Cannabis Stocks: Keep It Simple (Podcast)

Apr. 22, 2020 8:50 AM ETCGC, ACB, MMNFF, TCNNF, CVSI, TLRY, SHWZ, WEED:CA, TLRY:CA, ACB:CA5 Comments

Summary

  • After decades of long/short equity investing for hedge funds on the sell side, Mike Regan switched to covering the cannabis space for MJBizDaily.
  • We discuss the similarities between the internet bubble and the cannabis market today and what we can glean from those bubble valuations.
  • We also cover why capital structure is key, vertical integration in nascent industries, understanding margin potential, cannabis in Canada vs. US, and the challenges in the CBD market.

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Topics include:

  • 5:00 - Mike's background in long/short equity investing working for different hedge funds 20 years ago on the sell side covering cable and satellite stocks. Saw a post from MJ BizDaily, which runs the big MJBizCon Trade Show in the industry, looking for an investor and analyst and taught him the cannabis sector. After covering so many industries, Mike thought cannabis was really a CPG product with an ag angle and joined in July 2019 to bring fundamental, bottoms up analysis to the cannabis industry.
  • 7:30 - Main thesis is still a long-term and broad focus. Last year in cannabis looked like internet stocks around 1998/1999 - people know it's going to the next huge thing, but some companies have taken too many missteps. Cannabis is a commodity driven by supply and demand at its core and long-term bullish thesis will come about as long as the company is well run.
  • 11:00 - Canada's supply and demand issue. Overbuilt the market and the oversupply coupled with the dearth of retail space and high quality cannabis made for a disappointing rollout - 20% legal; 80% illicit market are the projections. Canopy (CGC) cut their production capacity recently - changing strategy which affects the whole market. Increasing their indoor grow vs outdoor grow which is less expensive so cutting costs. Canadian companies overall dealing with cash issues.
  • 12:30 - Is Canopy on the right track with cutting costs? They have a pile of cash and a corporate sponsor that says it's cutting off the spigot, but we'll see. Given they have about $1 billion, and the market's oversupplied, cutting back capacity, focus on wholesale and value chain seems to be a good strategy, but it will take time to see if it pays off.
  • 14:00 - Aphria's (APHA) global strategy. Makes more sense to go the branded route and global as they likely won't have the advantage in the US that people thought last year. If they achieve lowest cost of production it will be a huge positive for them and if Canada's oversupplied it makes sense to go international.
  • 15:30 - Aurora's (ACB) recent troubles; turnaround plans look like a tall order. It's hard to double or triple revenue while cutting nominal costs. Recently announced reverse split. Complex and variable capital structure. All these warrants are an issue for the sector and investors. And regarding debt, it gets equitized and then diluted, like we're seeing with MedMen (OTCQB:MMNFF). Brief discussion of iAnthus (OTCPK:ITHUF).
  • 18:00 - Looking at business models to glean which company is on the right path to profitability. Trulieve (OTCQX:TCNNF) already positive EBITDA. Medicine Man, now known as Schwazze (OTCQX:SHWZ), going through consolidation strategy, guiding to positive EBITDA once consolidation goes into effect.
  • 23:30 - Look if it's a business model you can understand - if by all reasonable measure they can't achieve reasonable cash flow, that's a company to avoid. Importance of looking at the fundamental details of consolidation plans or deals announced to know if they will turn negatives into positives. Medicine Man for instance now making itself into one of the biggest dispensary chains and vertically integrating. However, new announcements or management changes don't necessarily fix inherent issues.
  • 26:00 - In months ahead look for a lot more restructurings. Capital issues were present before COVID and COVID has exacerbated those issues. Medium-longer term, with US government ramping up expenses and needing more income, cannabis legalization looks more likely. But do the companies have the cash on the balance sheet and cash generation needed to survive the time it takes to get there, which could be years. A lot of the leaders in tech didn't exist during the internet bubble. The cannabis giants of 2025 may not exist today.
  • 28:30 - CBD companies have hit some challenges from the FDA, and in a nascent market it's tough to establish brands, as we saw with CV Sciences (OTCQB:CVSI) as they faced a ton of competition that won out shelf space which pushed them to cut prices which then hits margins. Cannabis is a brutally competitive consumer business, not necessarily dependant on how good your product is. Soon they'll have to compete against big CPG brands, which is even tougher.
  • 40:00 - How laws play out - especially in the US - will depend on what kind of company is better suited to succeeding in that legal market. The fact that it's been deemed essential by most of the medically legal states is a good lobbying argument for federal descheduling. If more tax revenue is needed and more government spending, plus a huge upending of retail market, legal cannabis could be a good solution, but it won't be discussed until after the immediate COVID concerns are dealt with.
  • 50:00 - Analyzing what other CPG companies had done in the internet bubble, they bottomed at 7.5x EBITDA and about 2.4x sales - though that's after reduced estimates. A lot of companies in US cannabis space are at that level. Valuations also starting to look like they do for 'normal' companies.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

This article was written by

On The Cannabis Investing Podcast, host Rena Sherbill provides actionable investment insight and the context with which to understand the burgeoning cannabis industry. Interviews with C-level executives, analysts and sector experts give you investment ideas to consider, help you think through your investing approach and provide you a new lens with which to understand this ever-growing sector.

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