Cabot Cannabis Investor Issue: January 25, 2023

We are back in earnings season again. This season tells us more about our companies, but it also helps us get a read on sector trends.

Let’s start with a look at takeaways on key sector trends from the quarterly earnings call by executives at Organigram (OGI). This Toronto-based company serving Canada, Israel and Australia may be small, with a market cap of $300 million. But its executives know the space as well as anyone, and they offered the following insights.

Big picture, this continues to be the best of times and the worst of times for the cannabis sector. Favorable cannabis reform at the federal level remains stuck. Price deflation will persist. But sales growth continues to be robust, legalization will continue to make progress opening new markets, and the long-term outlook is good, says Organigram.

Cannabis price deflation

“Price compression” will continue, but we are starting to see some improvements. The volume-weighted average spot price of cannabis in the U.S. in early January was $981 per pound, down 24.4% from a year ago, according to Cannabis Benchmarks. Prices had been falling by 30% or more for months.

“There is a lot of flower in the marketplace today, more supply than there is demand,” said Organigram CEO Beena Goldenberg in her company’s January 12 fourth-quarter conference call. She thinks price declines will continue. That’s because there is still a “significant surplus of production coming into the market” and this will lead to irrational behavior. “People will do what I might call silly things to get product out to try to generate some cash from that inventory. There will always be somebody who might make a move that isn’t what I would say is the best move for the overall industry, but might be the right thing for them.”

This won’t stop until capacity gets taken out of the market, she said. “Until the supply and demand gets aligned, this could always be a problem.” The good news is, that may already be happening. “Competitors are looking at moving production capacity to grow tomatoes. This is the reality of the market.”

The industry shakeout and M&A

With higher interest rates driving the cost of capital higher and wholesale cannabis prices falling hard, the weaker hands will be giving up this year. “As people run out of cash, I suspect we’ll have more of those that have to exit the market,” said Goldenberg. That’ll be bad news for people who lose their companies and their jobs. But it will be good news for investors in two ways. Reduced capacity will slow the price declines. And the trend will give companies with strong balance sheets the opportunity to pick up competitors at a good price, or otherwise gain share.

“This is going to be an interesting year in 2023. We all know that with the tight capital markets right now, a lot of companies are low on cash, and there might be great opportunities for us to explore,” said Goldenberg. “I do think there is opportunity to grow our revenue and our market share. I think it might be closer to the end of the 12-month period, and I think there might be more silly stuff happening in the short term until people really have to throw in the towel. But certainly, we believe there will be a consolidation in this industry, and there is opportunity for those who have scale and who have lower cost to be able to capitalize on the opportunity in the short term. We do have enough cash on our balance sheet to explore other opportunities.”

Germany and Europe: Progress soon

Germany is taking the lead in Europe on the legalization of recreational use. The key here is that once it approves legalization, other European countries will follow, opening up a huge market on a continent that has a bigger population than the U.S. We could see stock-moving progress in Germany soon. “While we saw draft regulations in the fourth quarter, we’re expecting to see their final regulation report out by the end of March. And so Germany is a market that we’re looking at, for sure,” said Goldenberg.

Bullish long-term outlook

“I’m happy to be in this space. It’s really exciting,” said Goldenberg. “We’re still seeing month-over-month and annual growth,” she said, citing data from the research group BDSA projecting 13% global compound annual sales growth to $57 billion in 2026 from $30 billion in 2021.

“There are a lot of markets, other commodities and other industries that would love to see 13% year-over-year growth. I think the consumers are going to continue to come.” She also expects Canadian regulators to loosen rules in a way that helps cannabis companies like hers, perhaps starting with an increase in the cap on THC concentrations in edibles.

Be wary of CBD plays

Purported health products delivering cannabidiol (CBD), a cannabis ingredient that does not cause a high, are popular among consumers. But Goldenberg does not see this as a good place to invest.

“We looked at CBD opportunities as many of our competitors did. Most companies who invested in CBD have not seen the benefit of that investment, mostly because it is a highly fragmented market in the U.S. Until Food and Drug Administration regulates CBD, we don’t really see it as a great opportunity.”

This is not surprising, given all the questions surrounding the true benefits of CBD. “The marketing has gone way ahead of the science and the law when it comes to CBD products,” concludes a Harvard University publication on the topic.

