Cabot Cannabis Investor Issue: February 22, 2023

Though cannabis sector sentiment is extremely dark because of price compression and lingering bitterness after the December drubbing, there are several reasons to be bullish on the group.

This suggests that it’s a good time to add to cannabis names as a contrarian investment. Warren Buffett tells us that the market should serve us, rather than influence our moods. If I am right about the underlying bullish trends, the market is serving up an opportunity in cannabis. But you have to look at this as a medium-term play.

We know about all the negativity in the space – declining wholesale prices, overproduction, the failure of politicians to get the ball over the line in banking reform in December. But what about the positives?

Here’s a look at sector developments since my update on February 8. Most notably: We may get a bullish catalyst out of Europe soon, says one CEO with skin in the game there; and in the U.S., states continue to march forward with legalization. The wild card: a possible banking reform redux in Washington, D.C. this year. My updates below include the most valuable sector insights from cannabis company earnings calls so far this month.

A Near-Term European Catalyst

By late May or mid-June, we should see progress on recreational use legalization in Germany. The news could support a rally in the sector, particularly in names and exchange traded funds (ETFs) that have exposure to Germany, like our Tilray (TLRY) and ETFMG Alternative Harvest (MJ).

“We’re really excited about the German process,” said Aurora Cannabis (ACB) CEO Miguel Martin in the company’s February 9 earnings call. “We expect to hear some more from the regulator in late spring.”

Martin says German recreational use regulations will serve as a framework that can be cut and pasted into other European countries like France, Poland and the Czech Republic, among others. “They’re looking to what happens in Germany.” In other words, German approval may speed up legalization throughout Europe, as a domino effect plays out. Martin thinks legal recreational use could launch in Germany by 2025.

He also hinted that Germany may announce more favorable regulations of medical use sales which are already legal in the country. “Not a lot of people are talking about [this],” he said.

Aurora Cannabis is not a suggested name here, but it is one of three companies that have a manufacturing license in Germany. So, the stock may see gains on news of progress in Germany. The company just reported a small increase in fourth-quarter sales compared to the prior quarter, but losses worsened by 29%.

Favorable State Developments

States continue to make progress on legalization, cannabis sales, and tax revenue growth. States that could legalize cannabis in 2023 include Delaware, Hawaii, Maryland, Minnesota, Ohio, Oklahoma, Pennsylvania, South Carolina, and Wisconsin, says cannabis sector expert and reform advocate Tod Harrison.

Here is a roundup of state-level advances since February 8.

* Another Minnesota House committee approved a bill to legalize recreational marijuana sales. That brings the total to nine committees approving the reform. An additional Senate committee also approved the bill, bringing the Senate total to six. Gov. Tim Walz (D) supports reform. Former populist governor Jesse Ventura also backs the policy change. In a departure from the approach used in many states, municipalities would not be allowed to ban marijuana businesses.

* The medical marijuana patient count in Florida grew 71% in the past two years, says Christopher Kimball, the state’s director of the office of medical marijuana use. This confirms that sales growth for recreational cannabis might also be robust, if or when it is ever legalized. Our Trulieve Cannabis (TCNNF), which commands over half of Florida’s medical use market, funds efforts to collect signatures to put recreational use legalization on the Florida ballot in 2024. It recently contributed another $5.5 million to support the ballot initiative signature gathering. It had previously contributed $20 million.

* A bill to legalize medical marijuana continues to make progress in North Carolina, when the state’s Senate Judiciary Committee recently held a hearing on the proposal. In a press interview, House Speaker Tim Moore (R) suggested reform has a good chance of being approved. He said more than half of lawmakers back medical cannabis reform. “I think there’s been a change. We have a lot of new members.”

* Gov. J.B. Pritzker (D) of Illinois says the cannabis sector has created over 30,000 jobs since recreational use was legalized in 2020. Illinois collected $445.3 million in tax revenue from $1.5 billion in cannabis sales last year. Other states considering legalization have no doubt noticed.

* Gov. Tony Evers (D) of Wisconsin included a medical and recreational marijuana use proposal in his budget request in mid-February. A majority of voters in the state support the policy change, but it faces resistance in the Republican-controlled state legislature. Prior efforts by the governor to pass legalization have failed.

* Two Senate committees in Hawaii approved separate marijuana legalization bills.

