How Will Weed Stocks Handle a Bear Market?
The great thing about sin stocks is that they’re resilient to bear markets. That’s because when things go pear-shaped, there’s always some consolation to be found in the bottom of a bottle. Nobody smokes fewer cigarettes in a bear market. If anything, people will smoke more and drink more. And they won’t necessarily switch to a cheaper substitute. Strong brand loyalty has been a long-standing feature of cigarette markets with brand loyalty rates of 85 to 90 percent. As for drinkers, the longer you drink, the more loyal you become, the more your liver hates you. The below chart from Statista shows that 40% of American drinkers who’ve been hitting the sauce for 10 years or more stick to the same brand.
That brings us to cannabis. The only way you can truly understand this market is to visit dispensaries on a frequent basis and observe what’s happening around you. We spent an extensive amount of time doing that, so we’re going to use our findings to gauge how a recession might impact weed stocks – particularly, multi-state operators (MSOs) in the United States.
A Bear Market for Weed Stocks
The value of a dollar today is increasing while the value of dollars in the future plummets. That means growth stocks are taking a hit across the board, and cannabis stocks are no exception. The biggest marijuana ETF by assets under management – the AdvisorShares Pure US Cannabis ETF (MSOS) – fell 54% year-to-date compared to a Nasdaq loss of 21% over the same time frame. As a result, the biggest weed stocks have taken it on the chin.
| Asset Name | YTD Return |
| Green Thumb Industries (GTBIF) | -58% |
| Verano Holdings (VRNOF) | -50% |
| Trulieve (TCNNF) | -50% |
| Cresco Labs (CRLBF) | -48% |
| Colombia Care (CCHWF) | -42% |
| Curaleaf (CURLF) | -38% |
We invested in just one cannabis stock in order to have a dog in the race. It’s a very small position, and this article was prompted by our desire to add some more shares. But first, we need to consider whether our thesis has changed given the current bear market. Will we add to our already small position, or decide that cannabis has gotten too risky for our risk-averse tastes? This all depends on how we expect the cannabis consumer to behave in times of economic calamity.
Price Sensitivity
When you offer people too many choices, they can’t make a decision. It’s a psychological phenomenon known as “choice overload,” and that’s what you face when walking into most cannabis dispensaries. The amount of product on display is overwhelming, and that’s when your budtender will direct you towards whatever brand their friend is trying to sell, and then you show your gratitude with a tip. To avoid choice overload, people will pick a particular product and demonstrate some allegiance towards it while they can afford to. When times get tough, we believe most cannabis consumers will be price sensitive. That is, they will use price as the key factor in their purchase. That’s not just based on our own field research in legal and black markets, it’s also backed up by proper academic studies like this one.
The above paper examined twenty studies which measured price elasticity with most studies finding that demand was price inelastic (demand is considered inelastic if demand for a good or service remains unchanged even when the price changes). Studies suggest that consumers will seek the lowest-cost unregulated cannabis to avoid reducing consumption with price being their primary consideration when making a purchase. This is intuitive when you consider that heavy cannabis users are often people who spend much of their income on the devil’s lettuce.
A handful of users consume most of the marijuana used in the U.S. with two-thirds of all users smoking the stuff daily. That’s according to a massive study released in the Journal of Drug Issues which took place over a decade and noted that Americans of all ages with a household income of less than $20,000 accounted for 29% of all marijuana use and 27% of all cigarette use. (Compare to only 13% of all alcohol use and 19% of the total adult population.) When times get tough, there are always ways to keep your habit while spending the same amount of income. A good example is Rick Simpson oil (RSO).
Incredible Edibles
To demonstrate the dramatic price variations seen in cannabis dispensaries we’ll use the example of edibles. If you haven’t tried them, you should. The typical dosage is 10 mgs which produces a mellow high that helps you more effectively research technology investments – or so we’ve been told. Our benchmark is to ideally pay no more than $1.50 per dose which means a typical package of edibles that contains 100 mgs will set you back $15. That number used to be $10, but it’s getting harder and harder to find edibles at a $15 price point these days outside of sales. At a random Washington State dispensary this week, we found edible prices ranging from $17 to $35 for 100 mgs. What most people who purchase these edibles don’t know is just how cheap they can be purchased if you think outside the box.
Most dispensaries we’ve been to stock a product called Rick Simpson Oil (RSO) which is 1000 mgs of pure extract that costs anywhere from $18 to $36 for a vial.
That works out to 18 to 36 cents per 10 mg dose. Just squeeze out an amount that’s about half the size of a grain of rice onto anything edible and munch away. That’s just one example of how cannabis consumers can save money when times get tough. Another way is by purchasing weed on the black market.
The Black Market Threat
KQED published an eye-opening article in January which talks about how it’s been virtually impossible for Californian growers to run profitable operations because the price for cannabis buds has plummeted upwards of 70% with taxes approaching 50% in some areas. Customers are finding far better deals on the black market with some claiming that legalized cannabis is being subsidized by the black market. Because the industry lacks a rigid control system, it’s easy enough for growers to move products out the back door to the black market while selling a minority of their production to legal dispensaries. Some dispensaries are selling up to 90% of their harvests to the black market, the article says. With California being the first state to legalize cannabis, perhaps this is a harbinger of what’s to come in other states.
Should people’s incomes become squeezed, they’ll gravitate towards the cheapest high. All those high-margin edibles won’t look so appealing, and many top-shelf strains on the black market rival what’s in dispensaries, if not supersede them in quality. Also, consider the novelty of cannabis dispensaries and their 700 different products on offer will wear off with customers moving back to the good old black market where things were cheaper and a whole lot simpler. For daily smokers, the biggest problem used to be getting caught by the popo. That’s no longer an issue, which means they’ll probably smoke even more frequently – if they can afford to, that is.
Key Takeaways
There are several implications from what we’ve discussed today. Firstly, vertical integration will be critical for multi-state operators to compete on price. Owning the entire supply chain will allow them to compress margins while still being able to operate a profitable business (one hopes). Focusing on a single state and then capturing a majority market share will also reduce competitive pressure and allow for economies of scale.
Once the dust settles from the acquisition frenzy that took place over the last several years, focus will be placed on operational excellence which simply means creating the model dispensary and then duplicating it across all locations. A key metric for cannabis investors to watch is “same-store sales” which will show how the current recession is impacting cannabis consumers’ purchasing habits along with “gross margin” which shows that MSOs can operate as profitable businesses when times get tough.
Conclusion
Cannabis stocks may not prove to be as resilient as other sin stocks if consumers are as price sensitive as we believe them to be. Some may go back to their old habits and start buying on the black market. Cannabis legalization means it’s now much easier to drive around with an ounce of weed you just bought on the black market stored in a container from a legitimate dispensary. The police don’t know where you bought that chronic. Cannabis is becoming more socially acceptable, and the black market is doing better than ever. Investors should watch for gross margin compression and falling same-store sales which will show that indeed consumers are becoming more price sensitive as times get tougher.
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