“No Comps”
“Cannabis is in price discovery mode”
Everyone wants to know what tomorrow’s stock prices are going to be, that’s human nature, if I know the future maybe I can make some money. I think it’s because of that, that folks ask me about cannabis trading prices. What price should an MSO trade at? I have absolutely no idea and I don’t think anyone really does. I was listening to a twitter spaces earlier in the week and Emily Paxia said that “cannabis is in price discovery mode,”. That really resonated. The truth is - at least how I see/interpert it - there are no comps by which to compare an MSO stock to some other industry.
Digging in. Over the years investors, executives and research analysts have sought to cast Cannabis as the new pharmaceutical, BevAlc, CPG, you name it they’ve drawn comparisons. But MSOs are both more than that, and less than that. I don’t judge or place blame on anyone for this, it’s natural to try and find a comparison, a mental shortcut so that you can compare one thing to another but I think we’re now seeing in the record low stock prices, the total lack of liquidity, the lack of focus and interest that there is just nothing to compare it to. Here’s why.
Your average MSO is in 12 markets, they’re vertically integrated which means they grown, process and sell retail (and sometimes wholesale), they’re in a mix of Medical and Adult-use markets (this is really more of a legal construct than anything, more on that in another missive). There revenue was growing double digits sequentially a few years ago and single digts annually last year. That’s our caricature. But digging in more deeply there are different businesses within that MSO, it’s commercial agriculture (the grow), it’s extraction, manufacturing, packaging, R&D, product development (processing) and then it’s a distributor/wholesaler, trying to push their products into other dispensaries, and finally it’s a retailer. Vertical integration became important a few years ago because there were product shortages and growing, processing and retailing your own product meant that you were turning $1-2 costs to grow a gram into $60-80 dollars eights which is to say it was incredibly lucrative. But there are material differences between all those different business, Marlboro doesn’t grow anything, they don’t retail anything, Budweiser doesn’t grow, or retail or even distribute, they’re brands and products. Those two companies acquire raw materials, work their magic on it and crank out cartons and 6-packs for others to distribute and eventually sell. I think that’s evolved over the last several decades because different companies had different expertise (lets say logistics) and profit-margin thresholds (distributors have very narrow profit margins). So our first failure as an industry was over simplifying and comparing a 60-100 year old industry with something that is brand new. It was a shortcut that led folks to attribute valuations of cannabis companies that were more than their BevAlc competitors because instead of a 15-20% margin these companies were believed to generate +60% margins. Nonsense.
The second failure was pumping these companies full of cash, asking them to chase growth (flags! revenue! funded-capacity!) and not profitability. Very very very few cannabis companies are routinely cash flow positive (that is after tax, capex, everything). How can that be when you’re turning pennies into dollars? Well there’s a shit-ton of work between those points, lots of hands, people, gross inefficiencies and outrageous costs of capital (more later). Because of the legal framework in the United States these companies cannot build one enormous facility in a single location to provide their products to the country, no instead they need 12 grow and processing facilities and a handfull of dispensaries to serve their markets. That cash is spent, it’s gone, instead of one facility that cost $40-100M is highly scaled, insanely efficient our model company has 12. Will those facilities be needed forever, probably not, they’re limited life between now and whenever interstate commerce and federal legalization occurs then a majority of them could be mothballed. Federal Legalization whic
h so many are hoping or begging for may make stock prices moon but it’s going to also lead to completely different kind of competition.
If you hadn’t already guessed I don’t have an answer on how to value MSOs, there is no easy mechanism or comparison so for now I think the only thing that prudent investors can do is apply a multiple on forward cash flows. Discount that is based on the company’s ability to pay off debt (not amend and extend), their cost of capital, and their growth and competition profile over the next few years. That may mean that we haven’t seen a bottom in stock prices.
This is not in any way shape or form meant to be investment advice, the majority of my personal net worth is in cannabis stocks and cannabis ETFs and that is (and has been) crushingly stupid over the last two years.