Illicit market remains a challenge, but that may soon change says one CEO

Lax enforcement against the illicit market continues to vex cannabis companies and governments hoping to collect marijuana tax revenue, and the problem isn’t getting better. “Today there are two very different cannabis markets in Canada,” Canopy Growth (CGC) CEO David Klein said in his company’s February 9 earnings call. “One that’s legal, highly taxed and regulated, and one that’s thriving in illicit. The unregulated illicit market is generating billions of dollars of revenue with a 40% market share, and faces virtually no risk of enforcement.”

Aside from advantages conveyed by a tax bill of zero, illicit venders also get a pass on quality control to spot impurities. “We expect the sector challenges to remain for years to come and as a result, the sustainability of this legal sector is in question,” said Klein. He’s referring to the Canadian market. But U.S. cannabis companies also lament the lack of enforcement against illicit sales, particularly in New York where legal dispensaries are just starting to open.

Curaleaf (CURLF) board chair Boris Jordan speculates that poor enforcement may improve as states face budget challenges because pandemic-era subsidies run out. The budget challenges will encourage states to step up enforcement to boost cannabis tax revenue on legal market sales, says Jordan.

Elon Musk Greenlights 420 Ads

Twitter became the first social media platform to allow cannabis ads in the U.S. in mid-February. Our Trulieve Cannabis was the first multi-state operator to advertise on Twitter. “Having a global social media platform recognize our industry is another step forward in the normalization of cannabis in the U.S.,” said Trulieve’s chief marketing office Gina Collins.

Other social media platforms including Facebook, Instagram and TikTok still prohibit cannabis advertising, but Twitter’s move could pressure them to update their policies. “This change speaks to the growing acceptance of cannabis as a mainstream wellness category, and we are hopeful it will serve as a catalyst for other social media platforms to follow suit,” said Kate Lynch, who handles investor relations for Curaleaf. Twitter previously only allowed ads for CBD topical products derived from hemp.

Robust Industry Sales Growth Projected

Cannabis companies currently suffer from marijuana price deflation and weakening demand following the pandemic-era sales spike. Medium term, however, the trends may improve. A recent report projects that annual recreational use cannabis sales will rise by more than 60% over the next five years.

The report forecasts $50.7 billion in annual sales by 2028, up from an estimated $31.8 billion in annual sales by the end of 2023. The projections were published by the consumer research group, Brightfield Group, according to High Times. Cannabis companies in the U.S. and Canada are now cutting back on production, which could also support pricing near term.

Cost Cutting Continues

Canopy Growth announced February 9 that it is substantially reducing employee headcount and production as part of a cost reduction effort expected to save as much as $160 million over the next 12 months. Because the best cure for low prices is low prices, production cuts like this could help firm up the dramatic 30% year over year wholesale price declines which have vexed the sector (see below). Curaleaf (CURLF) recently announced it is getting out of production in California, Colorado and Oregon. Companies are cutting costs to bolster balance sheet strength to survive, or make acquisitions of weaker players during the current cannabis sector winter.

Price Compression Leveling Off

Indeed, the volume-weighted average spot price of cannabis in the U.S. for the week-ended February 10 was $983 per pound, down only 19.5% year over year, according to Cannabis Benchmarks. That’s lower price compression compared to declines in the 30% range for much of last year. This is a bullish trend for cannabis companies. California and Oregon showed the best price stabilization, though prices were still lower (by 25% and 9%). The worst price deflation is in Arizona (-58.5%), Massachusetts (-56%) and Rhode Island (-49.7%).

A Wild Card: Federal Progress?

Will progress on cannabis law reform in Washington, D.C. create another big run-up in marijuana stocks this year? The probability of this is discounted to near zero, but it is not out of the question – one reason to accumulate cannabis names on the dramatic weakness now.

Cannabis reform advocate Sen. Chuck Schumer (D-NY) recently met with Republican senators to discuss progress on bipartisan cannabis legislation. Schumer met with Sen. Steve Daines (R-MT), Sen. Rand Paul (R-KY) and Sen. Dan Sullivan (R-AK). They discussed a path forward on banking sector reform called SAFE Plus, according to Marijuana Moment.

SAFE stands for Secure and Fair Enforcement Act. The Plus refers to controversial “equity” components that politicians on the left want to include in the bill, like criminal conviction expungement. These have been a sticking point for conservatives. All three of the Republican senators Schumer met with cosponsored the original SAFE banking act.

