There is a disconnect between fundamental performance and stock performance for U.S. cannabis companies, resulting in compressing valuations for those operations. But multiples on 2022 are nearing past trough levels. Strong second quarter earnings have not yet driven realignment.
The stocks of U.S. cannabis operators are down 9% on average since reporting good second-quarter results and reiterating guidance for 2021 and 2022. None of the stocks are positive, except The Parent Co, which announced a buyback after its stock dropped 69% from its high.
Public U.S. cannabis stocks are down 36% on average from their highs in February; meanwhile the index of U.S. small capitalization stocks, the Russell 2000, is 7.4% off its high achieved on March 15.
Yet the fundamentals of the cannabis stocks for the second quarter were generally good. Estimates were mostly achieved or beaten, and guidance for 2021 and 2022 was generally reiterated or raised. However, even those stocks that beat such as Green Thumb Industries, Cresco and Curaleaf, have all declined high-single digits; those that missed declined double digits.
The weakness in the broader small cap index explains some of the decline, as any drop in the Russell 2000 will lead to larger declines in U.S. cannabis stocks as well – no stocks trade in a vacuum. But it doesn’t explain all of it.
What can we glean from the results and earnings calls?
Guidance reiterated, while estimates are higher – too optimistic or under-promising?
Both Curaleaf and Cresco reiterated their previous guidance, yet consensus estimates are at the high end or above this guidance already. Curaleaf stated that it is “very, very comfortable” with 2022 guidance for a “30%-plus” EBITDA margin; consensus estimates have 33.4% already. Cresco guided to exit fourth quarter 2021 at $250 million in run rate revenue, yet consensus is already at $258 million.
Is this reiteration below consensus estimates disappointing for investors? Perhaps for some, but MJResearchCo views the approach to under-promise and over-deliver as a smart plan. The cannabis investment case is a long term one, not based merely on beating 2021 results.
Market expansion: Many large MSOs are expanding operations in Florida as that limited-license market matures. Despite some pricing pressure, these companies generally have beat expectations. As any market grows there will be expansions of capacity and price fluctuations, and these operators seem to be managing that growth well.
Operating leverage: As these companies grow revenue, they are scaling into their fixed costs, which expands margins and offsets gross margin pressure. Cresco noted that they see upside to guidance in 2022 due to operating leverage.
What drives gains going forward?
Multiples on 2022 estimates are nearing trough levels, with the U.S. cannabis stocks trading at about 3X sales and 9X EBITDA.
A similar disconnect between fundamental and stock performance occurred in the coronavirus-driven decline in March 2020, when stocks bottomed at 2X sales and 8X EBITDA , which proved to be an excellent buying opportunity.
In April 2020, MJResearchCo analyzed this in the context of prior market corrections in 2008 and 2001 when consumer/tech/pharma stocks bottomed at 2X sales and 7.5X EBITDA.
The market will shift to 2022 multiples instead of 2021 in a few months.
In the meantime, companies are building a growing, profitable and proven legal industry and supply chain at increasingly attractive valuations.