From Nick Colas, Chief Strategist at Convergex, discusses a rising investment theme:
Summary: It’s a lucrative time of the year for the legal marijuana industry: warmer weather, spring break, tax season (refunds!), and the drug’s celebrated holiday: 4/20. Our latest quarterly survey of numerous dispensaries in Colorado and Washington state shows increased foot traffic which averages from 100 to 400 daily visitors. Currently, stores are stocking up because come April 20th (the unofficial marijuana holiday), some dispensaries said they wouldn’t be surprised to see well over 500 people/day. Dispensaries are also fine tuning their strategies on how to boost transaction sizes, such as offering bulk deals, introducing price breaks, and offering higher end products. Both states continue to feel pricing pressure and implement daily discounts to compete. That said, Colorado dispensaries registered $82 million in retail sales in January (latest available data), not far off from the record of $85.8 million last September. Washington marijuana sales already total $135 million for January and February combined, up 65% from the prior year period. The only thing standing in the legal cannabis market’s way is the Feds, but even there our contacts are hopeful and open to some change, such as giving better guidance for dispensaries to operate and standardizing the industry across states. Please read on for the details…
Note from Nick: Over the last three years, Jessica’s quarterly surveys of the legal marijuana business have become the “Beige Book of Pot”. And while it is still difficult to find pure investment plays in the space, that doesn’t seem to curtail our institutional clientele’s desire to track developments in this fast growing business.
“Good people don’t smoke marijuana.” Past comments like this from U.S. Attorney General Jeff Sessions caused some concern for the legal marijuana industry after President Trump chose him for the job. Tensions between state and federal laws persist in retail marijuana friendly states, so the possibility of a crackdown by the AG would pose significant problems for the industry.
On a more hopeful note, Sessions recently said he thinks much of the Cole Memorandum issued by former Deputy James Cole in 2013 is valid, which gave “Guidance Regarding Marijuana Enforcement” to all U.S. attorneys for states where recreational marijuana is legal. Sessions followed up, “I may have some different ideas myself in addition to that, but essentially we’re not able to go into a state and pick up the work that police and sheriffs have been doing for decades.” The Cole Memorandum listed eight priorities for anti-marijuana enforcement, which you can read along with Sessions’ comments here: http://www.boulderweekly.com/features/jeff-sessions-and-marijuana-slouching-toward-reality/
Here’s the actual memorandum: https://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf
We’ve paid close attention to these developments as we’ve written many reports on the recreational marijuana market, interviewing numerous managers of dispensaries in Colorado and Washington each quarter. During this quarter’s review, we asked our contacts about their level of nervousness with the new AG. A few points here:
- Most managers weren’t too worried as they don’t expect changes in the near-term. One contact mentioned how it would be hard to undo all the progress and money being made in Colorado, for example.
- Some believe Sessions will simply tighten up the eight points under the Cole Memorandum, which could include some positives. For example, a Washington contact said perhaps certain changes would help standardize the industry across the states where retail cannabis is legal. This was a topic of discussion at a recent marijuana seminar she attended. In Washington, she said marijuana is already weighed and pre-packaged, whereas dispensaries in Colorado weigh it out at their stores. She thinks it would be helpful to go straight to retail mode and standardize packaging, sort of like how cereal boxes are all the same size.
- One contact was overall bullish on the Trump Administration for its pro-business rhetoric. Since marijuana is still illegal on a Federal level, dispensaries can’t take the same deductions as other businesses, leaving them with hefty taxes. Lowering tax rates could help their bottom line significantly. She was also confident in President Trump’s past comments that he’ll leave the issue to the states.
So how is the current state of the business? Here’s what we found based on our interviews over the past week:
- Price: Most stores reported downward pricing pressure in Colorado and Washington due to competition among dispensaries and vendors. An ounce in Colorado can sell for between $100 to $350 and $20 to $25 for an eighth on average depending on quality, location, and specials. Stores continue to run discounts, with one contact selling an ounce for as low as $99 and an eighth for $15 on the weekends.
- The managers we spoke to said there are large companies mass producing and selling ounces for only $100, so in order to be smaller and still compete they have to provide better quality. One of our contacts expects his prices to remain steady despite their smaller size given that they just won a few flower and concentrate awards, for example.
- In Washington, our contacts said margins for retailers continue to drop and there is more competitive pricing among growers as well, forcing them to become more efficient (like retailers). One manager also said that outdoor farms are starting to book in Western Washington where they have 360 days of sun in some parts: “their huge crops are driving down the price of cannabis overall (the average indoor cost is around $3.75/g and the average outdoor cost is around $2/g).” Therefore, a gram of retail marijuana goes for $6 to $12 now on average compared to $8 to $15 in our last report, with $10 being the standard price. The price of an eighth is down a bit as well to about $25 to $40 on average.
- Store Traffic: There are currently many factors contributing to an uptick in daily visitors at dispensaries in Colorado and Washington. These include warmer weather, spring break, tax refund season, and the biggie: 4/20. That last factor stands for the day marijuana is celebrated each year (on April 20th), and it’s one of our contacts’ largest days in terms of sales for the year. To put this in perspective, daily traffic at Colorado and Washington dispensaries we surveyed averaged 100 to 400 people. Some contacts believe they could see well north of 500 customers based on prior years. With the holiday just a few weeks away, dispensaries are busy preparing and making sure they have enough products on the shelves. One dispensary in particular teamed up with a cannabis touring company which will run a shuttle service between his store and a party venue. Going forward, managers expect increases in store traffic to continue into the summer as tourism picks up.
