Multi-State Operators (MSO) traded higher on Tuesday after Cantor Fitzgerald categorized four companies as "top picks." In a recent industry report, Pablo Zuanic analyzed the context of MSOs and offered insight on trends driving financial value. Although MSOs ETF fell 25% in June and 49% over the last three months (vs. a 7% drop for the S&P500), he still finds value in the current context.
The MSOs stock performance seems to be masking “encouraging medium and long-term sales trends,” with more states either legalizing cannabis (New Mexico and New Jersey), soon to start recreational sales (RI, CT/NY), or soon voting to legalize (MD, MO).
In addition, Zuanic noted Illinois could see growth accelerate as more stores open, as in the case of Michigan (+22% seq sales trends based on Apri/May data).
“Given mixed top-line trends top-down, declining prices, and cash flow issues for some, we doubt operating fundamentals will provide a spark for the MSO group's top-down (with the exception of those MSOs where NJ will account for a large % of sales). The second-quarter sales data so far are mixed, showing some improvement top-down in sequential terms (...), but not in YoY terms,” Zuanic wrote.
“We think there is a correctly increasing focus on profit margins and cash flow; wholesale prices are down 16% sequentially, down 20% YTD, and -35% YoY. Cash flow generation remains an issue (with high margins often offset by high-income taxes), and debt leverage is abnormally high for a few MSOs mentioned below,” he continued.
The analyst said the current state of affairs will lead to further consolidation and benefit those in a stronger position.
Yes, valuations are attractive
Cantor’s top picks are Cresco Labs (OTC:CRLBF) proforma (1.7x C23 EV/Sales), Curaleaf (OTC:CURLF) (2.7x), Green Thumb Industries (OTC:GTBIF) (1.6x), and Trulieve (OTC:TCNNF, CSE:TRUL) (1.9x).
“With the MSO average at 1.5x CY23 EV/Sales (we are putting less faith on EBITDA given restatements, a wide range of methodologies, and in some cases unrealistic guidance), we are less focused on valuation and more on quality,” Zuanic said.
He expects “decoupling” to occur in the group, with an increased focus on Europe, and stocks with exposure in those markets likely to benefit.
“Also, we like the ancillary space, although recognizing mixed fundamentals for MSOs may be an issue for service providers. We see value in the MSO group but would be selective (even though 2Q may not provide the spark needed). With top MSOs trading below 2x CY23 sales, we are buyers here, even though we recognize the group does not seem to find a bottom, the second quarter may not provide the spark needed, and caution investors that meaningful upside could still be 2-3 years away without federal-level reform (only de-scheduling can lead to MSO up-listing, in our view),” Zuanic concluded.
Cash flow and balance sheet
A key metric we will track in 2022 will be operating cash flow and debt leverage. According to Zuanic, the most levered MSOs (taking financial net debt plus leases, and income tax payables) were MedMen at 2.2x (broadly defined net debt on annualized sales) and AYR Wellness (OTC:AYRWF) at 1.4x.
“Three other MSOs were at 0.9x (Ascend (OTC: AAWH), Columbia Care (OTC:CCHWF), 4Front Ventures (OTC:FFNTF)). Of the rest, Jushi (OTC:JUSHF) was at 0.6x, but had the highest net interest expense ratio to sales (18%) ex MedMen (25%); TerrAscend (OTC:TRSSF) (0.5x debt to sales) was 3rd on this metric at 14%.”
Zuanic highlighted that “scale will matter.” “If MSOs were to raise 25% of their current market cap in equity, for Cresco, Green Thumb, and Verano (OTC:VRNOF), this would represent $400-500Mn in proceeds (more than the market cap of other MSOs); about $550Mn for Trulieve, and ~$900Mn for Curaleaf.”
Photo by Kelly Sikkema on Unsplash.
