Investors in the cannabis space have thus far focused primarily on the growers of the product. We first recommended Canadian greenhouse growers in 2016, added in 2017 and added again in early 2018. It has been a very profitable ride and I believe there is more upside ahead for cannabis growers over the next 12 months.
But they will eventually face margin compression, as the supply shortfall turns into oversupply. This is due to the massive amount of money that has been injected to rapidly expand production capacity at multiple companies. As they maximize output in an attempt to achieve revenue growth, market share and first-mover advantage, they will inevitably overshoot and the oversupply will drive down prices. Lower prices will equate to lower profit margins for the growers, but this is probably 12 to 18 months out, so there is still room for valuations to continue higher before the margin compression occurs.
Another way to profit from this high-growth emerging sector is through retail exposure. A big advantage to retailers is that they will not face the same margin compression as the growers, when all of the new supply comes online. Their margins are likely to remain high no matter what happens with supply and they stand to benefit from exploding demand in Canada, where cannabis becomes fully legal on October 17th.
To give you an idea of the potential for the retail side of the business, take a look at leading retailer, California-based Medmen (MMEN.CN or MMNFF). While it took a while for their share price to gain traction, it has rocketed 50% higher in the past week alone and is up 80% since their IPO in May. They currently operate 66 retail stores across 12 U.S. states.
Reamarkably, cannabis retail stores like MedMen can generate more sales per square foot than high-value retail leaders such as high-Apple or Tiffany. They do 5 times the average sales per square foot as Starbucks!
Cannabis retail outlets can typically generate revenues in excess of $5 million per store, per year. Medmen are targeting $20 million in annual revenue per store. The stores have a gross margin of 60% and are so profitable that they have an average payback of under one year. Clearly, the retail side of the cannabis industry is a good place to invest.
