Marijuana’s Substitution Effect on Alcohol

By in
Marijuana’s Substitution Effect on Alcohol

Just because many public marijuana companies are making 1-year lows today does not mean this disruptive industry has become irrelevant from an investment standpoint. Liquor companies especially understand this dynamic, which is why they have been some of the biggest and earliest movers to invest in the legal marijuana industry. The poster child for these deals is Corona owner Constellation Brand’s stake in Canadian marijuana producer Canopy Growth. Canopy even just named Constellation’s CFO as chairman of its board.

The reason: cannabis gives liquor companies a way to diversify their product offerings as sales of alcohol wane. For example, one of the Strategic Risks in Constellation’s latest annual report includes: “a general decline in beverage alcohol consumption due to consumer dietary preference changes or consumers substituting legalized marijuana or other similar products in lieu of beverage alcohol.”

So how real of a threat is marijuana to liquor sales? A recent study by researchers from Syracuse University and the University of Georgia sheds new and telling light on the answer. Here is a breakdown of their work and its findings:

#1) Goal: The researchers wanted to identify the impact of recreational marijuana legalization on both the alcohol and tobacco industries by analyzing online searches, ad impressions and clicks.

#2) Process: They looked at 28 million searches and 120 million ad impressions related to the cannabis, alcohol and tobacco industries. They mostly focused on 6 states that had legalized recreational marijuana between 2014 and 2017 to ascertain the effects of new legalization on internet browsing activity. These states included Alaska, California, Massachusetts, Maine, Oregon and Nevada.

#3) Results: The researchers found that recreational cannabis legalization “significantly increases cannabis search.” Encouragingly, “the increase comes from adults only, but not youth.” As for alcohol and tobacco:

  • Alcohol: Recreational marijuana legalization’s impact on “alcohol searches is negative and significant, indicating reduced interest in alcohol when cannabis is legalized and becomes more available.” Consequently, the authors “can infer a reduction of 10.9% in alcohol searches after recreational cannabis legalization.”

    They also found that marijuana legalization’s effect on “alcohol ad clickthrough rate and publisher’s revenue per impression are also negative and significant.”

    Conclusion: “cannabis appears to be a substitute for alcohol.”
  • Tobacco: Findings here were the opposite of alcohol, with adult-use marijuana legalization increasing tobacco-related search volumes. It actually “enhances consumer interest in tobacco products”, with their analysis suggesting “an increase of 7.8% in tobacco searches” following legalization.

Bottom line: the researchers concluded that cannabis and liquor appear as substitute goods, and marijuana and tobacco as complementary ones:

  • While “historically, both alcohol and tobacco companies have been… strongly concerned that legal marijuana may pose threats to them… our results suggest that tobacco companies may need to reexamine their presumption.” Marijuana legalization “in fact leads to increased interest in tobacco.”
  • “The alcohol industry, by contrast, has valid reasons to be concerned about legal cannabis and may need creative strategies to avoid market decline if recreational cannabis legalization passes.” The authors even note the partnership of Constellation and Canopy as an “exemplar”.

As for our investment takeaways, a couple of points to wrap up:

#1: Recreational cannabis may only be legal in 11 US states and DC thus far, but put another way over a quarter of the US population lives in those areas. A major reason marijuana stocks are currently trading at annual lows is because incremental cannabis legalization has not occurred at the pace expected. The lesson here: if you want to invest in public marijuana companies, you need to play the long game. Liquor companies understand this is a disruptive threat with a substitution effect that will play out over the next several years as more legalization occurs. That’s why Constellation invested in Canopy or Molson Coors partnered with a Canadian marijuana producer to develop cannabis-infused beverages for the Canadian market where it is legal nationally. The marijuana industry still needs time to develop and more legalization to take hold, but it already poses real risks to other markets.

#2: This study provides a silver lining for tobacco, another industry with companies investing in marijuana businesses amid declining cigarette sales. Marlboro maker Altria, for example, has a big stake in Canadian marijuana producer Cronos Group. Not only does marijuana legalization seem to complement the tobacco market, but Altria now has exposure to the growth of the marijuana industry both indirectly and directly. With Altria’s recent beating over its stake in Juul and the vaping health crisis, it could use some positive news.

The upshot: legal marijuana is still relatively new, but the effect of this disruptive market on other industries likely has far more implications than yet realized or appreciated. Public marijuana stocks may be struggling in the interim, but the industry is already changing consumer preferences and interests.

Study (only available for purchase): https://pubsonline.informs.org/doi/10.1287/mksc.2019.1176