The infused product manufacturing sector is arguably best positioned to capitalize on the wave of marijuana legalization in the U.S., with:
- Low tax liabilities and higher annual revenues make infused product companies attractive investment targets
- Infused products account for roughly 13% of total sales in four adult-use states—and it’s a growing category
- Infused product makers are among the fastest cannabis businesses to become profitable or break even
Growing consumer demand for marijuana-infused products is opening up a host of new investment considerations as these businesses begin to grab market share from cannabis flower.
Here’s a breakdown of the current market in the infused segment and trends investors should be mindful of.
The Infused Product Landscape
Cannabis-infused food and beverages account for roughly 13% of total sales in the adult-use states of California, Colorado, Nevada and Washington, according to Headset, a Seattle-based marijuana data analytics company.
In those markets, sales have grown from less than $10 million in 2014, when adult-use marijuana became legal in Colorado, to nearly $120 million in the first quarter of 2019 for the four markets combined.
It’s also worth noting:
- Sales of cannabis-infused gummy products dominate the category, accounting for 49% of sales in California, 46% in Colorado and 52% in Nevada, according to Headset. In Washington state, where regulations on gummy products are murky, the products account for only 17%.
- Sales of gummy products grew 140% from February 2018 to February 2019. Sales of caramels, chews and taffy grew 77%, and infused drink sales—a category that has attracted significant interest from liquor and beverage giants—jumped 52%.
- The top five edibles makers have captured 53% of sales in their respective markets, and the leading five beverage makers control an eye-catching 80% of their category. But retailers add an average of seven new products to their shelves every month to replace low-selling brands, which underscores an opportunity for investors to fund new infused product businesses that are out to capture market share.
- Infused product consumers are price conscious and favor goods that are priced in the $15-25 range. Roughly 80% of total sales are for those products. Higher-priced products—$35-$45—account for only 2% of sales.
- This is a saturated market. There are roughly 2,000 to 3,000 licensed infused product manufacturers in the U.S., according to the Marijuana Business Factbook, which underscores a need for capital that businesses can use to differentiate their products and expand into multistate operations.
- Infused product makers are likely to become profitable or break even about 14 months after launching, which is faster than vertically integrated businesses and marginally slower than wholesale cultivators.
Critical Benchmarks for Investment Targets
Brand, market penetration, profit margins and multistate operations are critical benchmarks investors should assess for infused product companies.
- Brand recognition: Unlike cannabis flower, which is increasingly recognized as a commodity, infused products rely on brand recognition. A brand is more than a logo and slick packaging, noted Diane Czarkowski, founding partner at Colorado-based Canna Advisors. It’s a business’ ability to leverage the talent of its executive management team, articulate its values to consumers and replicate its product quality in multiple markets. And if the executives have experience in traditional food and beverage industries, that’s a bonus. All of this wins trust with retailers and consumers.
- Market penetration: The top five edibles and beverage brands control the lion’s share of the market. Hefty market penetration—10% or more—is, of course, attractive, but investors shouldn’t be deterred by a lower figure on paper, because 1%-3% could be enough to make a brand a big player in a crowded field. “In California, for example, I don’t think anyone has in any way captured the market, so usually, even if you only have 2%-3% (market penetration), that means you’re a big player,” said Michael Huttner, managing director of investment banking for Young America Capital.
- Profit margins: Profit margins of 24%-34% are common for infused product businesses, but many companies are funding growth, which drives margins down in the short term. “A lot of these companies are producing real revenue,” Huttner said, “but they haven’t had real earnings because what they’re doing—and, for most of them, it’s a smart move—is reinvesting their profits in the company to expand their brands rather quickly, because there’s a race to be the brand that customers demand.” Lower margins, however, should be attributable to reinvestments in growth and not market conditions, Czarkowski noted. “Because of the volatility of markets that have oversupply or lack of supply, I wouldn’t feel comfortable investing in an early stage business that was making its projections based on a 10% margin,” Czarkowski said.
- Multistate operations: Multistate expansion should be equally as important to an investor as market penetration in any one given market. The most attractive investment plays would have operations in at least two states, with near-future plans to expand to half a dozen or more. “When I’m looking at investor presentations, I’m looking at whether the company has a solid brand with a solid track record and—maybe just as important—whether they are able to replicate their success in more than one state,” Huttner said. Brands that are content with their market share in one state are likely to be outpaced by others that are eyeing U.S. and international expansion.
According to the Marijuana Business Factbook, other key metrics that position infused product manufacturers as an increasingly attractive investment play include:
- About half of infused companies are moderately or very profitable.
