Cabot SX Cannabis Issue: November 30, 2022

The high-growth cannabis sector continues to be full of rapidly evolving developments that could move our stocks significantly at any moment.

Beyond the potentially transformative changes in the works on legalization, almost all our companies just reported solid third-quarter revenue growth.

That means this issue of the Cabot SX Cannabis Advisor focuses heavily on corporate trends and developments in the company update section, below. The updates are longer than usual, covering the key news events and developments at our companies revealed in quarterly results and other news flow.

The potential big-picture changes for the sector are so important, though, you need to keep them top of mind. So, let’s first take a look at five key sector trends and potential catalysts that could put a bid under our stocks.

So Bright, Gotta Wear Shades

“The future is bright for our industry,” said Cresco Labs (CRLBF) CEO and co-founder Charles Bachtell in his company’s third-quarter earnings call. “We continue to see legislative and regulatory progress at the state level, and we’ve never been closer to achieving federal reform on cannabis than we are today.”

Washington, D.C. now recognizes that the current Schedule 1 status for cannabis by the Drug Enforcement Administration – above cocaine and on par with heroin – is “out of date and out of step with American values,” said Bachtell. More states are opening up to legal recreational use.

The upshot: The growth potential for legalized cannabis sales is huge. Curaleaf describes the

cannabis industry as a “generational wealth opportunity” expected to grow to $45 billion in annual sales by 2026 from $24 billion in 2021. That’s a 14% compound annual growth rate. The research firm Headset projects 13% growth next year. Ask yourself, where else in the economy can you get exposure to such growth?

“I firmly believe cannabis is a multiyear double-digit growth industry with many more long-term catalysts that will drive increased consumer adoption,” says Curaleaf (CURLF) co-founder and board chair Boris Jordan.

As a further endorsement of the potential for cannabis stocks following a punishing 12-month sell-off, there’s been big insider buying at one cannabis name. That’s one reason I introduce it as a new stock for us, below. But first, here are the five sector mega-trends that may move cannabis stocks near term.

1. SAFE Banking

The midterm election results were a mixed bag for cannabis advocates. Republicans control of the House of Representatives was a negative. Conservative lawmakers are more likely to oppose legalization of recreational use and other changes that would help the industry.

The good news for the sector was that Democrats maintained control of the Senate, and the Republican takeover of the House puts pressure on lawmakers who favor change to get it done now. They think they need to act fast during the “lame duck” session that ends January 3, while they still might have the votes.

What’s in the works? The SAFE Banking Act, short for Secure and Fair Enforcement Act, would give cannabis companies access to banking services and credit card use for transactions, and some versions would allow cannabis companies to list on the major stock exchanges. “SAFE Banking Plus,” a reference to SAFE banking plus social justice reforms around cannabis, might be harder to get through.

Cowen Washington Research Group thinks there’s a 75% chance SAFE banking gets approved by year end, up from 60% in October. “We are increasingly optimistic that Congress will enact the SAFE Act on cannabis banking by the year end,” says Cowen analyst Jaret Seiberg.

This would significantly push up our stocks, one reason I just moved most of our cash into the ETF AdvisorShares Pure US Cannabis (MSOS) exchange traded fund (ETF).

It’s important to note that not everyone is so bullish. Evercore analyst Tobin Marcus puts the odds of approval at 40%. “I am getting the sense that Republicans feel like Democrats are asking for too much in terms of concessions — the Plus in SAFE Plus — as part of a deal,” he says.

That said, we continue to get signals from senators Chuck Schumer (D-NY) and Cory Booker (D-NJ) that something on SAFE banking will happen this congressional session (by Jan. 3).

Cannabis companies that have a big lobbying presence in Washington, D.C. offer the same signal. “I think the process has gotten so far, and there is so much commitment on both sides at this point, that I would find it highly unusual that we wouldn’t get something,” says Jordan, at Curaleaf. “I have never seen more cross-the-aisle activity on a piece of cannabis legislation in the Senate than we are seeing now. I think we really got a lot of energy behind SAFE at this point in time. I am very, very positive about it.”

Expect stock-moving updates at any point. Even headline news of progress will move cannabis names a lot.

2. State Activity

Beyond Washington, several key state-level developments would expand the industry and attract investor interest in our stocks.

New York, Connecticut and Virginia will make strides in opening up their legal recreational use markets in 2023. “We are pumped about ’23 in New York,” said Green Thumb (GTBIF) CEO Ben Kovler in his company’s earnings call.

“While timing is still unclear, we could potentially see New York’s adult-use program go live in the second half of 2023,” said Curaleaf’s Jordan. “We believe Connecticut will have its adult-use program kick off in the first half of next year.”

Rhode Island should launch recreational use sales December 1. Maryland and Missouri are launching recreational use. Election results in Pennsylvania, Minnesota and Wisconsin suggest legalization of recreational use is more likely.

