California's medical marijuana market has been up and running since the 1990s, but its adult-use marijuana market only opened for business in January. Initially, the state's adult-use market got off to a slow start, but third-quarter data suggests that perhaps the state is overcoming its growing pains. If so, it could be great news for cannabis companies like KushCo Holdings (KSHB) and MedMen Enterprises (MMNF.Q).

Getting on track

California's Emerald Triangle region is one of the country's largest sources of marijuana, and its medical marijuana market sales last year totaled about $3 billion, which makes the state's marijuana market roughly two times larger than Colorado's medical and recreational marijuana markets combined.

A marijuana leaf on a $100 bill.


There have been some bumps since the adult-use market opened earlier this year, but data reported by the state implies recreational marijuana market sales totaled about $350 million in the third quarter, according to Matt Karnes of GreenWave Advisors, and that represents a 24% increase from the second quarter.

The sales growth is due in part to a roughly 10% increase in dispensaries last quarter and higher average sales per dispensary. Karnes estimates that the average monthly sales for recreational dispensaries increased $50,000 quarter over quarter to roughly $300,000 in the third quarter.

The increase is encouraging because California's marijuana sales during the first six months of 2018 were disappointing. Consumers have been slow to embrace legal dispensaries due to obstacles that have prevented existing shops from obtaining recreational licenses and many cities and towns banning marijuana retail stores. Since those headwinds have crimped legal sales, California only pocketed $84 million in excise and cultivation taxes in the first six months of 2018, which was about $100 million less than the state had forecast in June.

California's third-quarter performance, however, suggests the state is getting back on track. Marijuana retail excise tax revenue of $52 million last quarter was nicely higher than the preceding two quarters.

A chart showing increasing marijuana excise tax revenue in California during each of the past three quarters.

Source: California Department of Tax and Fee Administration.

What it means for marijuana investors

Success in California could be a boon to marijuana companies, including KushCo Holdings and MedMen, because the black market still accounts for most of the state's marijuana sales. As more of those sales come out of the shadows, demand for retail packaging sold by KushCo Holdings and sales at MedMen's dispensaries should climb.

KushCo Holdings hasn't reported its financials for last quarter yet, but it did report preliminary fiscal-year financial results in September that suggest it's already benefiting from marijuana companies' need to work with a trusted supplier to meet regulatory packaging requirements. Its sales soared 171% year over year to $51 million last fiscal year.

Sales growth in California is even better news for MedMen because the retailer generates the bulk of its sales in the state. Its eight stores in California, including four in Los Angeles, accounted for 92% of MedMen's $20.6 million in fiscal fourth-quarter sales. In short, growing demand in California is mostly responsible for MedMen's revenue increasing 44% from its prior quarter.

Admittedly, both of these companies are risky stocks for investors to buy. Their shares trade on the lightly regulated over-the-counter market rather than a major U.S. stock exchange, and because marijuana is still illegal federally, there's always the chance that a crackdown in Washington, D.C., could derail their business models. Nevertheless, both companies should be able to deliver significant top-line growth for their shareholders if California's market continues to heat up, and that might make them worth watching.