- They have lower tax liabilities than marijuana retailers—who are subject to section 28E of the federal tax code—and lower startup and annual operating costs than wholesale cultivators, who face significant costs for energy and water.
- They also post higher annual revenue relative to their operating expenses.
Key Data Takeaways for Investors
An attractive investment play would have a robust line of value-priced products.
Gummy products are the clear winner with consumers, but it’s a crowded category with dominant players—Boulder, Colorado-based Wana Brands; San Mateo, California-based Plus Products; Mindy’s Kitchen-branded ingestibles for Chicago-based Cresco Labs; and Denver-based District Edibles, for example.
Any new gummy product would have to be different from what’s already available.
Denver-based Stillwater’s gummy, for example, uses a water-soluble powder to infuse its product, which speeds up the onset time of effects.
How a company differentiates itself—and not just how it says it differentiates itself—should be a key consideration.
This can be done through the hiring of an accomplished chef—consider Cresco’s partnership with James Beard Award-winning chef Mindy Segal, for example—or a collaboration with a biotechnology firm that develops rapid-onset formulations for ingestible food and beverages. It can also be done through a brand’s introduction of microdose products, non-GMO ingredients and vegan or sugar-free options to appeal to new consumers.
Another attractive feature in an infused business that is an investment target is its expansion outside of the infused product category, such as to concentrates or vaporizers. That strategy could increase revenue, because oils and vaporizers have seen explosive growth in the past two years.
Top Tips for Mitigating Risks
Similar to marijuana retailers and cultivators, infused product businesses face a number of unique challenges—and investors must be attuned to those vulnerabilities.
These products are often targets of anti-marijuana lawmakers, and they’re subject to heavy regulation.
In Washington state, for example, regulators have imposed prohibitive packaging and product design rules on makers of ingestible products. And, in other medical and recreational markets, there are often bans on color and flavor additives or entire categories of products, such as infused candy.
When federal prohibition of cannabis in the United States ends, infused product makers are also likely to face increased scrutiny from the U.S. Food and Drug Administration.
Additionally, they’ll be required to comply with Good Manufacturing Practice and strict food safety and defense measures. Those companies that are unprepared for this will face a significant capital outlay to get up to speed.
A manufacturer should have a plan to anticipate rule changes and pivot if needed.
“At some point, infused product manufacturers are going to have to expend the capital to get to there,” said Scot C. Crow, a private equity and merger and acquisition attorney in the cannabis practice group at the international law firm Dickinson Wright. “A company that has done that would be a more attractive choice (for investors).”
Who’s Leading the Way
Here’s a look at some of the clear leaders in the infused product segment:
- Wana Brands, a Colorado-based, privately held manufacturer of cannabis-infused products and vaporizers, was the No. 1-selling edibles brand in the U.S. in 2018, with $58 million in sales, according to BDS Analytics. That’s 40% more than the closest competitor. The company’s three-year revenue growth rate is 455%, and it had six of the top-eight-selling SKUs in Colorado in 2018, depending on the month of data queried. Wana products are available in six states, and the company plans to expand to 10 more states and Canada by 2020. According to retail data aggregator LeafLink, Wana Brands was the No. 1 seller in Arizona, Colorado, Nevada and Oregon in the first quarter of 2019.
- Plus Products (CSE: PLUS; OTCQB: PLPRF) was one of California’s top edibles brands by market share, according to BDS Analytics. The company’s retail sales hit $10.5 million in the fourth quarter of last year, an increase of 39.6% over the third quarter of 2018. According to Headset, the Plus Uplift Sour Watermelon gummy (right) was the top-selling branded product of more than 20,000 products sold across all cannabis categories in California last year. Plus Uplift and Plus Restore products were the Nos. 1 and 2 best-selling edible products in California, according to BDS Analytics.
- Massachusetts-based Curaleaf Holdings (CSE: CURA; OTCQX: CURLF) paid $949 million to acquire Portland, Oregon-based Cura Partners, owners of the Select brand of cannabis products. The transaction will increase market penetration for Select’s line of infused products, which are currently available in 900 retail shops in key adult-use and medical markets, including Arizona, California, Nevada and Oregon.
- Denver-based Dixie Brands (CNSX: DIXI.U) reported its annual revenue in 2018 increased 73% to $5.8 million. Fourth-quarter revenue increased 123% year over year to $1.6 million. Dixie raised $25 million in an oversubscribed Series C financing that closed Oct. 1, 2018. This financing was related to a public funding that the company undertook to fund corporate development activities. Earlier this year, Dixie announced partnerships that will introduce its products to Michigan and Latin America.