Recall that the cannabis stocks posted a spectacular run last November and December as Schumer teased SAFE passage by year end. In the end, cannabis stocks got “Schumer-ed.” The bill was not approved and cannabis stocks fell by 40% or more. It’s safe to conclude that if Schumer’s meeting leads to more concrete developments on SAFE banking, that would drive the group considerably higher once again. Though investors will be more skeptical this time around given the drubbing they took in December.

Cannabis sector lobbyist Don Murphy, of the Marijuana Leadership Campaign, recently published an opinion piece explaining why he is bullish on SAFE banking approval by Congress. He argues SAFE banking can pass because it has enough support among Senate and House Republicans, including House Speaker Kevin McCarthy (R-CA). “In spite of what you may hear, the glass is not half empty,” tweeted Murphy.

Portfolio Company News

In another survival move in the space, our Ayr Wellness (AYRWF) is selling its Arizona assets to reduce its long-term debt by $20 million. The buyer will also take over lease obligations that will eliminate $15 million in long-term lease liabilities. Ayr is selling three dispensaries, and cultivation and processing plants.

While exiting Arizona, where cannabis price compression is extreme, the company is boosting its exposure in another state that could soon approve legal recreational use sales. Ayr inked option agreements to buy Ohio medical use dispensary licenses. Ayr may be bolstering its position in Ohio ahead of expected recreational use legalization as soon as this year. The company has a 58,000 square ft. cultivation facility in the state.

Ayr also announced it appointed David Goubert as president and CEO. Goubert brings valuable brand management and retail sales experience developed at Neiman Marcus and the brand powerhouse LVMH. Ayr Wellness will report earnings March 9.

What to Do Now

I encourage you to consider three courses of action in the cannabis sector.

1. If you have zero or limited exposure to cannabis, consider building positions in our portfolio names or ETFs on weakness. Sentiment is extremely negative, and this often signals a good time to buy. Medium-term legalization trends at the state level in the U.S. and in Europe remain quite favorable. The cannabis oversupply overhang appears to be retracting, so price compression is easing. We may get positive news at the federal level by September and October 2024 at the latest. That’s when Democratic politicians will most likely once again tout progress on cannabis reform in Washington, D.C. to get out the vote. As a wild card, progress on SAFE banking could resume this year.

My personal policy is to begin adding to positions in small amounts on 2%-4% intra-day declines, then to increase buying if the declines worsen.

2. Because sentiment is so dark, I want to increase leveraged exposure to the sector. Thus, I am selling 29% of our AdvisorShares Plus US Cannabis (MSOS) position, or 1,500 shares, and putting the cash into AdvisorShares MSOS 2x Daily ETF (MSOX). This is the leveraged version of the MSOS ETF. The sale of 1,500 shares of MSOS at the February 21, 2023 closing price of $6.86 raises $10,290 in cash. I am putting all of that into MSOX at the February 21 MSOX closing price of $5.60. This buys 1,837 shares of MSOX. MSOS is now 17.8% of the portfolio, down from 23.7%. MSOX is now 7.3% of the portfolio, up from 0%. Increasing leverage with this move will hurt us on the way down, but help in up moves, which I believe will play out for the cannabis group over time, for the reasons stated above.

3. I am suggesting a new stock, Verano (VRNOF). This company looks promising because it has solid operating cash flow, which is necessary for survival in this environment. It has a lot of exposure to states where sales are ramping up quickly because of recently legalized recreational use. It has a lot of exposure to states that should legalize recreational use soon. For more details on Verano, see the company profiles section below. Available cash is low ($1,071), so I am only adding 351 shares, which represents just 0.8% of the portfolio. This should increase over time as I bring in cash from selling covered calls, or make other adjustments.

When our March 17 covered calls in MSOS are closer to expiring, I plan to reload the covered call position to generate some more cash.

Sector Performance

The New Cannabis Ventures Global Cannabis Stock Index is up 4.6% year to date, compared to a 3.1% decline in our portfolio.

Portfolio

Company Profiles

New Portfolio Additions:
Buy AdvisorShares MSOS 2x Daily ETF (MSOX)
Buy Verano (VRNOF)

Ayr Wellness (AYRWF): This is a vertically-integrated multistate operator based in Miami. It has 79 dispensaries in eight states: Arizona, Florida, Illinois, Massachusetts, Nevada, New Jersey, Ohio, and Pennsylvania. Ayr has 18 grow sites, 11 national brands, and a proprietary library of over 160 cannabis strains. It makes the #2 carbonated THC beverage in the U.S. (Levia).

