Cannabis Business Models: Concentrate on concentration

Because of the highly fragmented legal and regulatory landscape of the cannabis industry, the sources from which a company generates revenues can have a huge impact on the business’ opportunity and risk profile.

Your assessment of a company’s risk profile plays a huge role in how you price a potential investment.

Investors traditionally think of revenue concentration as the percent of revenue from a single or a handful of large customers.

Customer concentration is a solid start to framing the opportunity for revenue growth or the risk of a shortfall, but it can be expanded.

Other considerations for analysis include:

  • Geographic regions.
  • Products.
  • End-market quality.
  • Regulatory environment.
  • Margin life cycle.

Geographic region

How geographically diverse or concentrated are the company’s goods and services?

This can be critical when forecasting revenue growth and volatility.

Changing tariffs, taxes and exchange rates could impact international revenue results. Stage of economic cycle for a particular region can also play a major role in company growth.

If a major percentage of revenues are generated from a region that just tipped into recession, it might be time to adjust your forward estimates.

Regional concentrations can also be impacted by weather, such as hurricanes in Florida or harsh winter storms in the Northeast.

Product

Knowing product concentration (revenue mix) is key to understanding current financial results and accurately forecasting revenue growth and profit margin.

We wrote about understanding product mix in this story: Cannabis Due Diligence: The importance of understanding product mix.

End-market customer

The demographics of your end customers can have a big impact on revenue growth.

Consider this: What percentages make up the lower, middle and higher end of the wage scale?

If a company’s products are mostly sold to consumers on the lower end of the wage scale, slight economic downturns could have outsized revenue impacts. This is especially true when the product is paid for from the consumers’ discretionary income.

Additionally, the company might have little pricing power even in good economic times, as their customers are highly sensitive to price changes.

Margin life cycle

Margin life cycle is rarely mentioned until a company must explain a missed quarter.

Some customer relationships start at low margins and ramp up as the relationship grows, making it important to know when a company is onboarding one of these initial low-margin contracts and when it might reach mature margins.

Conversely, some large customers get reduced pricing as they buy more product. A large customer buying even more product is great for revenue growth, but it could put downward pressure on projected margins.

The above list isn’t exhaustive, but it provides a robust framework to begin assessing a company’s revenue concentration.

As part of our expanded product, we will analyze companies’ revenue concentration to create a more complete information mosaic.

Our goal is to provide you with valuable insight that will help you identify investment opportunities in the cannabis industry and how to capitalize on them. 

Craig Behnke can be reached at craigb@mjbizdaily.com