Q2 Cannabis Earnings Were Strong. But What Does This Really Mean?
Free Book Preview Cannabis Capital
Earnings reporting season is here, answering speculations about how high cannabis companies’ quarterly revenues will climb during these unprecedented times. But if you’re only focused on topline revenue, you’re missing a big part of the story.
Record-breaking cannabis sales in 2020
We already know from the retail sales side of the equation that cannabis has remained strong despite the pandemic and economic downturn, bolstered by its essential designation in most legal states. Marijuana Business Daily projects another record year for U.S. retail cannabis sales which are anticipated to rise by 40% by the end of 2020.
Legal states are experiencing explosive growth in both adult-use and medical markets, with that momentum helping to drive mainstream acceptance of cannabis. Cannabis’s essential designation and increased visibility have been a boon for companies that are well-positioned and focused on their core markets. We’ll see many of those companies posting record-breaking topline revenues for Q2 as well as upcoming quarters.
But strong quarterly topline revenue doesn’t necessarily equate to long-term viability. As we get a first look at some of the industry’s biggest players’ quarterly earnings, the real story rests with the bottom line—whether these companies are scaling to meet demand while building long term sustainability.
Adapting to a maturing cannabis market
Bringing in revenue isn’t that difficult in the current cannabis market, but many companies are burning through cash or utilizing fuzzy math to get there. While that may work in the short term, only the companies that are committed to transparency and long-term financial sustainability will be positioned for success as the cannabis market matures.
In these earnings calls, we’re seeing some companies that are turning big profits, while others who have big revenue numbers but aren’t making any money. One crucial differentiator I see is in how these companies are managing their SG&A.
As cannabis transitions to a more mature industry with real financials, management teams need to bring a different skill set. Simply focusing on topline revenue is no longer enough, and using revenue as an excuse to burn through cash is not sustainable. Instead, management teams should focus on operational efficiency and technology while scaling up. Prioritize growth opportunities, things like new stores or increased supplies. In most state markets, demand outstrips supply. You don’t need to spend excessive amounts of cash on marketing, but you do need to invest in the retail space and product to sell.
Playing the long game
Large institutional investors aren’t in the game yet due to cannabis’s federal status as an illegal drug. However, they’re closely watching to see which companies are transparently managing their SG&A. Once federal legalization comes into play—and I do believe the ship is sailing in the right direction here—then these investors will be jumping in and rewarding those companies that have focused on building strong fundamentals.
One of the biggest issues I see in the industry today is companies’ use of adjusted EBITDA to classify certain items like legal fees or consultants as one-time expenses, but in reality, these expenses occur every quarter. In some cases, you’ll see the delta between EBITDA and adjusted EBITDA is anywhere from $10 million to $20 million. Taking those kinds of liberties may help provide a short term bump, but will stand out to savvy investors who are looking for transparency before they’re willing to write the checks. In the end, companies aren’t doing themselves any favors when they play numbers games with their adjusted EBITDA.
Everyone is holding their breath, waiting for federal legalization followed by the influx of investors like Fidelity and BlackRock. What companies need to understand, though, is that those funds aren’t going to take a flyer on a company with fuzzy math. The sooner that cannabis companies clean up their financials, the more likely we’ll see big investors continue to come into the space. Focusing on the bottom line and embracing operational efficiencies and transparency—those strategies will pay huge dividends down the road.