Ayr reported 24% year-over-year third-quarter revenue growth and 9% sequential growth to $119.6 million. It posted 4.5% same store sales growth. Sales of national branded products grew 42.5% sequentially. The company bought two dispensaries in Illinois and opened more than 15 stores in Florida. It also added dispensaries in Pennsylvania and Massachusetts. Ayr reports losses, but adjusted gross profits rose 9.9%. Ayr projects operating income will grow 10% sequentially in the fourth quarter. The company ended the quarter with $100 million in cash.

“We grew retail market share in six of the seven states where we operate,” said CEO and founder Jonathan Sandelman. “Ayr continues to build market share with its revamped product offerings, a higher quality flower and premium genetics.”

AYR recently built out its brand development strength with the appointment of David Goubert as president and CEO. Goubert previously served as president and chief customer officer at Neiman Marcus Group, and he was at LVMH for 20 years before that.

Ayr is currently launching brands from its national portfolio in New Jersey, including Ayr’s Lost in Translation flower, Kynd flower, Road Tripper flower, STIX pre-rolls, Entourage vapes, Secret Orchard vapes, and Wicked soft lozenges. In early December the company announced that three Garden State Dispensary retail locations it purchased in New Jersey had been re-branded to operate under the AYR dispensary name. Ayr looks cheap with a trailing price to sales ratio of 0.19. The company is founder run, which can be a plus in investing. BUY

Cresco Labs (CRLBF): Chicago-based Cresco will become the biggest cannabis company in the world, once its acquisition of Columbia Care (CCHWF) is completed early next year. The deal will double Cresco Labs’ retail footprint and give it the number one market share in five markets. It will reach over 70% of eligible U.S. consumers. Cresco says the deal will close at the end of the first quarter 2023.

“The Columbia Care deal creates arguably the highest value footprint in cannabis, access to 180 million Americans, all 10 of the 10 highest projected 2025 revenue states, and exposure to the largest industry growth drivers of the next few years,” said Cresco Labs CEO and co-founder Charles Bachtell in the third quarter earnings call. “We are creating a company built to effectively compete today, and for industry leadership long-term.”

Azer, at Cowen, is not so sure. She recently downgraded her rating to market perform, citing doubts about whether the merger will go through given the failure of SAFE banking approval.

Cresco is already the #1 seller of branded cannabis in the U.S., with products in over 1,100 stores. It has a clear brand message that resonates with consumers. Cresco offers exposure to many attractive U.S. markets with an emphasis on Illinois. It holds a sustainable competitive advantage there with production limits 50% larger than its closest competitor and triple that of other large producers. It is also in Pennsylvania, Ohio, California, Arizona, New York, Massachusetts, Michigan, Florida, and Maryland.

Third-quarter revenue slipped 2% year-over-year to $210 million. It was hit by price compression, increased verticality among retailers, the strategic exit of third-party distribution in California. Adjusted for the changes in California, third-quarter revenue increased 2%. Retail revenue increased 11% year-over-year, to $118 million. On the wholesale side, revenue was down 7%, adjusted for the strategic exit from distribution in California. The company held market leadership in Illinois, Pennsylvania, and Massachusetts. It exited the quarter with cash of $130 million. The company opened a second dispensary in Orlando in December, bringing the Florida store count to 21.

Near term, the company expects sequential revenue declines in the fourth quarter, due to seasonality and a continued focus on verticality among retailers. But the company says this weakness will be temporary. It projects both wholesale and retail growth in 2023, thanks in part to store openings in Florida, Pennsylvania, and Illinois. The company is founder run, which can be a plus in investing. Cresco Labs has a trailing price to sales ratio of 0.61. BUY

Cronos Group (CRON): There’s been some big insider buying at Cronos Group and I think it makes sense to follow the insider into this name. Cronos is mainly a foreign operator with exposure to Canada and Israel. It’s in turnaround mode, and often insiders buying their own turnaround is a good combination.

Exposure to Canada sounds ominous. It is a highly competitive market, especially in flower. But Cronos has respectable brand strength there. It sells gummies, infused pre-rolls and vapes under the Spinach, Blue-Raspberry Watermelon and Tropical Diesel brands. Spinach products command 15.3% market share in the Canadian edibles category, and 19.8% share in gummies, according to Hifyre.

In Israel, Cronos sells dried flower, pre-rolls and cannabis oils in the medical market.

