As we enter 2Q21 earnings season, we ask, “what has happened with the stocks prices and estimates since 1Q21”?
The estimates for the US-Focused operators have increased, while the stock prices themselves have declined, compressing valuation multiples by about 1 turn.
For the Canada-Focused operators, the estimates and the stocks have both declined, and multiples have compressed by 2 turns.
Since March 31, 2021, the sum of the selected revenue estimates for the US operators have increased 5% for 2021 and 7% for 2022, and the sum of the EBITDA estimates has increased 1% for 2021 and 8% for 2022 (only stocks with consensus in both periods are included).
Yet the stocks are down an average of 10%, with only Green Thumb (+1%) and Harvest (+16% on the Trulieve deal, offset by Trulieve’s 25% decline) showing gains.
For the Canada-Focused operators, the stock prices declined 26% on average, with only TGOD up 5%, and directionally mirrored the estimate changes. The sum of the revenue estimates dropped 26% for 2021 and 14% for 2022, and the EBITDA loss worsened by US$206 million in 2021 and the EBITDA profit declining 84% in 2022.
What to make of this?
There are a few interpretations investors can infer:
- The US operators are not trading on fundamental results, but instead based on political sentiment and hope or fear of Federal laws passing or not, such as the SAFE Banking Act, MORE Act, and the recent draft of Schumer/Booker/Wyden’s Cannabis Administration and Opportunity Act (CAOA).
- the US operators have de-risked, entering second quarter earnings season with stronger fundamentals for a lower stock price.
- the market does not believe the higher estimates for the US operators, and is starting to price in misses and guide downs in second quarter results
The fact that much of the decline (-10% for the US and -18% for Canada) has occurred in July alone, and most of that since the release of the draft of the CAOA on July 14, implies the market is trading Federal politics and not fundamentals of the businesses themselves.
States continue to put forth legalization efforts, with New York and Connecticut the most recent quickly followed by proposals in the Rhode Island.
After the drawdown so far in July, the US operators at 3.5X 2022 sales and 11.1X 2022 EBITDA are trending toward the 2.5X sales and 7.5X EBITDA liquidation troughs seen in the dot com bust and Global Financial Crisis – yet we are not in a great liquidation by any means.
Since the end of the 1Q21, the US operators have dropped about 1-1.5 turns, while the Canadian operators have dropped about 2 turns on revenue.
For cyclical industries, investors often put low multiples on peak earnings and high multiples of trough earnings to even out the valuation.
But legal cannabis is, at this point, is not cyclical at all; it is a secular growth industry with 25% annual revenue growth for years as it converts the illicit market and sees continued market expansion via increasing legalization. Even within legalized states, the product is a consumable good that exhibits the stability of alcohol yet has greater growth prospects.
The biggest current issue for US cannabis has been the need for additional capital, the difficulty accessing lower cost financing from more traditional sources like banks and liquid public markets, and the burden of 280E taxes (which suck any free cash from the business and require owners to continue to add cash to pay the taxes).
A big issue in the proposed CAOA bill is the 25% excise tax to replace 280E. As we have shown in our 280E Analysis, 280E taxes work out to 8% of revenue assuming a 55% gross margin and a 16% pretax margin. The only way a company would pay 25% of revenue as a 280E tax is to have gross margins higher than 70% and pretax margins of negative 20% or more (shown in orange below) – hardly a sustainable business model.
The average for US operators is currently about 55% gross margins and 16% pretax margin; the green box is the average for cannabis companies and all the rates around 10-15% for sustainable businesses.
Also note that for companies with both high gross and pretax margins (ie little SG&A), the 280E tax is really just buried in the normal Federal income tax. These companies would be doubly punished by a high excise tax and a lot of income tax on their high margins.
Remember that state excise taxes would be on top of the Federal 25%, which could lead to total excise taxes 40% or more and basically support the illicit market.
As a result, we suspect the 25% is an anchor starting point for negotiations, so dropping to a more rational 8-10% feels like a favor from the sponsors and a win for opponents.
Premium Members can download PDFs of our Cannabis Comp Tables at this new Comp Table & Commentary page, with a list of all available tables on the right.
Premium Members can download the July 19, 2021 comp table at the button below.