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MedMen: A Pot-Stock Stinker For The Long Haul

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About: MedMen Enterprises Inc. (MMNFF)
by: Jeff Opdyke
Jeff Opdyke
Global Economy, portfolio strategy, gold, newsletter provider
Summary

Marijuana is the next, great consumer growth industry.

MedMen, with all its risks, has the potential to become a Category Killer in marijuana retailing.

The company's cash-burn rate is problematic, but if the company gets its arms around those issues, sizable growth awaits.

Gotham Green Partners is now exerting its influence, and that could be the turning point that sees MedMen finally move higher.

Home Depot and Walmart. Kroger and Pep Boys. Hobby Lobby, Macy’s, Best Buy and others. Trusted retailers all, some of them category killers.

Either way, millions of consumers flock to these stores daily to find the product brands they demand. It took time, or course, for all those companies to build the trust that we consumers place in them today. But when we need groceries, clothing, electronics and so on, these are the store names that immediately populate our thoughts.

All of which is an apt analog for what will absolutely take shape in the legal weed industry … the emergence of marijuana retailing category killers. And MedMen Enterprises is one of the retailers that will likely emerge as one of those category killers.

Yesterday, I began a three-part series looking at three pot stocks I believe have the potential to grow into the long-term category killers in their respective corners of the weed market as marijuana is increasingly legalized across the country and, at some point, is decriminalized nationally by the federal government.

I’m explicitly focusing on “long term.” I’m coming at the weed industry as the next, great fundamental consumer trend, not the next great trade. Back in the post-war 1950s and 60s, America’s consumer class emerged fully and it drove exponential growth in everything from branded breakfast cereal to branded fashion. Consumers – in the U.S and Europe – will do the same with marijuana, making weed the first, great long-term consumer-investment opportunity since the emergence of Apple’s iPhone.

The first potential category killer I wrote about yesterday was KushCo Holdings, the leader in the humdrum – yet strictly prescribed – world of packaging all the various marijuana products as they pass from grower to distributor to retailer to consumer.

Today, we move directly into retail with Medmen.

MedMen: A Winner No Matter Which Brands Are Popular

As I noted in yesterday’s dispatch, I want to be as close as possible to both the consumer and the growers. But I specifically do not want to own the growers, because once the federal government legalizes weed nationally, we will see a rash of independent and industrial tobacco growers flood the market, crushing profit margins for today’s marijuana growers.

Similarly, I don’t yet want to own the companies focused solely on making branded marijuana products – the branded joints, the branded edibles, etc. One day, the Budweiser and Gillette and Frosted Flakes of marijuana will emerge. And when they do, I will want to own them. But right now, there’s not an analyst or an investor who can legitimately or confidently claim what company that is. Brands today are shifting in the consumers mind like a game of musical chairs.

Just consider California, the most significant weed market in America at the moment. At one point, Kiva Confections sat atop the league table as the most popular weed-laced edibles brand in the state. Two quarters later, Kiva had fallen to fifth place, replaced by Plus Brands, which had been in seventh place two quarters earlier.

I’m not knocking Kiva, nor am I promoting Plus Brands. I’m saying that which companies will emerge as America’s go-to-brands for quality weed products is impossible to know in an industry that is so new and so regionally fractured that brands wildly popular in, say, Los Angeles, aren’t even known in San Francisco, much less another state.

Ultimately, any investment in a brand today is like throwing a couple bucks on the number 23 at a roulette table in Vegas – and then hoping 23 hits on all the roulette tables at once. It’s certainly possible, but a helluva longshot.

What I want in a long-term category killer is a company that prospers no matter which brands ultimately rise to the top.

And that’s MedMen.

If you’re a reader (who’s up to speed on weed) in parts of California, Arizona, Illinois, Nevada, Florida and New York, then you likely know the MedMen name, since those are the six states where the company operates its roughly 30 stores. (Massachusetts will join the list of states soon when a MedMen store opens in Boston’s Fenway neighborhood.)

As such, MedMen is a direct play on the consumer – the Walmart or Pep Boys or Kroger of legal weed. When you’re the retailer selling an abundance of different products, you don’t care if the consumer is buying Coke or Pepsi, chicken or steak. You only care that the consumer is buying something.

And when you’re the consumer, you want the convenience of walking into an inviting store to find the selection of products you seek.