In the U.S., Cronos sells hemp-derived supplements and cosmetic products under the brands. It’s exiting the beauty category, but it plans to ramp up cannabis sales.

Cronos has a 10% stake in Cronos Australia, a publicly traded company.

U.S. third quarter revenue slipped sharply (down 76%) as Cronos wound down businesses. But sales grew 11% in the rest of the world. Overall, the company posted a 3% year-over-year revenue gain to $20.9 million on a constant currency basis. Canadian revenue was down 2% to $13.9 million. But sales in Israel increased 98% year-over-year to $7.4 million on a constant currency basis.

The company is slashing up to $25 million costs this year, stemming the cash flow bleed. Consolidated adjusted EBITDA was negative $21.7 million, a $25.1 million swing from the third quarter of 2021. Cronos posted gross profit of $1.2 million in Q3, a $1.9 million improvement over the same quarter in 2021.

Cronos ended the quarter with $888 million in cash, or about $2.35 per share. It has minimal debt. Cronos isn’t sharing much detail, but with company valuations so suppressed in the cannabis space, some of that cash war chest could be deployed in acquisitions, possibly as a way to expand in the U.S. adult-use market.

As for the insider buying, director Jason Marc Adler purchased $4.4 million worth of stock in the $2.90 range in November and December. This is the first insider purchase in this name since August 2020. The price to sales ratio is 9.12, but Cronos trades at 0.73 times book value. BUY

Curaleaf (CURLF): Massachusetts-based Curaleaf was the industry leader in the third quarter, with revenue of $340 million. It operates 148 dispensaries and 29 grow sites in 19 states and its European operations. Here are three factors that support growth.

1. Curaleaf is an R&D powerhouse. A team of scientists is currently developing about 180 products. Near term, the company expects 75% growth in new product revenue year over year. About 20% of second-quarter revenue was generated by products launched in the last 12 months.

2. Curaleaf is an industry consolidator. It has a good M&A track record. The company’s executive chairman has a lot of experience rolling up fragmented and distressed industries. M&A is supported by a

healthy balance sheet and good access to capital. The company generated a record $60 million in operating cash flow in Q3 and ended the quarter with $198 million in cash against $599 million in debt, most of which is not due until December 2026.

Growth through acquisition is always risky. But given how much the cannabis group has fallen in the past year, there are probably a lot of good bargains out there. The company is cutting costs, which builds the M&A war chest.

3. Curaleaf will benefit from progress on legalization in Germany and Europe. It just completed the acquisition of a majority stake in Germany’s Four 20 Pharma, a licensed producer and distributor of medical cannabis that has more than 10% market share in Germany. Curaleaf International is the largest vertically integrated cannabis company in Europe. It has a lot of room to expand production, and it boasts import and distribution capabilities in the U.K., Germany, Italy, Switzerland, and Portugal. The company thinks Europe’s population of 748 million people potentially supports annual legal market cannabis sales of $229 billion, compared to $677 million in 2021.

“While international remains a small part of our revenue story today, we are investing in the long-term growth of Europe’s cannabis future now and expect it to begin paying meaningful dividends in 2024 and beyond,” says board chair and co-founder Boris Jordan. We will likely see significant progress on legalization of recreational cannabis in Germany over the next few months. This could open the floodgates to further legalization throughout Europe.

As for the third quarter, Curaleaf reported 7% year-over-year sales growth on November 7, and 1% sequential growth to bring in $340 million in the third quarter. Retail sales (76% of revenue) increased by 16% to $260 million, driven in part by store openings. Curaleaf posted its 19th consecutive quarter of retail sales growth. Wholesale revenue decreased 14% to $79 million, as the company continued to reduce its wholesale business in lower-margin states. Curaleaf losses declined to $51 million compared to $55 million in the third quarter of 2021.

Note that this company is founder run, which can be a plus in investing. Board chair Jordan and board vice chair Joseph Lusardi founded Curaleaf. The company has a price/sales ratio of 2.1, among the highest in the group. BUY

ETF AdvisorShares Pure US Cannabis (MSOS): This exchange traded fund (ETF) has large exposure to most of our portfolio names so it may seem redundant. However, I want to put it on your radar as a liquid trading vehicle for getting in and out of the group without having to make a lot of individual stock sales, and as way to get exposure to many of our names with one purchase. It also gives us diversification beyond our names, to positions like Verano Holdings (VRNOF), Jushi Holdings (JUSHF) and Innovative Industrial Properties (IIPR), among others. Consider accumulating this ETF on weakness of 2% or more. BUY

