The Importance of National Cannabis Brands
In reviewing what themes our readers click through most in our newsletter, anything related to cannabis is always a big hit. Interest in cannabis investing peaked last year, and now is the time when everyone appears fearful so you’re supposed to be greedy. If your investment thesis hasn’t changed, then now is the time to back up the truck and load up on shares of cannabis stocks. Right?
While there is money to be made in cannabis stocks as an investment thesis, the irrationality on display would keep most moderately conservative investors on the sidelines. We’re more likely to favor the approach described in our article on Investing in the Ancillary Cannabis Sector. Only invest in companies that incidentally benefit from increasing cannabis legalization – if you can figure out who they are. Another conservative way to play the cannabis theme would be to invest in one of the two major thematic ETFs for cannabis: the Horizons Marijuana Life Sciences Index ETF (HMMJ), or the ETFMG Alternative Harvest ETF (MJ).
Investors with a higher risk tolerance can cherry-pick stocks. There are the large Canadian growers, most of which trade in Canada and the United States. Then we have the “multi state operators” (MSOs) in ‘Murica where the regulatory environment is a disparate mess and each state needs to be evaluated in its own particular context. Today, we’re going to talk about the second biggest MSO out there – Cresco Labs (CL:CN).
About Cresco Labs
Founded in 2013, Cresco Labs is a $1.87 billion publicly traded cannabis company that is vying with Curaleaf for the title of “biggest cannabis company in the United States by market share.” The goal of Cresco Labs is to build “the most important cannabis company in the United States,” which means they want to be aligned with all the stakeholders in the value chain – customers, regulators, investors, and of course “the community.” Coming off as benign as possible is a good strategy when you’re operating in a regulatory environment that’s simply unprecedented. Geographical boundaries are what determine whether you’re seen as a “medical patient” or a felon.
If you look at the continued progress being made towards legalization, it’s not unreasonable to expect that cannabis will eventually become legal at the national level. Until then, multi-state operators cannot do any cross-border transactions whatsoever. Every single state needs to be operated within a silo, as its own little vertical operation. Trying to take excess “flower” from Vancouver Washington to Portland Oregon, a mere 20-minute drive, is illegal and could result in your license being pulled or worse. So, what’s one way a multi-state operator can bring states together? By developing a national brand.
National Cannabis Brands
If you’re trying to advertise a consumer product, some marketing channels let you target consumers by which state they live in – Google ads for example. If your Giggle Smoke strain is only available in Portland dispensaries, you could advertise to only people with their location set to Portland. If that same strain is available across the State of Oregon, you can then include anyone from Oregon. However, what if you wanted to advertise your Giggle Smoke strain using a channel where you couldn’t control the audience? What if you managed to get Joe Rogan talking about how much he loved Giggle Smoke on his massive podcast? Now, you have a problem. What’s the point of making people aware of how great Giggle Smoke is if they can’t go out and buy some on their way home from class?
The benefits of having trusted national cannabis brands already in place when cannabis becomes legal at a nationwide level are obvious. The question then becomes, how many stores can Cresco Labs’ brands be found in today? The company’s latest investor deck contains a slide with this metric expressed in “doors.” In other words, what percentage of dispensaries for each state contain a Cresco Labs branded product?
That chart also doesn’t reflect the recent acquisition of Tryke (anticipated to close during the first half of 2020) which would give Cresco Labs presence in two other states – Arizona and Nevada – the latter of which happens to be one of the fastest-growing cannabis markets in the U.S. If the acquisition goes through, Cresco will now own one of the most profitable private cannabis operations in ‘Murica with six operating dispensaries and significant historical sales. According to Cresco Labs, “in limited license states, retail financials can be attractive – especially when combined with owned brands.” To see the value in this statement, look no further than Tryke’s flagship Reef dispensary directly adjacent to the Strip:
The strategic value of this acquisition is obvious. In ‘Murica, it’s a rite of passage to visit the Vegas Strip. Having your brand prominently displayed 24/7/365 in one of the most valuable retail locations in the U.S. provides some outstanding visibility. However, in the same way the Vegas Strip lights mask all the money being lost by gamblers every day, the excitement of the cannabis opportunity masks the underlying regulatory risk that can decimate investors unexpectedly.
The Regulatory Risk Problem
It’s easy to get excited about how much money there is to be made in cannabis, a multi-billion-dollar market that’s just starting to take off in many states. A chart in the Cresco Labs investor deck (which could use a good proofread) spells this out simply:
Ten years from now, cannabis is expected to be an $80 billion market with expected profits of $24 billion. (Let’s not forget about the black market which is said to be really hurting legal Californian cannabis operators.) If you were able to capture just one percent of that market, you’d be bringing in $800 million a year in revenues and banking $240 million in profits. Compare those numbers to what Cresco Labs did last quarter – $36.2 million in revenues – and you can see just how little market penetration the second biggest MSO actually has. Last quarter’s $36 million extrapolates to $146 million a year which means they haven’t even captured one-quarter of one percent. Seems like a great opportunity here, but we need to take into account company-specific risk.
While absolutely anything could happen to Cresco Labs that might destroy the company’s prospects, the elephant in the room is regulatory risk. There is no way to control or predict problems that can arise when your product is something that’s new to regulators of all sorts. A good example of how regulatory risk comes on strong and fast can be found in Charlotte’s Web, a company we liked so much that we actually opened a small position in. Family run business, great product, lots of growth potential, the thesis hasn’t changed. What has changed is the share price which has now lost -62% since our last article on CWEB because of a class-action lawsuit from a bunch of whiners group of consumers who believe they were unfairly marketed to. Couple that with the below comments made by the FDA about CBD last November:
That’s exactly why we don’t like to dabble in cannabis stocks. They present far too much risk than we’re willing to accept, plain and simple. In the world of finance, risk is synonymous with volatility, which means risk can manifest itself in large upsides and large downsides. In other words, it’s a roller coaster of emotions that you better be prepared for if you decide that investing in cannabis is the way forward.
Conclusion
In the face of an industry-wide correction, Cresco Labs appears to be growing just as fast. Their jobs page is riddled with cool-sounding job opportunities like “cultivation agent,” or “patient care specialist.” Their “most important cannabis company” goal takes into account all the stakeholders, and their quest to establish national cannabis brands seems like the correct strategy.
Trying to decipher such a complex operation seems pointless. Instead, you should trust the tenured management team to grow the company without becoming too overextended when capital dries up – as it has. Then, you just hope and pray that no regulatory bombshells go off, and you should be good to go. Also, make sure you invest enough of your savings so that a home-run means you actually make some decent money. Your casa on the playa should be just around the corner.
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