There's no industry on the planet right now garnering more attention than the legal cannabis industry, and there are very good reasons for that. In 2019, the global marijuana industry is expected to generate a lot of jobs and lead to 38% sales growth to $16.9 billion.
Looking even further down the road, global marijuana sales could grow to between $50 billion and $75 billion by the end of the next decade. That represents a compound annual growth rate, between 2018 and 2030, of between 12.5% and 16.7% per year.
Of course, there's no country in the world that offers more long-term potential than the United States. Even though cannabis remains illicit at the federal level, and it's unclear when or if this might change, the weed industry is blossoming at the state level in 33 states. The legalization of recreational pot in California, the fifth largest economy in the world, is very likely to eclipse annual sales throughout all of Canada. That makes vertically integrated dispensary operators in the U.S. a pretty hot commodity among investors.
But make no mistake about it: Not all dispensary operators are created equally.
MedMen dishes on its third-quarter operating results
Last week, upscale dispensary chain MedMen Enterprises (MMNFF 4.49%) released the preliminary revenue results from its fiscal third quarter, ended March 30. The company's full quarterly report is due out in May.
For the quarter, MedMen recorded $36.6 million in systemwide revenue, which includes all of its retail operations, and represents a 22% increase from the sequential second quarter. Inclusive of its pending acquisition of privately held PharmaCann and other smaller buyouts, pro forma sales in the third quarter jumped 11% to $54.9 million from the sequential third quarter. Sales growth was particularly strong at PharmaCann, with $15.5 million in quarterly revenue, up from $9.8 million in the sequential quarter.
MedMen, which has demonstrated sales per square foot in its established California stores that are on par with that of Apple stores, ended the quarter with 82 retail licenses and 32 open stores (including pending acquisitions). For added context, MedMen had just 66 retail licenses when it agreed to purchase PharmaCann for $682 million in October 2018.
This might sound like solid progress, but for someone closely following MedMen's expansion, I'd caution that a true stinker of a quarterly report awaits Wall Street and investors next month.
Cover your nose, because this could get ugly
The first warning in MedMen's results comes from how the company generated most of its revenue during the third quarter. Aside from sales growth of 34% and 513% in Nevada and Arizona, which are two states MedMen is just starting to build its presence in, organic sales growth in MedMen's 10 Southern California locations slowed to a crawl. Officially, the 10 Southern California locations contributed $24.9 million, combined, which was only 5% sequential growth from the second quarter. That's anemic sales growth in a leading state for recreational cannabis sales.
Aside from slowing organic sequential sales growth, gross margin declined two percentage points to 51% in the third quarter from 53% in the second quarter. Despite a gross profit of $19.5 million, before fair-value adjustments on biological assets, the income statement is going to be hideous once general and administrative costs, sales and marketing expenses, and depreciation and amortization are added in. Thus far, recurring operating expenses have cost MedMen $73 million in first quarter, almost $78 million in the second quarter, and it has even more stores operating now than ever before. In other words, another quarterly operating loss of more than $50 million is highly likely.
Also contained within MedMen's preliminary sales report was a quarterly breakdown of soon-to-be acquired assets. Although PharmaCann sales grew nicely, its other acquisitions saw sales nosedive. In fact, revenue from pending acquisitions actually fell 7% on a sequential basis to $18.3 million. This suggests that MedMen may be grossly overpaying for its acquisitions to expand to new markets.
In other words, it's going to be an ugly quarterly report.
Forget MedMen, and consider these alternatives
The good news is, not all vertically integrated dispensary stocks are a losing money hand over fist. Whereas MedMen could be one of the slowest vertically integrated dispensary operators to turn a recurring profit, there are already a handful that are generating an operating profit.
For starters, Trulieve Cannabis (TCNNF -5.15%) reported record sales and profits just under two weeks ago. Trulieve, which has more than two dozen dispensaries open in Florida, recorded $102.8 million in full-year sales, a more-than-quintupling from the previous year, and gross margin of 67%. Meanwhile, operating expenses totaled a mere $29.2 million, leading to an operating profit of more than $39 million. It's unclear if Trulieve can maintain such robust results as it aims to expand into California and Massachusetts, but for now it's a true standout among dispensary stocks.
Harvest Health & Recreation (HRVSF) has been impressive in its own right, too. The company, which is the midst of acquiring privately held Verano for $850 million in an all-stock deal, reported $30 million in revenue, and $17.4 million in gross profit before adjustments, in the first nine months of fiscal 2018. When compared to $14.4 million in operating expenses, Harvest Health has generated close to $3 million in operating profit in 2018, through nine months. It's unclear if expenses will remain this low for Harvest Health given its massive acquisition, but the company has demonstrated that operating profits and the well-being of its shareholders is important.
In sum, forget about MedMen. Sure, its sales per square foot are impressive, but the company hasn't given investors any reason to be excited about its near-term prospects.