AdvisorShares MSOS 2x Daily ETF (MSOX): This is the leveraged version of the ETF MSOS. It theoretically goes up (and down) by twice as much as MSOS, though the relationship does not always hold exactly. Consider accumulating on weakness of 2%-4% or more. BUY

ETFMG Alternative Harvest (MJ): This ETF has outsized foreign exposure, which means it could benefit more than other marijuana exchange traded funds if we see progress on legalization in Germany and Europe. That could happen in the form of draft legislation and decriminalization of recreational use in 2023. “Legalization in Germany could be a tipping point for global expansion,” according to cannabis experts at ETFMG. This would put additional pressure on other European Union members to move forward with legalization. It could also encourage reform of the 1961 U.N. Single Convention on Narcotics which prohibits the cultivation and sale of recreational cannabis. “Such a result would be momentous and would open the doors to a global market,” says ETFMG. Owning this ETF broadens our industry exposure to names outside our portfolio, like Canopy Growth (WEED), SNDL (SNDL), Cronos (CRON), and GrowGeneration (GRWG), among others. BUY

Green Thumb (GTBIF): Chicago-based Green Thumb is our portfolio’s largest position. Green Thumb was the third-largest cannabis company in the U.S. in the third quarter, with operations in 15 markets. It has been the most profitable multistate operator of all the big ones, based on its consistent record of profitability over the past nine quarters – a sign of good management.

Green Thumb manufactures and distributes a portfolio of branded cannabis products including &Shine, Beboe, Dogwalkers, Doctor Solomon’s, Good Green, incredibles and RYTHM. The company operates a national retail cannabis stores called RISE. It has 77 retail stores in 15 U.S. markets.

Green Thumb is expanding its medical footprint in Florida through a lease agreement with the convenience store chain Circle K. This could be a big deal, since the Circle K chain has 600 locations in Florida.

Green Thumb reported 3% sequential Q3 sales growth and 12% year-over-year growth to $261 million, on November 2. Year-to-date revenue increased 17% to $758 million compared to the first nine months of 2021.

Revenue growth was primarily driven by increased retail sales in New Jersey and Illinois, the addition of 12 retail locations, and increased store traffic. Same-store sales (at stores open at least 12 months) declined 1.6% as price compression offset continued traffic and volume growth. Gross margins slipped to 50.2% from 55.4% in the comparable period last year. Green Thumb posted its ninth consecutive quarter of positive net income, delivering $10 million, or four cents a share in profits. The company reported $48 million in cash flow, and cash of $147.3 million against $255.5 million in debt.

Key performance drivers for the retail business for the quarter were: Legalization of adult use sales in New Jersey; new store openings and store purchases, particularly in Illinois, Maryland, Massachusetts, Minnesota, Rhode Island, and Virginia; and increased store traffic particularly in Illinois.

Ongoing market developments in Illinois and New Jersey could be strong catalysts for Green Thumb Industries, says Stifel, which has a buy rating on the stock. Illinois will increase its store footprint by more than 2.5 times. Considerable upside exists in New Jersey as product offerings expand.

A positive here is that Green Thumb is founder run. Founder Ben Kovler is chairman and CEO. Research shows that founder run companies often outperform. Kovler has a 26% stake in the business and holds nearly 59% of voting power. Green Thumb trades at a price to sales ratio of 2.1, which seems reasonable given its 12% year-over-year sales growth. BUY

Organigram (OGI): Organigram reported an impressive 43% increase in fourth-quarter sales on January 12 to $43.3 million compared to $30.4 million the year before. The company booked a penny per share in earnings which was three cents above estimates. OGI reported adjusted EBITDA of $5.6 million, compared to negative adjusted EBITDA of $1.9 million the year before. That was the fourth consecutive quarter of positive EBITDA.

Cost of sales increased only 13% against that 43% sales gain, so gross margins expanded to 30% compared to 18% the year before. OGI reported $12.8 million in gross profits, compared to $5.5 million. “We achieved a record harvest and the lowest cost of cultivation in the history of the company,” said CEO Beena Goldenberg in the earnings call.

Organigram contained costs by using more automation and improving crop yields. Yield per plant increased 30% because of better LED lighting and watering techniques. Organigram’s plant science team regularly conducts research to improve terpene and THC levels and create more disease-resistant plants.

