In this note, I want to try to peer beyond the veil of the next few quarters, to imagine what the marijuana business will look like as it matures. Right now, cannabis lives in a legal gray zone. The pot business is hemmed in by federal criminal statutes and onerous state regulations. At the same time, states that have legalized weed have seen skyrocketing tax revenues, and the industry promises jobs and investment opportunities. These prospects will only become more attractive to legislatures as the economic costs of the coronavirus pandemic impact state and local budgets. Public opinion has shifted decisively in favor of legalization, and the current protests against police brutality will only reinforce this trend. So, I regard cannabis legalization as a matter of time. My question: what would that mean for cannabis companies? How should cannabis investors prepare?
In what follows, I will compare some metrics among what I regard as the “big three” most investable cannabis companies today, namely Trulieve (OTCQX:TCNNF), Green Thumb (OTCQX:GTBIF), and Curaleaf (OTCPK:CURLF). I understand that some people will think I am leaving important candidates out. Also, my comparisons will only be for the most recent quarter. My goal here is to think about the future of the industry, rather than carefully compare current businesses. (All data is calculated from company financials and earnings calls.)
Big picture effects
The most obvious consequence of marijuana legalization is that the industry’s total addressable market gets very large. Relatively conservative estimates of the US market are $50B+.
Another obvious consequence is that competition increases dramatically. We get a hint of what this might look like from the situation in Oklahoma, a state that has taken a free-market approach to its medical marijuana industry. Oklahoma, population 4 million, has 2,000+ licensed dispensaries and 7,000+ other marijuana-related businesses, and many of them are using Yahoo or Gmail contact information. Barriers to entry are very low.
These two large effects pull in opposite directions: increased demand tends to increase profits, increased supply tends to decrease profits. The challenge for a cannabis company will be to create a sustainable moat.
Other big picture effects: the value of licenses, currently worth millions of dollars, falls. Certain administrative hurdles, like banking, go away. As the industry shakes out, at least, some cannabis companies uplist to major exchanges, where their greater visibility begins attracting institutional capital.
Current business models
Because of current state and federal regulations, cannabis companies are more or less forced to be vertically integrated. This involves them in three separate businesses.
First, there is the agricultural business of growing marijuana. Second, there is the business of turning marijuana plants into customer products. The simple version of this is producing smokable flower. However, oils, creams, edibles, and so on require more processing. Third, there is the retail business of selling consumer packaged goods to customers.
These lines of business require three different areas of expertise, and I don’t see any particular reason that, in a less regulated environment, they need to stay in the same company. Whether you compare pot to other agricultural products, or other pharmaceuticals, I can’t think of any food or drug companies that are fully vertically integrated. But how will each segment evolve?
The agriculture business
Right now, the interstate transport of cannabis is illegal, so pot must be grown in the same state it is sold in. Economically, this is inefficient. With full legalization, you can imagine marijuana becoming a Midwestern field crop. Even if it remains indoors, it would be grown wherever yielded the lowest cost.
There is no reason I can see why this business would not be taken over by ordinary farmers. Brands would buy from (or possibly be owned by) farmers they worked with, the way Sunkist does for oranges, or Driscoll’s for strawberries, or Tyson (NYSE:TSN) for chickens.
The advantage in this line of business will go to whoever can be the lowest-cost producer, or the lowest-cost producer without sacrificing a certain level of quality.
At the same time, today’s marijuana companies are developing expertise in growing marijuana at scale. No one else has this expertise to the same degree. The metric that best captures success at low-cost production of weed is gross margin.
|
Trulieve |
Green Thumb |
Curaleaf |
|
|
Gross margin, MRQ |
65% |
52% |
70% |
The processing business
The process of taking raw agricultural product, and producing consumer packaged goods, is where I think the future of the business really lies. Brands function as quality guarantees and also lifestyle identities; people develop loyalty to them. This is the only part of the cannabis value chain I think will develop a sustainable competitive moat.
There are two parts to the success of a processing business. The first and most important is brand loyalty. This is normally measured by customer surveys, and there is no data at present like that. A less subjective way to measure it is repeat customers. Of the companies mentioned in this article, only Trulieve is providing (tracking?) that data. They claim 74% repeat customers in the MRQ.
The second part is, again, low-cost production. Here, the best metric, although a rough one, is SG&A margin.
|
Trulieve |
Green Thumb |
Curaleaf |
|
|
Customer retention |
74% |
? |
? |
|
SG&A margin, MRQ |
29% |
44% |
36% |
The retail business
Right now, cannabis companies meet the public mostly through medical dispensaries. Adult-use stores are legal in a few states but are generally co-located with a dispensary. Since the coronavirus struck, these retail storefronts also often support curbside and home-delivery options.
I can imagine these stores evolving in a few ways. If they did not have to be involved in the other two steps of the value chain, Rite Aid (NYSE:RAD) or Walgreens (NASDAQ:WBA) could do the work of medical dispensaries. With full recreational legalization, cannabis products could be sold behind the counter at every convenience store, the way alcohol and tobacco are now. In other words, the “cannabis store” is a product of current regulations, and as those change, the stores will go away.
Even if the specialized stores remain, they may evolve. Perhaps they will become mostly or exclusively takeout-and-delivery places, like Domino’s Pizza (NYSE:DPZ). Perhaps (again like Domino’s), they could be franchised.
For the near future, however, cannabis retail excellence is the same as any other kind of retail excellence: know your product, provide good customer service, maximize sales and customer satisfaction. We don’t have much helpful data, but here’s what we do have:
|
Trulieve |
Green Thumb |
Curaleaf |
|
|
Revenue/store |
$2.0 M |
$1.7 M |
$1.7 M |
|
Average basket size |
$127 |
? |
$83 |
|
Average visits/month |
2.7 |
? |
2.3 |
|
Same store growth |
27% |
24% |
? |
Conclusions
In the future, the marijuana business will look much different than it does today. As legalization proceeds, I expect the agriculture business to be outsourced to farmers, and the retail business to be handled largely by existing retail outlets. The real value proposition in the cannabis business is developing a branded product that people want to buy, regardless of who grows it or retails it. Right now, success on this dimension is very hard to gauge.
The companies in this article have very different strategies to develop their brands. Trulieve is developing, you might say, intensively seeking to own the state of Florida. Curaleaf is developing, extensively growing nationwide as fast as possible. Green Thumb is pursuing a middle course and also wholesaling their branded products to other stores.
Purely on the metrics observed in this article, however, it is hard not to like Trulieve. They are most excellent on the retail front. What is perhaps most telling is that they are tracking and reporting a lot of retail metrics. They are also controlling operating expenses better than the other two companies.
Curaleaf has an edge over Trulieve in gross margin which it then loses in operating margin. Green Thumb does worst on both measures. It is doing reasonably well on retail metrics, but we could use more data.
Disclosure: I am/we are long TCNNF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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