News roundup

While lawmakers in Washington, D.C. delay cannabis sector reform, progress on legalization continues at a rapid pace at the state level, and sales trends remain robust. Written below is a roundup of key recent developments outside of Washington, D.C. It may take time for these trends to get reflected in cannabis stock prices. But the bullish trends in public opinion, sales and legalization are undeniable.

As for Washington, D.C. lawmakers, eventually these trends should make it clear they have to come around on issues like favorable banking reform and de-scheduling of cannabis from Schedule I under the Controlled Substances Act of 1970. Both will be watershed changes for the group, since they would help bring capital and institutional investors into the space, and boost profits by reducing tax burdens. Keep in mind that we do not need actual progress to see sentiment improve towards cannabis. Substantial headline news of progress will attract interest, as we saw in late 2022 when suggestions circulated that banking reform was imminent, which turned out to be wrong.

Public opinion trends

* A late December 2022 survey by Data for Progress found 65% of Americans favor cannabis legalization. The poll found support among 75% of Democrats, 67% of Independents, and 52% of Republicans. It found that those under 45 were more likely to support the change. “Our poll shows that voters are ready for the U.S. government to finally legalize the adult use of recreational marijuana,” said the self-described progressive think tank. All these findings are in line with other cannabis opinion polls. The poll results continue to suggest federal lawmakers should favor cannabis sector reform.

Sales trends

Despite ongoing price declines, marijuana sales continue to advance sharply. Sales are growing in the 6%-10% range sequentially (month over month) and more than 30% year over year. That is impressive, considering that cannabis prices are declining 30% year-over-year at the wholesale level, though price compression is more moderate at the retail level. Here are some recent sales trends.

* Cumulative cannabis sales in Missouri advanced 7% in December compared to November. Missouri dispensaries sold $40.25 million worth of medical cannabis in December. Total sales were $605.1 million since medical use was legalized in October 2020. Recreational use sales should begin February 6, 2023. Missouri has a population of about 6.1 million people.

* Arizona recreational-use sales advanced 6% month-over-month to reach a new high in October 2022 at $85.4 million. Arizona voters approved recreational cannabis in 2020 and medical use was approved in 2010.

* Michigan cannabis sales climbed 9% in December compared to November and increased 32% over the prior year, to hit a record $221.7 million.

* Washington, D.C. reported a 10.5% increase in December medical cannabis sales to $3.5 million (month-over-month, and also compared to the prior year).

SAFE Banking

* Rep. Nancy Mace (R-SC) reaffirmed her efforts to convince more fellow Republicans to support cannabis law reform, in a January 20, 2023 appearance on Real Time with Bill Maher. “Republicans have been on the wrong side of cannabis,” said Mace, who also reiterated her intention to win approval of her States Reform Act. The bill seeks to remove cannabis from Schedule I. The presence of a high-profile House conservative lobbying fellow Republicans to support cannabis reform increases the odds of approval of favorable measures like SAFE Banking, which would allow banks and credit card companies to serve cannabis companies. No one knows when this will happen.

* The Michigan Cannabis Regulatory Agency (CRA) is worried about escalating robberies of cannabis delivery drivers. “This is a concerning trend that not only puts drivers at risk but also undermines the state’s legal cannabis market,” CRA Director Andrew Brisbo said in a Fox 17 report. A standing argument in favor of allowing banks and credit card companies to serve dispensaries (SAFE Banking) is the high risk of theft in this cash-only sector.

Legalization trends

Efforts to legalize cannabis sales at the state level continue to advance. While some of these states are small, progress would sustain the momentum behind legalization. Also recall that each state has two senators regardless of population, and they are more likely to approve federal reform if they get a clear message this is what constituents want.

* A Minnesota House committee approved a cannabis legalization bill that would allow the purchase of up to two ounces for adult use and expungement of prior cannabis records. Minnesota legalization of recreational use this year seems likely. This is a sizeable state, with a population of 10 million. Of course, we’d still need to see if the state limits dispensary licenses. Fewer licenses favor multistate operators like the companies in our portfolio, by reducing competition.

* A Republican South Carolina senator has refiled a bill to legalize medical marijuana, modified to eliminate problems that derailed it last year. South Carolina has a population of about 5.2 million people. South Carolina is home to Rep. Nancy Mace (R), who, as mentioned above, has pledged to win over fellow Republicans on cannabis reform.

