As the markets collapsed in March 2020, taking an already weak cannabis sector with it, I asked a simple question when working at MJBizDaily:
“At what multiple did small-midcap consumer, industrial, agricultural, pharma, and tech equities bottom in the 1999-2003 Dotcom bust and the 2008-2010 Global Financial Crisis?”
The answer is 2.4X sales and 7.5X EBITDA Forward 1 Year Estimates.
The US cannabis market can purchased collectively today for 2.5X 2022 sales and 7.7X 2022 EBITDA per our comp table, which calculates multiples more conservatively than most.
US cannabis is a long-term secular growth story now trading at multiples more common in slow growth mature businesses, even in global financial corrections.
Some stocks are also starting to generate free cash flow, which we think will start to support the stocks on a yield and even dividend or buyback basis.
Public legal cannabis companies never existed in past market downturns, but companies with the same business models with non-cannabis widgets – retailers, branded CPG, agriculture, industrial suppliers, wellness – did exist. So did years long bull markets, declining rates, and exogenous shocks causing rapid tightening of liquidity and estimate reductions.
So I built the analysis in FactSet’s Universal Screener, looked only at companies that were $20 billion or less at their peaks (troughs of large caps like Walmart are irrelevant), cleaned the data, included bankruptcies to eliminate survivorship bias, and found 1,429 past observations (535 in the Dotcom bust, 894 in the GFC).
The key slide from the April 7, 2020 webinar detailing this analysis is below (jump to minute 21 for this analysis). You can download the original slides here, and reference slides 20-26 for the relevant financial crisis trough analysis.
The net conclusion is US cannabis stocks are trading similar to consumer/industrial/agricultural stocks in both the 1999-2003 dotcom bust and the 2008-2010 Global Financial Crisis.
Our comp table typically has higher multiples than most because its policies typically increase multiples: it excludes net cash, and includes shares and debt for pending acquisitions, but the estimates remain consensus, who typically do not include acquisitions until close – so some accretive deals are not included.
With free cash generation, we would consider adding net cash back to those operators, which would lower their multiples further.
The stock pricesa have been saying that cannibs has been in a liquidiation crisis for months now, given the tighter capital markets, excessive optimism on legislation giving way to excess pessimism, cycling tough COVID comps, and oversupply in California (whigh we noted in May 2021). These multiples are typical of liquidity dislocations because of the lack of access to capital, similar to traditional consumer smidcap in the Global Financial Crisis.
But what about 280E?
280E taxes are basically an excise tax applied to gross profit, but because of accounting rules they come after EBITDA. It is true that the traditional companies in the historical analysis had lower tax rates compared to cannabis, so the after-tax multiple is higher for cannabis, right?
Yes and no.
Two counter arguments:
The first is that 280E will likely go away with some form of legalization or descheduling. Since most investors think legalization will happen within the next 7.5 years, the impact of capitalizing 280E taxes a 1X multiple for less than 7.5 years becomes a wash.
Second, we at MJResearchCo also calculate EV/EBIDA – the same multiple after deducting taxes – for US cannabis as well as consumer comps for our Premium Members. While we only disclose the EV/EBIDA multiples to clients, many US cannabis companies are trading lower than comparable alcohol and consumer names AFTER TAX on EV/EBIDA.
This EV/EBIDA view is actually incredibly conservative, because it assumes that the 280E tax remains forever – which most think it will not.
If it is replaced with an excise tax on revenue, then the accounting actually would not affect the EBITDA calculation, but we detail the potential changes to income statements in a post-280E world here.
The Risk? Estimate Cuts
The risk to the current multiples is that the consensus estimates for 2022 are still too high. Earnings cuts by sell side analysts after 4Q21 earnings reports next month could lead to price compression in the stock prices.
Estimates for 2022 have already declined 6% since December 31 and 14% since September 30, so the question is how much more. At a certain point, investors know a miss is coming and sell ahead of it, and stocks trade up on the passing of the expected miss. Below is the same total valuation table with estimates from September 30, 2021: 2022 EBITDA estimates have dropped from $4.3 billion to $3.8 billion .
However, the long-term narrative remains intact, and the much larger return will come from upside to the consensus estimates for the long-term potential rather than trading the pressure in California in the fourth quarter.
On Average, I feel fine… Different industries get different multiples
The problem with averages of course is the spread – like the old joke about the statistician who “feels fine, on average” with his head in the oven and feet in the freezer – but he still burned.
Not all industries relevant to cannabis stocks bottomed at 7.5X EBITDA; medical specialties were higher, commodity chemicals lower.
And since most of these comps weren’t vertically integrated, there would be a conglomerate premium or discount for a US cannabis company
Premium Members can access the data by industry below. It includes the peak and trough EV/S, EV/EBITDA, and P/B multiples, returns high to trough, returns trough to +1, +2,+5, +10 years, and the average days from peak to trough.