Vireo Health: The Achilles' Heel Of Multi-State Operators
Summary
- Vireo is a small multi-state operator with primary assets in Minnesota, Maryland, Arizona, New York, and Mexico.
- Most of Vireo's markets are secondary and the company lacks scale in each market which resulted in its weak financial performance.
- The stock had an almost 400% rally in the last 12 months including a 110% rally in 2021 alone; the stock is overvalued in our view.
Vireo Health (VREOF) is a small multi-state cannabis operator in the U.S. that has seen its share price surging ~110% in 2021 so far. We think the company's shares look expensive and overheated at the moment. Vireo's asset portfolio remains one of the weaker ones among MSOs. Most of Vireo's assets are sub-scale and the company is still unprofitable. We see a challenging path forward for Vireo and the company's persistently lackluster financial results exposed the biggest weakness for the MSO business model: the inability to create value through a multi-state portfolio due to failure to create scale and reach profitability on an individual market basis.
(Source: Author)
Vireo's Assets
Vireo operates in five core markets in addition to four states that it deems as non-core. It is easy to see that Vireo's primary markets are less attractive at the moment due to small sizes and high competition. Minnesota, Maryland, and New Mexico are very small cannabis markets at the moment with limited potential. New York is very small at the moment but the potential for adult-use legalization could be appealing notwithstanding the current cap of only 4 stores per operator.
Arizona just began its recreational cannabis sales in 2021 after a successful ballot turnout during the November 2020 election and represents the biggest opportunity for Vireo right now. The company has also been actively divesting its non-core assets including selling its Pennsylvania retail and wholesale business to Jushi for $37M and selling its Ohio processing license to Ayr for $5M during 2020. The company is also mothballing its other non-core assets such as Massachusetts and Nevada due to capital constraints.
(Source: IR Deck)
Vireo's asset footprint is relatively weak and its presence across so many non-core markets is definitely a drag on its financial performance. We have discussed in the past that the MSO model is not a fool-proof plan because there are limited benefits of combining operations in different states. The current laws prohibit interstate trade and each state has unique regulations. What is really the benefit of having the Maryland operation and Arizona operation under one roof?
Except for access to capital and small overhead savings, the financial benefits are limited at the moment. Therefore, we have always preferred MSOs with significant scale and profitability in attractive markets such as Green Thumb (OTCQX:GTBIF) and Trulieve (OTCQX:TCNNF). We have also been critical of companies prioritizing footprint over profitability such as Acreage Holdings (OTCQX:ACRHF).
MSO Business Model
If you recall the horrendous fallouts of many Canadian LPs such as Aurora Cannabis (ACB), the ominous sign was when LPs openly brag about their greenhouse building which only led to billions of losses recently. Similarly here, we think MSOs that have prioritized the number of states it operates in instead of scale and profits will be found in a tough spot down the road.
Vireo is actually one of the very few MSOs that disclose state-level sales which provide insights into its various markets. Its home market Minnesota generated $4.3M in sales during Q3 which equals ~$17M annually. The New York operation generated ~$11M annualized revenue while the rest of the business is much smaller. Therefore, the question really becomes how Vireo plans to grow in these markets because the MSO business model is highly inefficient.
Instead of building one massive greenhouse to supply multiple markets, the company is now investing in its Arizona capacity that won't benefit its other markets. Despite the recent progress in Congress on potential legalization, we fully expect the existing state-level cannabis regulation to remain in place even after federal legalization. Therefore, it is extremely important to differentiate MSO players that don't create value with multiple state presence versus those that do. And we would argue that Vireo so far has not proven its ability to create value under its MSO business model. Instead, the company has shown a somewhat confusing strategy towards its footprint management.
The company has three retail licenses in Pennsylvania but decided to sell its cultivation facility in a move away from vertical integration in a fast-growing, attractive market. It also owns licenses in Massachusetts but has idled the asset so far. We think Vireo's strategy of focusing on secondary markets such as Minnesota and Maryland is questionable and its sub-scale operation in Arizona will limit its ability to grow.
(Source: SEDAR)
Financials and Valuation
Vireo has a market cap of $380M and trades at 7.6x EV/Sales which is at the high end of the peer range. The most successful MSOs trade at 10-15x EV/Sales and the mid-tier players such as Ayr Wellness and Jushi trade at 5-10x EV/Sales. Therefore, we think Vireo should trade at a discount to the mid-tier players due to its weak profitability and lack of growth. Vireo has been EBITDA negative for the last two years while other MSOs are already reporting EBITDA margin in the range of 25-50%. The lower quality of Vireo assets is obvious, therefore our view that its valuation looks stretched.
(Source: Author)
Going forward, we think Vireo's underperformance will become increasingly obvious as 2021 is shaping up to be another strong year for the industry. However, it is important to position yourself in the right markets such as Illinois, Arizona, Pennsylvania, Massachusetts, and Florida. Vireo's lack of scale and clear strategy across its markets are confusing and will limit its near-term performance in comparison to other MSOs.
Conclusion
Vireo is an example of an MSO business that has struggled to get off the ground due to relatively weak end market exposure and lack of scale in each of the markets. We have seen that the most successful MSO players all have a deep presence in core markets such as Trulieve in Florida and Green Thumb in Pennsylvania/Illinois. Ultimately, investors need to see profits and consistent growth which are supported by in-state presence instead of the number of markets. Due to Vireo's expensive valuation relative to its fundamentals, we are cautious about Vireo shares in the near term.
This article was written by
Analyst’s 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.
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Comments (13)
And latest article out today suggests NY rec legal seems to be back on track for April 1 budget introduction.Wherever Vireo has chosen to refocus, their business decisions seem to be working. The fact that they have mothballed NV and MA suggests that they could be acquired at any time.
That's my bet.
They dont grow like peers, thats why their valuation is lower compared to peers. I disagree on small caps getting the biggest bump on uplisting. Institutional investors are not going to bottom feed. Just my opinion.
Which stock is going to go up the most when New York legalizes?
Which stock is going to go up the most when Minnesota allows flower? and eventually legalizes? (small market, but there are currently only two licensed operators for the whole state)This stock is all about investing in the future progress of cannabis legislation, not its current operations.
They're no where near GW and if thats what they want to be, then they are doing an awful job of getting there. Theyre not even on Zynerbas playing field.If this company was really about the science, they'd be investing there instead of holding a grab bag of random assets. They should sell the licenses that comprise their multi state footprint and focus on innovative medical uses for cannabis. As it stands, theyre running a horribly inefficient cannabis business, burning cash, and selling off assets to plug the holes. If the CEO is as smart as you say, he should focus on his strengths. The guy clearly isnt someone who could provide guidance on "MSO operations and federal banking" as he hasnt shown a prowess in operations or capital management IMO. P.s. everyone with half a brain is quite confident cannabis is better than opiates for a myriad of issues. That's not groundbreaking and the FDA still doesnt care. CBD has been legal for years and cant be fully utilized. Vireo ceo cant beat big pharma lobbyists. Long JAZZ