* Hawaii lawmakers have filed bills to legalize marijuana. Legalization is more likely now that Gov. Josh Green (D) is in office. He’s said he’d sign a bill to legalize recreational cannabis use. Hawaii has a population of just 1.4 million.

* A Delaware House Revenue & Finance Committee has approved two bills to legalize recreational cannabis use. Delaware has a population of one million.

* The U.S. Virgin Islands has legalized cannabis sales. USVI population is tiny at 106,000, but the move adds to the legalization momentum in the sector.

Tax matters

* A New Jersey Senate committee approved bills that would allow cannabis companies to deduct business expenses on state tax returns. The bills offer a state-level workaround to the federal prohibition of business expense deductions at cannabis companies, the so-called 280E problem. A provision of the Internal Revenue Service (IRS) called 280E blocks the deduction of expenses when reporting the sales of Schedule I and II controlled substances. Cannabis is a Schedule I drug, under the Controlled Substances Act of 1970.

* Connecticut House Majority Leader Jason Rojas (D) introduced a bill that would allow cannabis companies to deduct business expenses on state tax returns as a 280E workaround.

* Missouri is the most recent state to allow cannabis companies to bypass 280E.

Cannabis research

* States that approve legal cannabis sales see significant declines in prescriptions for the opioid codeine. That’s according to researchers who mined Drug Enforcement Administration (DEA) data for a study published in the journal Health Economics. The study found recreational use legalization was linked to a 26% reduction in pharmacy sales in 11 states that legalized recreational-use cannabis sales between 2010 and 2019.

* The Food and Drug Administration (FDA) released finalized guidance on developing cannabis-based drugs. The “Cannabis and Cannabis-Derived Compounds: Quality Considerations for Clinical Research” guidance now goes into the Federal Register for public comment.

Company news

For a detailed review of fourth-quarter results at Organigram (OGI), please see the company profiles section below.

Connecticut launched recreational use sales on January 10, and this will incrementally help several names in our portfolio. Retailers seeking approval for recreational use sales include one store each for Green Thumb (GTBIF) and Trulieve Cannabis (TCNNF), and four for Curaleaf (CURLF). Connecticut has a relatively small population of 3.6 million. But recreational use sales should benefit as buyers who had travelled to Massachusetts to buy cannabis decide to shop at home. New York’s slow rollout of stores may also drive users who want to purchase legally to the Nutmeg State. The state is expected to generate over $215 million in revenue in the first year of adult-use sales, says Headset.

Curaleaf got a hybrid producer license from Connecticut in early January. Curaleaf has four Connecticut dispensaries in Stamford, Hartford, Milford and Groton. Curaleaf also announced the opening of its Palm Beach Gardens and Clermont dispensaries in Florida, which has approved medical use only. It now has 57 dispensaries there, and 147 nationwide.

Ayr Wellness (AYRWF) opened two dispensaries in Florida in Tarpon Springs and Orlando. Ayr appeared at the top of the “most levered” multistate operators list compiled by Pablo Zuniac at Cantor Fitzgerald. Highly levered cannabis companies are riskier now because of deflation in the sector, and higher interest rates and lower stock prices which make it more difficult to raise capital. To compile his list, Zuniac created a “broad net debt” benchmark that includes tax debt, leases, and contingent liabilities.

Jushi Holdings (JUSHF), TerrAscend (TRSSF) and Ascend Wellness (AAWH) also topped his list. I am not suggesting that you consider those three names.

What to do now

If you are new to the group or you do not have full positions, this is a good time to buy the stocks and exchange traded funds (ETFs) in our portfolio, below. Cannabis names got washed out late last year when expected banking reform failed. The sector is depressed because of a lack of progress on reform at the federal level. But the inexorable momentum towards legalization at the state level continues, boosted by overall voter support. Eventually, this momentum will win out. Meanwhile, the stocks look cheap, based on a price-to-sales basis. Many are trading down around one times sales, which is low considering the growth, and the growth potential.

I want to start generating income from our portfolio by selling covered calls against our ETF positions. When you sell a call, you give someone the right to purchase a stock or an ETF from you at a pre-arranged price. If the security never goes above that price, the calls expire worthless and you keep the income. The risk is that the security gaps higher, your position gets called away from you, and you miss out on upside. The key here in my view is to keep timelines short, to a month or two, and strike prices high enough to reduce the odds of losing the position, but not so high that premiums are meaningless.