- Our contacts are also branching out with advertising to help attract more customers. This ranges from in house marketing and local newspapers to music venues and social media. One manager said he started advertising a special sale on the radio, which helped increase his average transaction size by $10 to $90. He also hired a company to assess and improve his dispensary’s customer service. In order to increase the store’s online presence, he encourages his employees to ask customers to write online reviews and receive an extra $5 every time their name is mentioned. No doubt the longer these dispensaries have been in business, the more creative they’ve become at discovering ways to boost traffic.
- Mix: The ratio of product categories sold varies depending on each store and their marketing focus. Typically the order from most purchased to least is: flower/pre-rolls, concentrates/edibles, and miscellaneous items including wellness products such as topicals (cannabis infused balms, creams, and oils). Concentrates remain the fastest growing product in popularity as consumers continue to get more educated and comfortable with this variant. They’ve also grown market share as a greater variety of cartridges and concentrates come to market with better technology, enhanced refined processes, and lower failure rates.
- One manager said he still sees a new form of concentrate every couple of months as the science improves. Another manager reported he now uses more out of house than in house companies to supply his dispensary with concentrates. Lastly, one store said a change in packaging and labeling laws has helped as products need to display the level of potency and milligrams. Therefore, people buy the products with higher THC levels, choosing concentrates over flower (even though, as he said, they may only get one gram of concentrate versus 3.5 grams of flower).
- The average transaction size per customer ranges from $20 – $40 all the way up to $100. Some contacts report a fall given the drop in prices, while others list a few factors increasing transaction sizes, including tax refunds and better advertising. Others try different approaches, such as offering bulk deals and introducing price breaks to incentivize customers to buy extra weight. One dispensary said offering higher end ‘wellness’ products increased their sales average “a ton”.
Even with continued price competition, dispensaries are still raking in the cash. Here’s a sales breakdown for Colorado and Washington:
- Colorado: Last year, medical and retail marijuana sales reached $1 billion in the first ten months and finished with $1.3 billion in sales for the year. Looking at just recreational sales, dispensaries received +$861 million in 2016 (+49% y/y) and $82 million in January 2017, up 57% y/y based on tax data from the Colorado Department of Revenue. Not a bad start to the year given that the record was $85.8 million last September and sales only reached $52 million in January 2016.
- Washington: Dispensaries sold $696.3 million in 2016, up 95% y/y according to the Washington State Liquor and Cannabis Board. In the first two months of this year, they registered $135 million in sales, up 65% y/y. For the past eight months, they’ve sold north of $60 million worth of marijuana per month.
To wrap up, here are some miscellaneous topics we discussed with store managers during this quarter’s survey:
- Out of state funding: Last year, Colorado Governor Hickenlooper signed bill 16-040, which eliminated the state’s two year residency requirement to get a marijuana business owner license, making it easier for businesses to receive out of state funding. Since that went into effect on January 1st, I asked how it was going. My contacts in Colorado said investors are getting a little more wary of the industry. They say the challenge now has switched to IRS Section 280E, which doesn’t allow businesses to deduct ordinary business expenses from gross income associated with trafficking in a Schedule 1 or 11 drug (as classified by the Controlled Substances Act). Marijuana is a schedule 1 drug, so dispensaries are taxed at a much higher rate than regular businesses.
- Even though dispensaries continue to post impressive sales figures, I frequently hear from managers that “it looks like we are making way more money than we actually are.” Until 280E clears up, one manager said investors aren’t as interested. They’d rather wait for small businesses that can’t pay the taxes go under and buy the property to build their own business as opposed to investing in a business barely breaking even with debt. The fallout from this is that it makes it very difficult for smaller stores to survive. This same contact said large companies tolerate the situation because it pressures smaller competition and gives them more market share, all the while mass producing and building scale.
- Bitcoin: Some marijuana stores have started accepting bitcoin out of convenience for customers as they typically accept cash only due to their difficulty receiving or maintaining a bank relationship as cannabis is illegal federally. A startup called POSaBIT allows customers to purchase and use bitcoins in marijuana stores rather than using cash. One of our contacts said his store tried it in beta, and although it increased convenience for their customers, having credit card accessibility didn’t raise their sales. Moreover, the fees POSaBIT charges per transaction started to add up over time and it was ultimately not worth it to him financially.
- Here’s a useful article for more information: http://www.seattleweekly.com/news/you-can-now-buy-pot-with-a-credit-card-in-washington-state-because-technically-youre-not/
- Marijuana testing rules in Oregon: In our last report this past December, we noted the challenges Oregon faced after the Oregon Liquor Control Commission created the recreational market last October. New and onerous testing regulations caused shortages of supply (particularly for concentrates) and consequently higher prices. Managers we spoke to this past week said the challenge remains to a smaller degree but still has its difficulties. One contact reported she is frequently told she’ll receive test results in two weeks and doesn’t even have them in six weeks. Bottom line, the Oregon Health Authority is still working on adjusting the rules. This should serve as a cautionary tale for states that just legalized recreational marijuana this past November as they create regulations for when they allow stores to open as soon as next year.
