| 2023 | 2024 | ||||||
| Price: | 4.82 | EPS | 0 | 0 | |||
| Shares Out. (in M): | 65 | P/E | 0 | 0 | |||
| Market Cap (in $M): | 312 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 0 | TEV/EBIT | 0 | 0 | |||
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Description
Long MSOS
Thesis: Long MSOS ETF to play the bombed out, but catalyst rich, US cannabis sector. Sector is trading near all-time lows with trough valuations, but stands to benefit from LT tailwinds as states continue to transition to adult use, the illicit market shrinks and further reforms/rescheduling likely eliminate punitive taxes and other obstacles to margin improvement. MSOS is heavily weighted toward the largest and most diversified operators, which are best positioned to survive until legalization and thrive thereafter.
Main Highlights
- Sector trades near Trough levels on valuation, and is relatively cheap vs 'Sin Staple' peers despite faster growth
- MSOS trades at ~7.2x EV/2023 EBITDA and ~5.6x 2024 EBITDA (based on top ~9 positions representing ~95% of holdings)
- By contrast, Tobacco peers MO and BTI trade at ~7-8x EBITDA, and Beer peers BUD and TAP trade at ~8.5-10x
- MSOS growing Revenue ~mid single digits (’22-24 CAGR) in-line with beer peers, and above tobacco’s ~LSD/Flat growth
- By contrast, Tobacco peers MO and BTI trade at ~7-8x EBITDA, and Beer peers BUD and TAP trade at ~8.5-10x
- Sentiment in the sector is completely bombed out, with most names trading at or near All time lows
- MSOS is down ~30% YTD, ~60% over past year and ~80% from inception (~Sept 2020) with many constituents trading below their COVID lows
- Shares of 10 largest operators are down ~72% vs election day 2020
- This is all despite drastically increased scale with most of the top operators now doing 2-3x Rev vs 2020 lvls
- Shares of 10 largest operators are down ~72% vs election day 2020
- MSOS is down ~30% YTD, ~60% over past year and ~80% from inception (~Sept 2020) with many constituents trading below their COVID lows
- MSOS trades at ~7.2x EV/2023 EBITDA and ~5.6x 2024 EBITDA (based on top ~9 positions representing ~95% of holdings)
- Despite headwinds from Macro, the industry has continued to see volume growth, which indicates healthy underlying demand for cannabis. Margins meanwhile have been impacted by pricing (due to competition and trade down by consumers)
- Several states (IL, PA, MA) saw wholesale product pricing down ~30% YoY in May 2023
- However, recent commentary indicated that product Pricing is starting to stabilize QoQ in most of these markets
- IL state data shows continued strenght in demand, as the # of items sold up ~10% YoY in each month so far in 2023
- Several states (IL, PA, MA) saw wholesale product pricing down ~30% YoY in May 2023
- Tailwinds from continued State reforms and gaining share from the Illicit market should drive growth medium term
- US Legal Market expected to grow from ~$30b currently, to ~$70b in 2030
- Will benefit from more states converting to adult use which should add ~$20-25b (see section below)
- Legal market continues to take share from illicit market
- Illicit market estimated at $40-70b/yr, thus total market (legal + illicit) is already ~$70-100b vs Alcohol at ~$250b
- Illicit market will shrink over time as people prefer legal supply and eventually will go away similar to illicit market for alcohol
- Processes decrease, consumers prefer tested product and legal purchases
- MSOS is top Heavy and weighted toward larger operators which benefit from Scale and Oligopoly dynamics vs smaller peers
- Top 2 holdings (GTII & CURA) are ~46% of overall holdings, Top 5 are ~81% overall, and top 7 are ~90%
- Building efficiency gap between MSOs (higher tech machines, techniques, using big data and professional software and tools) and 'Mom and Pop' and illicit (no real capex invested).
- Recent macro woes has only accelerated this trend, as Multi State Operators (MSOs) have been forced to get more disciplined on OPEX/productivity and Capex, meanwhile subscale/single state players are under pressure with some being forced to sell at distressed prices and exit unprofitable states/segments.