I suggest selling 10 ETF AdvisorShares Pure US Cannabis (MSOS) calls with an $8 strike and a March 17 expiration. I’m going to assume fills at the bid, which is 26 cents. Since each call represents 100 shares, this means $26 in income per call, or $260 total on 10 calls. That represents 1,000 shares. I also suggest selling 10 MSOS calls with a $10 strike and a June 16 expiration. I’m assuming a fill at the bid, which is 45 cents. This means $45 in income per call, or $450 total. Selling both positions raises $710 in cash. That’s not a large amount of money, but it is worth collecting at least some income against our MSOS position.

Note that you might get better fills by using limit orders 5 cents higher for each of these calls (which is below the current ask), and then waiting for a fill which is possible, especially on upside volatility. Often in trading options that are less liquid it makes sense to use limit orders and patience. To keep things simple and conservative, I’m just going to assume fills at the current bid. As (or if) these expire worthless, I will start a new covered call position two months out, in a form of laddering.

Sector performance

The New Cannabis Ventures Global Cannabis Stock Index is up 7.2% year to date, compared to a 2.93% decline in our portfolio. I believe the index is outperforming us so far this year because it has more low-quality names. They fell more last year. So they were hit harder in the tax loss-related sell-off late last year, compared to our higher-quality names. Thus, they have rebounded more this year once tax loss selling abated. I think we will catch up and outperform over time.

Portfolio

Company profiles

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. 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 this 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 0.66. 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 9.91, but Cronos trades at 0.79 times book value. BUY

Curaleaf (CURLF): Massachusetts-based Curaleaf was the industry leader in the third quarter, with revenue of $340 million from 21 states, 144 dispensaries, 29 cultivation sites, and European operations. But it will likely be surpassed by Cresco once the Columbia Care acquisition is complete.

Still, Curaleaf is the winner on the perception front. Its market capitalization of $4.8 billion tells us investors expect a lot from the company. Not that it hasn’t already proven its mettle. “By the end of 2022, Curaleaf will have grown revenue at a staggering compounded annual growth rate of roughly 105% since 2018,” notes board chair and co-founder Boris Jordan. The company projects $1.45 billion in 2022 sales, more than double 2020 sales. 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. It expects at least $40 million in cost cutting next year.

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 Jordan. We will likely see significant progress on legalization of recreational cannabis in Germany over the next few months and during 2023. 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.

The company added six retail dispensaries in Arizona, Nevada and Florida and closed one in Colorado, bringing the store count to 142. It opened two Florida dispensaries in November after the quarter closed, talking to total to 144. The company opened a second dispensary in Tallahassee in December, bringing the Florida store count to 55. 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.

Sales growth was hurt by delays in the opening of a Bordentown, New Jersey store, and Hurricane Ian in Florida. Strong NJ sales growth and two new store opening offset these negatives. 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 2.2, 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 a 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. 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 by the end of the year, 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), 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. But it will likely fall to fourth after Cresco’s acquisition of Columbia. Yet 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.

Green Thumb is expanding its medical footprint in Florida through a lease agreement with the convenience store chain Circle K. Through this exclusive agreement, Green Thumb can lease space adjacent to Circle K stores. Green Thumb is starting with a “test and learn phase” that will see about a dozen medical dispensaries at Circle K convenience stores and gas stations in 2023. 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 1.9, 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 line up. “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 2.5. 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.

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.

A risk here is that Tilray fails to produce positive free cash flow, so a dilutive capital raise is possible. On the other hand, the company projects it will turn cash flow positive by August next year, and a strategic alliance with the cannabis company Hexo (HEXO) could bring substantial cost savings over the next two years. Tilray reported fiscal second-quarter earnings on January 9; they weren’t great – revenues declined 7% year over year, with a net loss of $61.6 million. And yet, the stock is up 12% in the two weeks since, perhaps in part because the company’s cash position has improved 30% from a year ago, and its adjusted gross margin deficit has narrowed. The price-to-sales ratio is 2.78. BUY

Trulieve (TCNNF:) Trulieve has long been the biggest medicinal marijuana vendor in Florida, where it has a 50% market share. It was the first licensed operator there in 2016. It now has 120 dispensaries, and eight production sites. 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

The next Cabot SX Cannabis Advisor issue will be published on February 22, 2023.