp. through its partnership with Molson Coors Brewing Co., are launching cannabis beverages. “There’s going to be more people who are built to do beverage manufacturing than the market needs,” he said.

Still, Mr. Weaver said Canopy hopes to capture even a small portion of the $23.2-billion alcohol industry in Canada. “Any way you do the math,” he said, “it can show a tremendous opportunity.”