May Mayhem for Pot Stocks

May will bring further clarity to the booming cannabis industry, as many of the biggest hitters will be reporting their earnings and updating investors on market conditions in the US and Canada. In Canada, retail is set to improve with more retails stores being added (and coming online) in the largest Provinces. And finally, to the US, where one of our favourite Licensed Producers is set to make its debut on the NASDAQ.

 

Earnings galore

This month sees most of Cannabis's A-Listers delivering their earnings results. Every quarter, the earnings are scrutinised ever more closely, as analysts look for the cannabis companies to start actually delivering significant revenue, and execute on their business plans. For the past couple of years, earnings have been pretty simplistic. Little revenue, no profit, and massive cash burn as a result of aggressive expansion in production capacity and global footprint.

But with Canada legalising recreational cannabis on October 17 last year, the game has changed, and companies are now starting to report very big revenues.

 

"Canopy Growth could generate more than $1 billion in revenue by the end of its fiscal year"

 – Bill Newlands Constellation Brands CEO

 

Just last quarter Canopy Growth delivered just over $80 million in revenue, and as per the above, they could go on and generate $1bn in 2020. These are some big numbers

Companies reporting in May include the following (there are more, but not of interest to The Green Fund.

 

Cronos

After Altria (the owners of the Marlboro brand) invested $2.4bn in Cronos last December, the stock has seen hyperbolic growth. Cronos has the second-best balance sheet in the business (after Canopy who have $4.4bn thanks to their Constellation Brands investment) as a result of this investment and are now considered the fourth most valuable company in the sector (behind Canopy, Aurora, and Tilray).

Although Cronos now has the backing of one of the Big players (Pharma, alcohol and tobacco), its recent results have been disappointing. Simply put, they are not generating very much revenue. After their last quarter's figures, they have approximately 2% of the Canadian recreational market. The company trades at over 300x sales, more than 10x as much as peers who have significantly higher cannabis sales.

Cronos also benefits from an intriguing deal with Ginkgo Bioworks. If Ginkgo can successfully synthesise individual cannabinoids, this could allow Cronos to develop market-leading, cannabinoid-based medical products or even recreational products, without the massive capex costs associated with building and running industrial-scale cultivation facilities. Analysts have expected earnings at $-0.02 and revenue flat on $5.14. This is a big one to watch…

 

Aurora

The second largest cannabis company on the planet, Aurora Cannabis, have really upped their game over the past 12 months. The undisputed kings of acquisition, their purchase of CanniMed for $1.3bn in early 2018 was followed by their $2.3bn acquisition of MedReleaf in mid-2018. In addition, they have the second largest production capacity in the industry (behind Canopy), boasting the ability to produce over 500,000kg's over annum when at full capacity.

This is driven by their technology-leading Aurora Sky facility. The one million square foot, technology-driven facility near the Edmonton Airport, is capable of producing over 100,000kg per annum.

 

 

Essentially, Aurora faced two key execution risks. The first was how they would successfully integrate so many businesses and leverage true economies of scale. The second was their ability to get the Aurora Sky facility operational, on time, and to be able to demonstrate the ability to produce the quantities they said they could. They hired the ex-Head of Integration at Vodafone, and he has done a sterling job. Integration? Check.

Aurora Sky is now operational and starting to produce cannabis in significant quantities. The company is quickly becoming one of our favourite Canadian LP's and offers investors significant upside given that Aurora does not (yet) have a big partner (as Canopy and Cronos do) and has not made a move into the US in any big way. These results should put them back to #1 until Canopy releases their results. 

 

 

Tilray

Tilray could be considered the "crypto pot stock' after their phenomenal run-up in late 2018 (the stock listed at $17 and rocketed to a high of $300 just two months later). However, with a very tight float and the dissipation of some of the hype, the stock finds itself in far less stratospheric levels, at around the $60 per share mark.

In the last quarter (ending December 2018) they reported revenues of $21m with a gross margin of  20%. This margin is well below its peers and the revenue is very small given their enormous valuation. Look for much bigger revenue numbers in this quarter and for significant improvements in the margin, given they are only focussed on the medicinal cannabis market (where selling price and margins are traditionally much higher).

 

MedMen

MedMen – what can we say? This is one of the larger positions in our portfolio and we still believe there is massive upside for investors on this one. They are (in our opinion) the undisputed kings of retail. No other Multi-State Operator (MSO) that we know has the same level of brand awareness in the market. They have some of the biggest retail stores, in the best locations, and are affectionately known as the "Apple" of cannabis retail. 

The acquisition of PharmaCann earlier in the year, for over $650m, has positioned them as one of the biggest MSO's in the market. Superb coverage of the US and one of the most dominant players in California (the largest recreational state in the US), they are well positioned for massive growth in the coming years.

