Cannabis is Booming, But There’s Reason for Caution

2020’s record-breaking cannabis sales tell an incredibly optimistic story about the industry’s resilience during an economic downturn. Many cannabis business operators are putting all their faith into that story as they plan their next steps. Here’s why I wouldn’t get too comfortable with that perspective yet.

Looking at the Bright Side: Essential Designation Pays Off

As pandemic-related lockdowns spread across multiple sectors, cannabis was deemed essential in nearly every legal state. This designation quickly advanced the industry by several years, with states rapidly adopting safety-driven emergency regulations for legal dispensaries, including online ordering, cashless transactions, dispensary curbside pickup and delivery in some areas. More convenient shopping alternatives and debit card payment options, in turn, encouraged consumer spending and drove larger basket sizes.

In March, sales figures in several of the largest adult-use markets sharply increased as panic buyers stocked up, fearing that dispensaries might ultimately be shut down. By April, consumers also had more money to spend thanks to the $2.2 trillion CARES Act passed by Congress. The one-time payments of up to $1,200 per adult provided an additional bump in adult-use sales.

Top-Line Revenue Versus Bottom-Line Realities

Even as the stimulus winds down, cannabis retail sales have remained strong, boosting topline revenues. Demand outpaces supply in many markets making it nearly impossible for cannabis operators to fail, short of outright mismanagement.

But as we saw during Q2 earnings calls, many companies are burning through cash or losing control of their SG&A. Artificial conditions tied to the pandemic—loosened regulations, hobbled competition from other sectors due to shutdowns—are allowing these struggling companies to stay afloat as they gamble that the market can only go up.

Lessons from the Housing Crash

When looking at the market this year, I flash back to my work in the mortgage world during the 2007 housing crash. Many companies over-leveraged themselves but got an artificial lifeline through lower interest rates that kept revenue flowing even as home prices drifted further out of line with average household income. Success was predicated on the assumption that the housing market could only go up. This mindset worked as long as interest rates stayed low, regulatory oversight remained weak, and investors didn’t dig too deep. Of course, we all know how that ended.

I see similar dynamics in the cannabis industry right now. Cannabis business operators got a lifeline earlier in the year as consumption increased during the shutdown. Everyone was stuck at home with few options for relaxation other than cannabis, alcohol or bread-baking. However, as restaurants, bars and entertainment venues begin safely opening back up to consumers who are eager for in-person experiences, it’s uncertain what the impact will be on cannabis sales.

There are also no guarantees that emergency guidelines allowing curbside pickup, delivery or cashless payment will remain in place after the pandemic, yet cannabis businesses are forecasting future growth based on these current operating conditions.

State and local inspectors have also seen their priorities shift toward assisting with more broad pandemic response efforts in places like Denver, taking the microscope off cannabis operations for now. We all want to believe that everyone in the industry is always on their best behavior. Still, there’s no doubt that the temporary lack of enforcement has benefited some operators who would otherwise be put out of business.

Is a Return to the Past Possible?

The pandemic may be giving the industry a false sense of security. We were deemed essential, we quickly rose to the challenge of adapting to new regulations, and we’re providing jobs and bringing in much-needed tax revenue. Many people think this means there’s no way we’re returning to the past, but in this highly-regulated industry, the world doesn’t always make sense.

We need to remember that when it comes to cannabis, not everyone has the same mission. As temporary mandates roll back, the regulators will go back to being regulators. They don’t care about the additional tax revenue that came in with loosened regulations, but they do care about revenue they’re supposed to generate for their department through enforcement and fines. There will always be competing interests to contend with.

Federal Legalization Comes with Opportunities and Risks

Without a doubt, federal legalization or passage of the SAFE Banking Act and MORE Act would represent a significant victory for cannabis, opening the doors to institutional investors while also spurring new opportunities for innovative programs, including those focused on social equity.

However, many cannabis business operators stop after thinking of all the upsides without factoring in the challenges that legalization will bring. Things will become easier but also more competitive as supply increases to meet demand, licenses multiply and new players flood the market. How will you hold onto market share after four other stores open within a mile radius of yours?

Determining Whether to Build for the Future or Cash Out

Operators focused on long-term sustainability should be doing the work now to build a deep, narrow geographic footprint that reflects regional tastes and will generate brand recognition and customer loyalty. This work will pay off in the long term as the market continues to mature.

Businesses may also want to look at whether now is the time to cash out. Just because they’re achieving record sales this year doesn’t mean it’s guaranteed in the future, even if cannabis reform moves forward.

Looking Beyond 2020

We’re facing a lot of uncertainty politically and economically as the world stabilizes. There’s no doubt the road to recovery will be rocky at certain points. A lot of cannabis companies are riding high thanks to 2020’s unique environment. But as the landscape shifts, we can expect to see fallout as some companies find themselves unable to survive during a return to some form of normal. 

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