The company also benefitted from economies of scale since production volumes increase as the company expanded its Moncton facility in New Brunswick, Canada. Organigram harvested 22,000 kilos of flower during the quarter compared to 12,000 kilos in the same prior year period, a 92% increase.

The company maintained its #3 position among Canadian licensed producers. It also shipped $5.9 million of high-margin flower to Israel and Australia. Organigram has locked in a three-year supply contract with a company called Canndoc in Israel. It has a long-standing relationship with Cannatrek in Australia, and it added another customer there called Medcan. The company is negotiating with potential customers in Germany. CEO Goldenberg also alluded to “creative ways” to get into the U.S. cannabis market, but did not offer details.

The company has a comfortable $95 million in cash. But it plans to spend $29 million this year on capacity expansion and automation. The company continues to expand its Lac-Supérieur facility, expected to come online in May. This should boost profit margins, since the facility will have a lower cost structure.

OGI expects to generate positive free cash flows by the end of calendar 2023. OGI also guided for higher revenue this year. It expects improved profit margins because of increase international sales which produce higher profits, and increased sales of higher margin finished products like those in its Holy Mountain lineup. “We expect our focus on product innovation, brand revitalization, strong sales execution and advanced plant science will enable us to continue to gain share,” said CEO Goldenberg.

British American Tobacco (BTI) is a big investor in Organigram, owning 19.4% of the company, an endorsement of its potential. The two companies collaborate to develop cannabis products. The price to sales ratio is 2.1. BUY

Tilray Brands (TLRY): Tilray is a cannabis and consumer packaged goods company with one of the biggest global footprints in the industry, following its 2021 merger with Aphria. CEO Irwin Simon founded The Hain Celestial Group, a natural food company, which is in the business of brand development. This is a key factor for cannabis companies, too. So, the Hain Celestial experience may bode well for shareholders.

Tilray is a big recreational and medicinal cannabis supplier in Canada, but it also offers medical cannabis in 20 countries on five continents through its subsidiaries and agreements with pharma distributors. It has operations in Canada, the United States, Europe, Australia and Latin America. It sells craft beer and CBD products in the United States.

Tilray seems like a good play on expected legalization of recreational use in Europe over the next few years, because it has been making significant investments there. It has a medicinal marijuana distribution network in Germany. It has production facilities in Portugal and Germany, the largest medical cannabis market in Europe. Tilray recently got approval from the Italian Ministry of Health to import and distribute medical cannabis.

CEO Simon forecasts legalization of recreational use in Germany in 2024. Once Germany legalizes, other countries will follow suit, probably using Germany’s regulatory framework as a blueprint on how to proceed.

Tilray sells hemp food products through its Fresh Hemp Foods division, and it has a craft alcohol business called SW Brewing, the tenth largest craft brewery in the United States. Tilray also holds convertible debt and warrants in MedMen Enterprises, a U.S.-based dispensary with over 25 stores in six states, including California, Illinois and Florida. Conversion of the debt and warrants could eventually bring a significant outright ownership stake.

Sales fell 7% to $144 million in the fourth quarter, and a risk here is that Tilray produced operating cash flow of negative-$17 million that quarter, according to filings. The company says it produced $25.4 million of free cash flow in the quarter, positive adjusted EBITDA and $119.6 million in annualized cost savings. It reported $433 million in cash against $609 million in debt. The price to sales ratio is 2.78. BUY

Trulieve (TCNNF): Trulieve has long been the biggest medicinal marijuana vender in Florida, where it has a 50% market share. It was the first licensed operator there in 2016. It now has about 120 dispensaries and eight production sites there. Cannabis activists are trying to get recreational use on the Florida ballot in November 2024. A win would be huge for Trulieve, since it already dominates Florida. Approval could make Florida the largest legal U.S. cannabis market with 22 million residents and 130 million tourists a year.

Meanwhile, Trulieve has been expanding across the country via acquisitions. It is diversifying its presence into Pennsylvania, Maryland, and Massachusetts, among other states. It had 176 dispensaries at the end of the third quarter, including 19 in Pennsylvania and 19 in Arizona. It has three dispensaries in Maryland, which is in the process of legalizing recreational use. Sales outside of Florida, Pennsylvania, and Arizona are so small, the company does not consider these markets to be material. But Trulieve has solid prospects given its geographic hub system, with Florida the company’s Southeast hub, Pennsylvania its Northeast hub, and Arizona the Southwest hub.