So why has the stock lagged the markets so much in 2019? Simply put – management. It started with their IPO and associated compensation packages. Not only did Adam Bierman (CEO) and Andrew Modin (COO) have super-voting rights that gave them control of the company, but they also had remuneration packages in the millions of dollars.

 

Adam Bierman and Andrew Modlin

 

The market was outraged, so much so, that they changed their remuneration structure and tied their performance to the performance of their share price (which right now means they are well out of the money). Then there was the disastrous capital raise they undertook earlier in the year. At the time of the raise, their share price was performing so poorly, that they reduced the deal price after the deal had been announced to the market. This was highly irregular and it put the stock under even more pressure.

And finally, the legal battles. There are currently three lawsuits open against the company for a variety of reasons. Suffice to say that none of them are material in nature and ultimately should not impact the stock in the medium to long term.

So after all of this, why are we so bullish on them? One reason is the players that have surrounded the company. First off, their ties to Cronos (they have a 50/50 joint venture with Cronos to operate Canadian retail stores under the MedMen Canada brand), and more recently the $250m investment from Gotham Green. Led by Jason Adler who we believe to be one of the smartest investors in the industry, Gotham Green was founded by both Adler and Mike Gorenstein (current CEO of Cronos). Getting the picture yet?

MedMen recently put out guidance for their earnings report: 

  • Systemwide revenue of US$36.6 million (CA$48.8 million). 
  • This represents a 22% quarter-over-quarter increase over its fiscal 2019 Q2
  • Systemwide revenue, pro forma (for acquisitions that have not yet closed) was US$54.9 million (CA$73.2 million)
  • For the third quarter, the gross margin across its retail operations was 51% compared to 53% in the previous quarter. 

We believe this stock offers significant upside and also believe they are a prime acquisition candidate with Cronos being the most obvious partner (given their cash balance and the above-mentioned ties). 

 

Trulieve

The heavyweight of Florida and one of the most profitable companies in the cannabis ecosystem, they are the largest player in Florida – a market deemed to be one of strongest for medicinal cannabis given the demographic and age makeup of the state – and also have the most number of dispensaries open.

Last year, Florida enforced a dispensary cap on all companies, limiting the number to 35 per company. At the time, Trulieve already had 14 dispensaries open and hence argued these should not form part of the newly enforced cap. They recently won that battle in the courts and had the original 14 stores grandfathered. They can now open up to 49 dispensaries, thus putting the market leader in an even stronger position relative to its competitors.

They recently purchased a small operation in Massachusetts and a retail store in California. Although both of them are very small, Kim Rivers – the current CEO – stated that Trulieve's strategy is to start very small, learn how the state and market operates, and then scale…profitably. They also secured an exclusive production and distribution deal with SLANG Worldwide to bring their #1 best selling products to the Florida market. The largest retailer selling the best products – smart.

Based on their track record, who could argue with that? Last quarter they reported $36m in revenue with gross margins of 58% and, importantly, operating cash flow gains of $8m. Expect bigger numbers this month!

 

North America

Just last week in Canada, Alberta announced that they were finally lifting the cap on the number of retail stores, and are in the process of issuing an additional 26 licenses. Their release stated, "..the increase in supply and stock levels in existing stores has been enough for us to issue 26 additional retail licenses."

In November 2018, the Alberta Licensing Commission stopped issuing new retail licenses. The organisation said at the time that a national pot shortage meant producers were delivering just 20% of the cannabis that they had agreed to supply.

The Canadian recreational era has gotten off to a terrible start, although we are not surprised by this. The fact that on legalisation date there were less than 50 retail stores open, online commerce sites not being able to deliver orders, and coupled with massive shortages in supply, meant that the numbers coming out of the market have been anything but great.

Add to that the fact that legalisation launched with only flower and low-potency oils, meaning that the dominant form factor of edibles and extracts was not available in the legal market. No surprise then that the black market has continued to thrive. 

However, with the legalisation of edibles and extracts set for October, look for significant increases in retail revenues. This is precisely the reason we are still so bullish on this market.

We have two of the best retail plays in the fund at present and are banking on significant growth in this area of the market in the coming 12-24 months. Something to bear in mind is the fact that Canada's packaging rules treat cannabis as they do tobacco, meaning no excessive branding or advertising. This "white box" approach means it's not the producers that command the attention and loyalty of the consumer …it's the retail brands and their associated product range. 

And finally, to the US, where it is expected that Organigram will uplist to the NASDAQ in May. More and more cannabis stocks are migrating to the major US exchanges, as it potentially allows for wider access to institutional and retail investors. In addition, it should raise Organigram's profile which could make finding commercial partners easier.  Expect more of this.

 

And there you have it

Expect major volatility (in both directions) as some of the biggest players in the world deliver earnings results that could well move the dial. The numbers are going to start to get very big!

And for all you Star Wars fans out there, May the 4th…

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Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

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