During May broad US indexes finished about flat and cannabis stocks posted another negative month. The US cannabis markets have lost money in 14/15 months and are in the midst of a 75% drawdown. There is no way to sugarcoat it: this is a painful period.
With the cannabis universe, the top-ten US plant-touching multi-state operators (MSOs) declined on average by 8%, which was better than -12.8% for ancillaries and -14.9%$ for Canadian LPs. This is the reason you see better performance from $MSOS (US only) versus $YOLO (global) cannabis ETFs.
The Green Giants portfolio faired better than the industry benchmarks and is now besting $MSOS and $YOLO by about 10% year-to-date. This indicates we are doing a good job with stock selection in the cannabis universe, but it does not make up for the fact we are taking real losses in absolute terms. To be clear, I expected a turnaround in cannabis stocks and positive returns and this has not happened.
Most of our outperformance this month came from a timely entrance into Ayr Wellness. I won’t rehash the story, you can read about the trade idea and the strong performance coming into the New Jersey CRC meetings. On the flip side, GTI and Terrascend had miserable months and were the biggest drags on performance. With thinly traded names on the OTC exchange, I try not to read too much into four-week performance periods. In many ways, US MSOs are like private-equity positions.
We are posting terrible absolute returns, but outperforming the top industry ETFs year-to-date and since inception.
Below is a graphical illustration of how the various benchmarks performed during May.
And, here is a chart from @cannalorian on Twitter showing the performance of US cannabis stocks month by month in 2022. If you like pretty charts, he's worth a follow.
There were a number of first-quarter earnings reports in May. Studying state-level data gave us a good idea that results would be underwhelming. Most reported slightly lower quarter-over-quarter revenue, stronger year-over-year growth, and various degrees of margin pressure. Q1 is often challenging due to the effects of Croptober that floods the illegal markets with cheap outdoor flowers from the West Coast, a spending hangover from the holiday season, and this year people are simply spending money elsewhere.
During the pandemic period, many people had extra cash from the government stimulus checks and were spending more time at home. The checks have disappeared, restrictions have loosened and many are traveling, eating out, and spending less time at home enjoying cannabis. We have seen declines in alcohol consumption, Netflix usage, and the once super-popular Peleton bikes.
The biggest driver of cannabis revenue is new states opening, or more stores coming online in current markets. We have been in a flat period for both, and this is one of the main reasons growth has slowed recently. However, this is changing.
New Jersey Approvals
The New Jersey CRC met on May 24th. This is the first meeting since they made the first approvals for adult-use sales back on April 11th. Coming into the meeting, New Jersey had 12 stores open for the first month and did $24 million in adult-use sales.
The committee met in May to discuss expanding cultivation and converting more retail stores from medical to adult-use sales. They approved new cultivation sites for Columbia Care and Ayr Wellness, plus new adult-use sales at all three Ayr stores, Terrascend's Lodi store, and Ascend's Montclair location. Everything up for a vote was granted.
This meeting was particularly important for Ayr, as they were not approved at the April 11th meeting and it was important for them to not fall further behind their New Jersey competitors. Having three stores converting to adult-use and expanding cultivation from 25k square feet to 100k sent the stock significantly higher ahead of the announcements. New Jersey is the most meaningful new market in 2022 and more stores and bigger grows will add much-needed revenue in the next couple of quarters.
Illinois Retail Expansion
Illinois is a massive market that has been plagued with major delays in rolling out much-needed new stores. The state has 12.8 million people, but only 110 retail cannabis stores. This has left many parts of the state without access to legal cannabis and suppressed wholesale prices. To quote Leafly:
The Illinois cannabis market is set to expand with the release of 185 new retail licenses for social equity applicants. On Friday, May 27, Cook County Circuit Judge Michael Mullen ended a court-ordered stay on licenses that had stalled the opening of all new stores for nearly a year.
