No More Faking, Time to Make It

SOMEDAY CANNABIS STOCKS will be traded based on fundamentals like market growth and balance sheets and company prospects and we’ll all shake our heads at the kind of volatility that, in the past two years, has seen New Cannabis Ventures’ American Cannabis Operator Index:

• Soar 143 percent upon the election of Joe Biden to the U.S. presidency in November 2020
• Undergo a grinding 84 percent decline over his first 20 months in office as the long-time drug warrior moved sluggishly on campaign promises to decriminalize cannabis
• Snap back by 35 percent in a single day—Oct. 6, 2022—when the president issued a handful of pardons and said his administration would look at rescheduling cannabis

When they stop being “story stocks” and start trading on fundamentals, today’s valuations will look remarkably cheap, at least for the companies that survive this era in which valuation hinges on politics rather than performance. Some of those survivors will likely be among the multi-state operators (MSOs) that hold 25 of the 50 spots in the Global Cannabis 50 ranking featured in the Winter 2023 issue of GCT.

How MSO Trading Multiples Compare

A Global Go Analytics study of MSO revenue and market caps shows the top 10 MSOs to be trading at a mere 2x their trailing twelve-month (TTM) revenue through June of 2022. That’s less than the 2.9x price/sales ratio at which the broad U.S. market trades, according to an NYU by-sector analysis (see table 1). And it’s even cheaper compared to the price/sales ratios of companies operating in comparable sectors of the economy, particularly compared to tobacco, alcohol and drug companies that trade above 4x sales.

TABLE 1: COMPARABLE INDUSTRY PRICE-SALES RATIOS

Here’s the thing: It’s not politics-driven volatility causing this seeming lag in price/sales ratio for the top cannabis MSOs compared with companies selling similar products. Alcohol, tobacco and drug companies are consumer products companies, while the vertically integrated MSOs simply are not. The bulk of MSO sales comes from retail. Stocks in other specialty retail sectors trade at just 0.9x sales and retail distributors at 1.4x sales. Retailers and wholesalers traditionally trade at lower multiples than branded product companies given the competitive and thin-margin nature of their businesses.

That’s why some of the MSOs are positioning themselves as brand marketers, only operating retail stores while required to by vertical integration rules and to familiarize consumers with their brands. Others are keeping their focus on retail as wholesale margins shrink, particularly on flower products, in rapidly maturing adult-use markets.

Both models have worked in other product categories. There are plenty of successful companies selling their own branded products out of their own stores and being valued well above typical specialty retailers:

• Starbucks trades at 3x its $32 billion TTM revenue
• Nike trades at 3.6x
• McDonald’s trades at 8x

Cannabis Is Different

None of those highly valued, household-name market leaders operate in sectors looking ahead to a decade or more of double-digit growth in their Total Available Market (TAM). But the cannabis MSOs do live in such a sector. U.S. legal cannabis companies have the fundamental tailwind of superior market growth filling their sails no matter what happens in Washington.

Even with federal legalization unlikely through at least 2024, the MSOs’ TAM is nearly certain to grow robustly, while the individual companies are also likely to grow their Serviceable Addressable Market (SAM) as they enter new states, and also grow their Serviceable Obtainable Market (SOM) as they roll-up smaller competitors.

The top 10 MSOs generated TTM revenue of $6.4 billion through June 2022, per our research. After almost all of them gave back their Oct. 6 “Biden Bump,” their combined $13-billion market capitalization on Nov. 4 means that together they are trading at a 2x price/sales ratio.

The companies don’t disclose state-by-state revenue, so we can’t do a detailed forecast for each. But to get an idea of how Wall Street values the 10 in light of the fundamental growth in their markets, we did a rough forecast of their 2025 revenue, which could reach $12 billion if they continue to build and acquire their way to a uniform 5 percent market share across their states. Against that forecasted revenue, the MSOs traded on Nov. 4 at just 1.1x their potential 2025 revenue (see table 2). At an assumed 10 percent market share, their current price/third-year-sales ratio would be just 0.5X.

TABLE 2: TOP 10 U.S. MSO VALUATION METRICS, PROJECTED TO 2025

Price/Sales Ratios Start to Diverge

There is one indication that investors are getting past their single-minded focus on federal legalization: individual MSO price/sales ratios have diverged dramatically. For the Top 10, these range from 0.4x to 3.0x against TTM revenue, with their price/third-year-sales ratios (at the assumed 5 percent market share) ranging from 0.1x to 2.5x.

For now, investors appear to favor size and geographic reach, with Curaleaf commanding a premium multiple with its licenses in 19 states and $1.3 billion in TTM revenue.

As federal regulation recedes in importance to investors, state regulatory regimes will become of paramount importance in understanding the varying prospects of the MSOs—and every other U.S. cannabis company for that matter. The common assumption that the best prospects for growth and profitability lie in limited license medical states is now an open question, as growth slows in many such states and state regulators make the adult-use pay-off less certain.

Spending in medical-only Florida grew 25 percent in September per BDSA data, for example, while it sagged by 13 percent in medical-only Maryland (the latter state’s voters passed a ballot measure in November to legalize recreational cannabis in 2023). Sales in adult-use Michigan soared 31 percent while dropping by 25 percent in adult-use Nevada.

With plenty of states still to legalize, not to mention the rest of the world, the legal cannabis market will certainly remain among the fastest growing sectors of the economy. But the growth of individual companies will more and more come to reflect the markets they’ve chosen and how they execute in them rather than just general exuberance or caution over a novel product.