The cannabis industry has been facing a harsh reality check as many of the ancillary businesses that were expected to benefit from the legalization wave have failed to deliver on their promises. These so-called “pick and shovel” plays, which provide products and services to the cannabis growers and retailers, have seen their stock prices plummet after disappointing earnings reports.
What are Pick and Shovel Plays?
The term “pick and shovel” plays comes from the gold rush era, when entrepreneurs made more money by selling tools and equipment to the miners than by mining for gold themselves. Similarly, some investors believed that investing in the cannabis industry’s supply chain would be a safer and more profitable strategy than betting on the volatile and uncertain cannabis market.
Some of the examples of pick and shovel plays in the cannabis industry are:
- Hydroponics and cultivation equipment suppliers, such as GrowGeneration (NASDAQ: GRWG) and Scotts Miracle-Gro (NYSE: SMG), which provide lighting, nutrients, soil, and other essentials for growing cannabis plants.
- Packaging and labeling solutions providers, such as KushCo Holdings (OTC: KSHB) and Greenlane Holdings (NASDAQ: GNLN), which offer compliant and customized containers, bags, jars, vapes, and accessories for cannabis products.
- Software and data analytics platforms, such as Akerna (NASDAQ: KERN) and Helix Technologies (OTC: HLIX), which help cannabis businesses with inventory management, compliance reporting, point-of-sale systems, and customer insights.
Why are Pick and Shovel Plays Struggling?
Despite the optimism surrounding the cannabis industry, especially after the legalization of recreational cannabis in several U.S. states in 2020, the pick and shovel plays have not been able to capitalize on the growing demand. Some of the reasons for their poor performance are:
- Competition and commoditization: As the cannabis industry matures, more players enter the market, offering similar or cheaper products and services. This erodes the competitive advantage and pricing power of the pick and shovel plays, forcing them to lower their margins or lose market share.
- Regulatory uncertainty: The cannabis industry is still subject to complex and evolving regulations at the federal, state, and local levels. This creates challenges for the pick and shovel plays to comply with different rules and standards across different jurisdictions, increasing their operational costs and legal risks.
- Customer concentration: Many of the pick and shovel plays rely on a few large customers for a significant portion of their revenue. This exposes them to customer churn, payment delays, or contract renegotiations. For instance, KushCo Holdings reported that its top 10 customers accounted for 63% of its revenue in Q3 2023, while Greenlane Holdings disclosed that its top three customers represented 51% of its net sales in Q2 2023.
How are Pick and Shovel Plays Reacting?
In response to the challenging market conditions, some of the pick and shovel plays are taking measures to improve their financial performance and strategic position. These include:
- Cost-cutting and restructuring: Some of the pick and shovel plays are reducing their headcount, closing or consolidating their facilities, streamlining their product offerings, and optimizing their supply chain. For example, KushCo Holdings announced a 50% reduction in its workforce in Q3 2023, while Akerna implemented a 20% reduction in its operating expenses in Q4 2023.
- Mergers and acquisitions: Some of the pick and shovel plays are pursuing mergers and acquisitions to achieve economies of scale, diversify their revenue streams, expand their geographic footprint, or access new technologies. For instance, GrowGeneration acquired four companies in Q2 2023, while Akerna agreed to acquire Viridian Sciences in Q4 2023.
- Innovation and differentiation: Some of the pick and shovel plays are investing in research and development, launching new products or services, or entering new market segments to enhance their value proposition and competitive edge. For example, Scotts Miracle-Gro introduced a new line of organic soils for cannabis growers in Q3 2023, while Helix Technologies launched a new e-commerce platform for cannabis retailers in Q4 2023.
What is the Outlook for Pick and Shovel Plays?
The outlook for pick and shovel plays in the cannabis industry remains uncertain as they face multiple headwinds from competition, regulation, customer concentration, as well as macroeconomic factors such as inflation, supply chain disruptions, labor shortages, and consumer sentiment. However, some of the pick and shovel plays may be able to overcome these challenges by leveraging their core competencies, pursuing strategic partnerships or acquisitions, innovating their product portfolio or service offerings, or expanding into new markets or segments.
The cannabis industry is still in its early stages of development and growth, offering ample opportunities for the pick and shovel plays to capture value and create shareholder returns. However, investors should be cautious and selective when investing in these companies, as they may not be as resilient or profitable as they appear.
