The hole between US hashish fundamentals and inventory efficiency

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For US cannabis companies, there is a discrepancy between fundamental performance and stock performance, which is driving down valuations for these businesses.

But the multipliers for 2022 are approaching the lowest point. The realignment was not yet driven by the strong result in the second quarter.

U.S. cannabis operators stocks have fallen 9% on average since the sector posted good results for the second quarter and reiterated its guidance for 2021 and 2022.

None of the stocks are positive except for those of The Parent Co., which announced a buyback after its stock fell 69% from its high.

U.S. public cannabis stocks are down an average of 36% from their February highs. Meanwhile, the index of US small cap stocks, the Russell 2000, is 7.4% below its March 15 high.

Still, cannabis stock fundamentals were generally good for the second quarter. Estimates have largely been met or exceeded, and forecasts for 2021 and 2022 have generally been repeated or raised.

But even those that beat stocks like Cresco Labs, Curaleaf and Green Thumb Industries have all seen high single-digit declines; those who missed fell double digits.

The weakness of the broader small-cap index explains part of the decline, as any decline in the Russell 2000 will also result in larger declines in US cannabis stocks – no stocks trade in a vacuum. But it doesn’t explain the whole decline.

What can we read from the results and results calls?

The guidelines are repeated while the estimates are higher – too optimistic or not promising?

Both Curaleaf and Cresco reiterated their previous projections, but consensus estimates are already at or above these projections.

Curaleaf said it was “very, very comfortable” with its 2022 forecast for an EBITDA margin of “30% plus”; Consensus estimates already have 33.4%.

Cresco aimed to end the fourth quarter of 2021 with run-rate revenue of $ 250 million, but the consensus is already at $ 258 million.

Is such a repetition among consensus estimates disappointing for investors?

For some, maybe, but MJResearchCo views the under-promise, over-delivering approach as a smart plan. The cannabis investment case is a long-term strategy that isn’t just based on beating the 2021 results.

Market expansion: Many large operators in several states expand their operations in Florida as this limited license market matures. Despite some price pressures, these companies have generally exceeded expectations. As a market grows there will be capacity expansions and price volatility, and these operators seem to be coping well with that growth.

Operating lever: As these companies increase their sales, they increase their fixed costs, which increases margins and offsets the pressure on gross margins. Cresco noted that its 2022 projections are up due to operational leverage.

What is driving future profits?

Multiples of estimates for 2022 are nearing their lowest point, with U.S. cannabis stocks trading at roughly three times sales and nine times EBITDA.

A similar discrepancy between fundamentals and stock performance occurred in the coronavirus-related 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 previous market corrections in 2008 and 2001 when consumer / technology / pharmaceutical stocks bottomed out at 2X sales and 7.5X EBITDA.

In a few months’ time, the market will shift to 2022 multipliers instead of 2021.

Meanwhile, companies are building a growing, profitable, and proven legal industry and supply chain on increasingly attractive valuations.

– Analysis by Mike Regan and Colin Ferrian, MJResearchCo ([email protected])

Offer of the week / In partnership with Viridian Capital Advisors

Greenlane capital increase could affect the KushCo deal

Greenlane Holdings (Nasdaq: GNLN), one of the largest sellers of cannabis accessories, packaging, and vape products, has completed a $ 31.94 million gross sale of securities to select accredited investors as part of its stock exchange program.

The deal consists of:

  • 4.2 million Class A units were sold for $ 3.16 per unit, with each unit comprising one Class A share and 0.6 shares with five-year warrants with an exercise price of $ 3.55.
  • 6.1 million pre-funded warrants (exercise price $ 0.01 with no maturity) containing 0.6 shares of warrants identical to Class A shares.

The attached warrants are valued at approximately 42 cents per unit at a calculated net share price of $ 2.73.

Greenlane’s share price has fallen 18% since the August 9th stock deal announcement, largely due to the perceived dilution from the increase.

Impact on the deal between Greenlane and KushCo

One of the most interesting aspects of this deal is its impact on the deal originally announced in March by Greenlane-KushCo Holdings.

The transaction is a stock-only transaction in which KushCo shareholders will receive a number of Greenlane shares (down to 0.2546 initially) for each KushCo share held.

The transaction makes a lot of sense as it combines KushCo’s relationships with the multistate operators and licensed manufacturers, as well as Greenlane’s branded offerings.

The merger also provides cost-saving synergies, valued at $ 15-20 million over two years, and eliminates competition between companies.

One feature of the KushCo-Greenlane deal that seems less understood is the exchange ratio.

The complicated formula shown below has a simple intent: to keep Greenlane’s stake in the combined company between 50.1% and 51.9%.

Viewed another way, the variable exchange ratio protects KushCo shareholders from being diluted by Greenlane capital increases.

That ratio has stayed in a tight range of 0.25-0.2546 since the deal was announced.

The transaction does not pose any antitrust challenges and the shareholders’ vote is scheduled for August 26th.

The chart below shows the risk arbitrage spread since the merger was announced. It narrowed to a low of 0.4% at the end of June and would be negative on August 16 if the capital increase does not change the exchange ratio.

However, Viridian Capital Advisors assumes that the exchange ratio will change to around 0.3 as a result of the stock issue.

We calculate the current spread at around 13%, which is quite high for a deal that makes very good economic sense and is about to be approved by shareholders.

The only explanation we can find is that the mechanism to correct this spread is to short Greenlane and buy KushCo and there are simply not enough investors willing to take this trade to fill the gap conclude.

Cannabis Investing, The Gap Between US Cannabis Fundamentals And Stock Performance

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