I’ve visited several MedMen, as well as several other dispensaries in Southern California and Las Vegas. MedMen stores are a winner. They’re bright and airy and minimalist – much more a high-end jewelry store than overpacked supermarket or drugstore. They're certainly not some seedy "head" shop in a sketchy area of town.

A staff of half-a-dozen or so “bud-tenders” stand between a long, glass display counter and what is effectively a low-rise credenza. In both are the products currently in stock. Along with an abundance of raw marijuana bud of various strains to treat various afflictions or to create a particular kind of high, the display cases showcase a cornucopia of branded consumer products: weed-infused chocolates, gummies, cookies, and candies in all manner of flavors. Marijuana-laced juices, sodas, and energy drinks. Pills and tinctures to help you sleep, to help you wake up, to help you relax, or to temper a particular kind of pain. Pre-rolled joints in branded tubes and of various strains. Oils, vapes, and cartridges, again in scads of strains for various purposes. Teas. Creams and ointments, mints and mouth sprays … and products for your pets. And that’s not a comprehensive list.

It's functionally no different than a corner pharmacy, only more zen.

Small Store Count – Huge Sales Per Square Foot

As the store stats I mentioned a few paragraphs back indicate, MedMen at the moment is a tiny retailer. Thirty stores across a six-state population of more than 100 million tells you just how small MedMen really is.

Southern California alone has some 25 million people stretching from the northern suburbs of Los Angles down through San Diego. And yet MedMen has just 12 stores serving that vast population. There might be 12 CVS and Walgreens in just a couple square miles in Los Angeles.

Sure, pharmacies are a tad more relevant to the average American than is a marijuana dispensary, but marijuana’s growth will demand a far – far! – larger number of dispensaries in coming years and decades.

As an investor, that’s the kind of trend I want to tap into for the long haul. It’s functionally no different than the growth of McDonald’s in the 1960s and 70s, when the Baby Boomers fell in love with fast food and propelled the burger chain’s growth.

Consider this stat: MedMen’s sale-per-square-foot (a primary financial measure in the retail space) is above $7,900 in California. By comparison, Apple, widely touted for its outrageous sales-per-square-foot, has less than $5,600 revenues/sqft.

Weed dispensaries simply knock it out of the park when it comes to sales, which is exactly why I want to own stock-market exposure to a marijuana retail shop — and why I specifically want to own exposure to the retailer I think has the potential to become the nationally known chain.

With flagship stores in Los Angeles, the Vegas Strip and New York’s City’s Fifth Avenue, MedMen is clearly trying to build a high profile for itself to attain brand awareness and first-mover status among pot shops.

As it is now, marijuana retail is widely fragmented. The industry is built largely around a mom-and-pop model in which entrepreneurs see a gap in the market on their side of town and open a dispensary. The vast majority of those will remain as single shops because mom and pop don’t have the capital, the competence or the constitution to expand to another two or three stores or more. Over time, bigger players with deep-pocket financing and expansion ambitions will arrive to roll up the industry and create a nationally known retailing destination for marijuana.

That’s the MedMen approach – opening new stores while also snapping up competitors. It's an approach that will ultimately lead of America's first nationally known marijuana retail store.

One such deal recently collapsed, however, and that gets us to the risks of stock like MedMen.

The Risks To Consider

MedMen was set to takeover PharmaCann in a nearly $700 million deal. The combination would have added numerous stores and three new states (Pennsylvania, Ohio and Maryland) to MedMen’s footprint.

Alas, MedMen called off the all-stock deal last month. Wall Street responded by taking down MedMen’s share price. I understand why, but it seems a bit short-sighted (as does most of modern Wall Street). The deal was originally struck almost a year ago when MedMen shares were trading in the $5 range. By the time the takeover was called off, MedMen’s shares were under $2. The deal was suddenly too costly to MedMen, and I get that – it was long-term thinking rather than pleasing the Street in the moment.

Instead, MedMen executives say they’re going to focus on growing the brand in key markets such as California, which, again, makes a lot of sense to me from a long-term perspective. For better or worse, California defines much of America’s biggest trends. As MedMen comes to define retailing in California, its name will permeate the culture, which will help the brand grow nationally, even if that growth is a bit slower.

Still, the deal’s collapse highlights the challenges you face as a MedMen investor for the long haul.