- Punitive taxes, and higher interest rates are already constraining further supply growth
- Weaker/smaller producers likely to continue to drop out, which should balance S/D medium term
- Meanwhile no AMZN or WMT competition for a long time
Comps:
State Rec Conversions:
Recent conversions (IL & NJ) have been extremely successful despites some challenges
- NJ REC began April 21, 2022
- NJ went from $250m MED mkt in 2021 to $600m Med + Rec in 2022
- NJ expected to hit ~$2.0-2.5b at maturity (per Stifel estimates)
- NJ went from $250m MED mkt in 2021 to $600m Med + Rec in 2022
- IL went from $250m in 2019 to $1.03b in 2020 (year 1, $670m Rec + $365m Med) and grew to $1.8b in 2021 (year 2, $1.38b Rec + $397m Med)
- IL Adult use was $1.55b in 2022 despite disappointing/delayed roll out of new stores
New Conversions look promising (CT, MD, NY & MN) and could add ~$8-13b to legal market
- MD $480m market previously and expected to grow to $1.4b-$1.8b at maturity (per Stifel estimates)
- NY $150m market now and expected to grow to $6.5b-$9.5b at maturity (per Stifel)
- MN $50m market now and expected to grow to $1.4b - $1.6b at maturity (per Stifel)
- CT currently run-rating ~$250-300m/yr, and with a similar sized population and GDP as Oregon should represent ~$900m - $1b market at maturity)
Future conversions (VA, OH, PA, FL) represent another $10-11b
- VA $50m now and expected to grow to $2b - $ 2.5b at maturity (per Stifel)
- OH $480m now and expected to grow to $2.8b - $3.4b at maturity per stifel
- PA $1.1b now and expected to grow to $2.5b at maturity (per Jefferies)
- Florida $2.2b now (~$5b including illicit) - $6b at maturity including tourism (per Jefferies)
[1] A ballot initiative for legalization of adult-use cannabis in Ohio for 2020 failed but is expected to reemerge on the 2023 ballot
[2] Possession and cultivation of adult-use cannabis became legal in VA on July 1, 2021. However, state lawmakers must still iron out details related to marketplace rules and criminal justice reform before sales can begin on Jan. 1, 2024. Additional delays here seem likely given current Gov Youngkin’s agenda.
[3] PA Gov. Shapiro supports adult-use cannabis, but the main obstacle is the state’s Republican Senate, whose leader has opposed the effort. Still progress here looks inevitable given the state has recently passed bills to increase medical access by eliminating qualifying conditions, and only 1 in 4 PA residents oppose Adult use.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
- Catalysts
- De-scheduling & 280e[1] Removal
- If cannabis moves to Schedule 3 or below, then 280e would no longer apply.
- Stifel estimates this would improve operating cashflows by ~40% on avg
- Individual states have also pursued reforms to eliminate state lvl 280e taxes
- If cannabis moves to Schedule 3 or below, then 280e would no longer apply.
- States continue to convert to Adult use
- OH, VA, PA highly probable near term
- Large southern/red states like FL and Texas are likely to follow medium term as legalization becomes the norm rather than the exception
- SAFE Banking
- Expands banking and capital markets access
- Should lower cost of capital
- Allow operators to move away from cash only transactions
- Expands banking and capital markets access
- TSX Uplisting from Small Canadian exchange (CSE) and OTC
- TerrAscend became the first US plant-touching cannabis company to be officially listed on a Tier-1 exchange on the Toronto Stock Exchange, with others expected to follow
- Uplisting to the TSX should improve liquidity and availability to at least some institutional investors (this uplisting removed the ban on custody services from MS and BNY)
- Federal Legalization
- M&A returns post reforms
- De-scheduling & 280e[1] Removal
[1] Section 280E penalizes traffickers of Schedule I or II drugs by disallowing the deduction of “ordinary and necessary” business expenses—such as below-the-line deductions—after reducing gross receipts by cost of goods sold, or COGS, essentially resulting in federal income tax liability calculated based on gross income, not net income. Jefferies estimates that given the impact of 280e (on Federal and State taxes), MSOs are paying effective corporate tax rates of ~70-90%.
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