This is big news for MSOs with wholesale operations in Illinois. Aaron Edelheit wrote about this in a piece titled, "The Fundamental Disconnect in Cannabis." He says:
If one were to assume that each new dispensary earns $5 to $10 million in revenue (down from the $17 million current average), this would bring in additional $925 million to $1.8 billion in retail revenue. If we assumed that wholesale took half of that retail revenue total, that means the wholesale opportunity is $460 million to $900 million.
The biggest wholesalers in Illinois are Cresco, Green Thumb Industries, Verano, and Curaleaf. Wholesale prices had been declining in Illinois, due to the lack of stores to sell products. 185 new doors should buoy the market, stabilize prices and provide a meaningful bump for these MSOs. The market (of course) completely ignored the news and the stocks had zero reaction. While this is frustrating in the short term, seeing good news being ignored only amplifies the long-term opportunity.
MSOs Join Forces to Sue Federal Government
In an unexpected piece of good news, several CEOs of top multi-state operators are working together to sue the federal government. To quote an article from Marijuana Moment:
Abner Kurtin, founder and CEO of Ascend Wellness Holdings, told Marijuana Moment in a phone interview on Friday that this is an “industry-wide effort,” with at least six major cannabis operators “favorably disposed” to joining the suits—one of which would focus on stopping the federal government from impeding intrastate cannabis commerce and another challenging a tax provision known as 280E that blocks the industry from taking tax deductions that are available to any other company.
They hired David Boies of Boies Schiller Flexner LLP to attach the case. Among other things, David's casework led to the invalidation of same-sex marriage in California. The goal of this suit is to remove intrastate cannabis commerce restrictions and repeal 280E, the tax treatment that blocks cannabis businesses from taking standard deductions.
Below is an example of how 280E impacts cannabis profits. In this instance, Green Thumb Industries' effective tax rate is 60.8% currently. Without 280E (a level playing field), their tax rate drops to 25.3%, a 59% reduction. Repealing 280E would be a massive boost to all cannabis businesses. This lawsuit is a big deal and I'm excited to follow their progress.
Investors are anxiously waiting for a catalyst to reverse sentiment. We are seeing news improving, particularly with expansion in New Jersey, new retail in Illinois, and the potential for Connecticut, New York, and other east-coast markets to open soon. New states not only expand the TAM (total addressable market), but they also have higher initial margins. Cannabis is a state-driven growth story and we've been in a lull.
There also is the potential that SAFE Banking could pass. This would lead to lower lending rates, the ability to use credit cards in stores, and a safer environment (due to less cash on hand) for industry workers. Most importantly, it may open up the investor base and provide more access points. The America Competes Act is heading into conference and it is possible SAFE slips into this bill. Political pundits speculate this is around a 25% possibility. If it fails here, there is also a potential SAFE could pass after the midterms in the lame-duck session. I have no edge in predicting politics, so I largely share what I hear from other experts.
From a fundamentals perspective, the next round of good news will come as we track New Jersey sales and see the positive impact on next quarter's earnings. This is especially true for Ayr, Ascend, GTI, Verano, Curaleaf and Terrascend. The latter is particularly interesting, as Terrascend has the exclusive rights to Cookies in New Jersey. I expect all legal cannabis to do well in the Garden State, but Cookies with their splashy branding and trendy strains are going to crush on the East Coast. Cookies products will draw New Jersey residents, as well as people crossing over from New York and Pennslyvania.
It's always helpful to step back and revisit the big picture. In baseball terms, we are either in spring training or the first couple of innings. Cannabis is only adult-use legal in 18 states, is federally illegal, a schedule one drug, and operators cannot access basic banking services. Institutions also are not able to invest due to custody or regulatory issues. There is a massive opportunity to be unlocked, it's just been slow getting there.
The chart below from Needham shows how small cannabis is in comparison to other industries, along with a low valuation and strong margin profile. Improving fundamentals, low valuations and the potential for catalysts have me optimistic about the second half of the year.
Finally, if you are free at 1 pm PST on Thursday, June 9th, I'll be joining Morgan Paxhia of Poseidon on their Twitter Spaces along with special guests. It should be an educational hour-long event. Follow me on Twitter and I'll share the link to the Spaces.
Thank you for your continued support.
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