Trulieve posted third-quarter year-over-year revenue gains of 34% to $301 million in November. But sales declined 6% sequentially in part because of Hurricane Ian in Florida and the closing of non-core operations. The company reported a net loss of $115 million. That turns into net income of $4 million when you exclude substantial one-time costs related to asset impairments and the closure of California dispensaries, redundant cultivation operations in Florida, and wholesale operations in Nevada. The company opened 11 new dispensaries in Arizona, Florida and West Virginia.

It ended the third quarter with $114 million in cash against $941 million in debt. Third-quarter operating cash flow was negative-$22 million, a $23 million improvement over the second quarter. The company expects positive operating cash flow in the fourth quarter, and positive free cash flow next year. “U.S. cannabis has significant white space ahead, with many states yet to implement medical or adult use programs, and the growing appetite for substantive federal reform,” said CEO Kim Rivers. It has a price to sales ratio of 1. BUY

Verano (VRNOF): Chicago-based Verano is one of the top five publicly traded multi-state operators in the U.S. by sales. The company has 123 stores and 14 cultivation and processing plants in 13 markets. One of the most attractive qualities of this company is that it has a big presence in high-growth markets like New Jersey, Illinois, Florida and Connecticut, and states that are about to legalize recreational use like Maryland and Pennsylvania.

It also has solid operating cash flow at a time when financial strength is important due to pricing and sales pressure in the sector.

The company’s portfolio of brands includes Encore, Avexia, MÜV and its signature Verano line of product. To capitalize on the consumer’s trading down to value brands, Verano moved up the rollout of a new budget line called Savvy last year. It operates dispensary concepts called Zen Leaf and MÜV. It also has a licensing agreement with Mike Tyson’s Tyson 2.0 cannabis company to launch legendary wrestler Ric Flair’s new cannabis line, Ric Flair Drip Cannabis.

In a sector where a lot of companies are reporting substantial sales declines, Verano posted 2% sequential and 10% year-over-year sales growth to $228 million for the third quarter. Profit margins rose. Adjusted EBITDA margins grew to 36% from 34% in the prior quarter.

Here’s more on Verano’s presence in states where cannabis sales are growing rapidly because they recently legalized, and in states that should legalize soon.

Verano has three dispensaries in New Jersey, and it is one of the top wholesalers there. Third-quarter wholesale revenue tripled over the prior year. “We expect to see some normalization over the coming quarters as some of the initial adult-use excitement wears off, especially versus peak summer months,” cautioned founder, chairman and CEO George Archos in the third-quarter earnings call. “However, we remain bullish about this state.” Wholesale revenue will grow as New Jersey approves more dispensaries.

Verano has opened 23 new dispensaries in Florida since February 2022. It plans to dial back expansion there now, to allow these stores to catch on. It has 64 locations there. “We’re pretty comfortable with our Florida footprint now,” said Archos, in the third quarter earnings call.

Verano has about 15 dispensaries in Pennsylvania with plans to open a few more. The state faces pricing pressure as the dispensary count grows, by around 20% last year. To combat this challenge, Verano launched a mid-tier brand called Essence and the value brand, Savvy. Pennsylvania faces pressure to legalize recreational use now that bordering states New Jersey and New York have done so. The political makeup of lawmakers following the most recent election is now more favorable for legalization.

Maryland is a legacy state for Verano. It operates four dispensaries there. This presence should give it an edge as recreational sales begin in July.

Verano is one of the largest wholesalers in Connecticut, which just launched legal recreational use sales.

The company also operates in Arizona, Nevada, Ohio, and Massachusetts.

The company has been dialing back capital spending plans to bolster its balance sheet. But it has some of the strongest operating cash flow in the business. Verano produced $65 million in operating cash flow during the first nine months of last year. It ended the third quarter with $76 million in cash, against debt of $392 million. It also refinanced a $350 million credit facility through October of 2026. This gives Verano enough balance sheet strength to consider acquisitions of weaker players facing challenges due to sector weakness.

Verano is founder run, which can be a plus in investing. Cantor Fitzgerald’s Pablo Zuanic has a $10, 12-month price target on the stock. You should always be skeptical of sell-side price targets because of potential investment banking conflicts of interest. However, this is notably higher than Verano’s recent stock price of around $3. Verano guided for a softer revenue and declining margins in the fourth quarter, but this may already be priced in to the stock. Verano has a price to sales ratio of 1.18. BUY

The next Cabot SX Cannabis Advisor issue will be published on March 29, 2023.