As I noted in the previous piece on KushCo, investing in legal weed today takes some fortitude. The product is not yet legal on a federal level and a strongly right-wing administration trying to buy Conservative votes could step in and challenge the legality of marijuana nationally. If so, all marijuana stocks would be crushed.

I don’t see that happening. First, the Constitution (state’s rights) would impede federal efforts. And, second, the U.S. government is addled by far too much debt and far too little income. Legalized weed would allow the feds to impose excise taxes just as they do on alcohol and cigarettes, thereby generating much needed cash flow into the Treasury.

And, of course, there’s always the risk that another competitor becomes the better-known, national retailer. That risk is hard to quantify at this stage. But I’ll say this: There’s plenty of room for more than one category killer. Coke and Pepsi, McDonald’s and Burger King, Home Depot and Lowe’s … so I’m not too worried here.

MedMen also has had some personnel issues. As part of the PharmaCann collapse, MedMen axed its CFO … and earlier this year, a previously fired CFO filed a lawsuit against MedMen’s founder and CEO claiming racism, homophobia, misogyny and financial misconduct. The CEO, Adam Bierman, told the Boston Globe the accusations were “absolutely silly and disgusting. This guy wants to blackmail me and wants all this money — I say, ‘Sue me,’ and he puts out all this incendiary stuff.”

All I can say about this is that these things happen. All manner of companies deal with C-suite personnel issues, including most recently McDonald’s.

Finally, there are the losses and the cash burn.

Though MedMen's revenue base is ramping rapidly - up 227% in fiscal 2019 - the company still lost $79 million on roughly $130 million in income. I won't venture to guess as to when the losses abate. No one, including sell-side analysts, can tell you that answer with any honesty. Moreover, the company has had to borrow from private-equity firm Gotham Green Partners at a steep rate - 6% - to keep operations afloat.

MedMen absolutely must address this. Costs have to come down, and maybe that's part of what went into MedMen's thinking regarding terminating the PharmaCann deal. General and administrative expenses for fiscal 2019, for instance, were $244 million ... again, on sales of roughly $130 million. I would not be surprised is Gotham Green steps in at some point to impose rationality on MedMen's admin expenses, namely in the form of a salary cut on MedMen's top brass. That, alone, would go a long way toward reducing costs and freeing up cash the company can use to grow the business.

A 10-Bagger In the Making?

I look at all the risks and I accept them because I understand I’m getting in at the earliest stages of a cultural sea-change. I also realize the financial risks that MedMen represents -- that if the company does not get control over its spending, the share price will continue its southerly trajectory into penny-stock land and, ultimately, oblivion.

I don't see that happening.

MedMen is already part of the weed culture. It has created a certain zeitgeist in weed retailing, and it's brand name is strong. Gotham Green Partners knows this, and it has already wrestled away control of MedMen's board of directors. That's the first step in bringing rationality to the company's cost structure.

The way I see it from a fundamental, long-term view is that buying shares of MedMen now is similar to buying McDonald’s shares in the 1960s, just as the chain was beginning to pop up all over the U.S. The burger joint had at least three decades of domestic store growth before it really tapped out its American footprint, a stretch of time that saw Mickey D’s stock rise from a split-adjusted pennies per share to nearly $50.

Fast food is a good analogy. That industry has faced all sorts of challenges – from demands for greater pay to health worries about fatty meals and sugary drinks, and through it all the companies have grown and prospered.

Marijuana retail will be no different.

I’m not saying MedMen’s store growth will last for decades, that it will ever be the size of McDonald’s, or that its share price will follow the same path. But I am saying the marijuana industry will scale up, and MedMen’s store count, and ultimately its annual sales and profits, will double and triple and quadruple. Heck, MedMen might even franchises its operations at some point.

As all of that happens, the company’s stock will rise. How high? Who knows? But at today’s price – about $1.15 per share – I can easily see MedMen being a 10-bagger over the next five to seven year. And from there … onward and upward as legal weed continues expanding.

MedMen shares trade on the Canadian Securities Exchange in Toronto under the symbol MMEN. As I write this, the shares are priced at about C$1.54 (US$1.15). I would be a buyer up to C$5 (US$3.72).

In my next dispatch, we will take a look at the distribution side of the industry. It’s dull. It’s boring. But it’s necessary. And it’s a sector where I want some of my dollars at work.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.