Besides their need for tax revenue, politicians are responding to the will of voters. A recent Gallup poll suggests 68% of Americans support the legalization of cannabis. Liberals aged 18 to 29 were the most supportive at 86%, while conservatives aged 65 and older were the least supportive, at 32%. However, 65% of conservatives aged 18 to 29 support legalization.

3. European Legalization

Led by Germany, Europe may be on the cusp of widespread recreational use legalization. It could play out over the next two years. That doesn’t mean we have to wait two years for stock-moving developments. Significant signs of progress along the way will do the trick.

Expect the most progress near-term in Germany, which currently allows medical use but bars legal recreational use. A draft version of a recreational use legalization proposal has leaked, and there will be actual developments next year. Jordan, the Curaleaf co-founder and board chair, expects legal recreational sales will start in 2024.

“We are very encouraged by the movement we are seeing from the German health minister and the establishment of a baseline regulatory framework from which negotiations can begin,” he says. “The importance of Germany as a catalyst for the European cannabis industry cannot be overstated.” He expects Germany will be a $10 billion market, supplied by domestic and international producers, including Curaleaf, and several other names of ours.

Progress in Germany could set off a domino effect in Europe. “We fully expect that Portugal and Spain and all of these countries will go through this process as Germany goes through it,” says Jordan. Curaleaf predicts European market legal sales overall will eventually hit $229 billion a year, up from $677 million in 2021. Curaleaf International has a significant presence in eight European countries.

Tilray says that beyond Germany, three countries “have expressed a clear political ambition” to legalize recreational use. They are Portugal, Luxembourg and Malta. France, Spain, Italy, and the U.K. are debating regulations for cannabinoid-based medicine. The Czech Republic is expected to present a plan to legalize adult-use cannabis in first half of 2023.

4. Federal Re-scheduling

President Joe Biden last month called for a review of the current Schedule 1 status of cannabis by the DEA under the Controlled Substances Act. As I’ve written, this could take years since it calls for a lengthy process involving three federal agencies. Government moves slowly. But again, news of progress along the way would put a tradeable bid under our stocks.

The key here is that the federal government does not have to fully de-schedule (decriminalize) cannabis for changes here to help the sector. Re-scheduling cannabis to Schedule 3 or lower would unlock value at our companies by vastly improving their tax status. Currently, IRS regulations prohibit the deduction of expenses at companies for the production of Schedule 1 and 2 substances. This is the so-called 280E tax provision, named after the section of the law that created this rule.

In its third-quarter earnings call, Curaleaf’s Jordan said that over the last three years it has paid nearly $350 million in extra taxes “that we could have used to invest in the business and our communities for the benefit of all our stakeholders.” For context, over the trailing 12 months Curaleaf posted $1.3 billion in revenue and losses of $127 million.

Re-scheduling could also clear the way for more medical research.

5. Strong Growth Despite Inflation and Consumer Caution

Despite negative consumer sentiment and concerns about a recession, cannabis demand has held up. Unit sales growth recently increased 22% year-over-year, according to BDSA, a cannabis market research group. That’s partly because prices are falling so fast, around 30% year over year at the wholesale level.

But even in dollar terms, growth is OK. U.S. cannabis sales exceeded $6.6 billion in the third quarter, for 3% year-over-year growth and 2% sequential growth, said Green Thumb CEO Kovler. That amounts to an annual run rate of over $26 billion.

Cannabis company CEOs like to say that this demonstrates cannabis is recession resistant. But this isn’t entirely accurate, since we are not in a recession. Third-quarter GDP growth was positive, and the Atlanta Fed GDPNow estimate puts Q4 growth at 4.33%.

Still, the medium-term growth projections remain robust. “The legal U.S. cannabis market size is expected to triple by 2030, reaching an estimated $75 billion in annual sales,” said Trulieve Cannabis (TCNNF) CEO Kim Rivers in her company’s third-quarter earnings call. “This impressive growth forecast does not fully include new market expansion. Only 21 states have legalized cannabis for both medical and adult use, and most of these states are located in the Northeast and the West. A majority of states have yet to legalize cannabis, leaving significant white space and catalysts ahead.”

What to Do Now

Stay fully invested ahead of potentially big news from Washington by the end of the year, meaning progress on SAFE banking. Add shares of Cronos Group (CRON), a new stock with favorable insider buying. How much? I am rescinding the limit order to buy $5,000 worth of MSOS in the $11.20 range and putting that amount into Cronos at current prices. If or when we free up cash by selling part of our MSOS trading position on SAFE banking (or other) news, I’ll consider adding more to Cronos, as a medium-term multiyear holding. For details on Cronos, see below.

Sector Performance

The New Cannabis Ventures Global Cannabis Stock Index is down 61.7% year to date, compared to a 34% decline in our portfolio.

Portfolio

Stock Updates

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. We maintained strong unit volumes across nearly all of our markets, demonstrating the defensibility of cannabis as a consumer staple.”

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 has built an incredible foundation over the past three years, and now my job is to help optimize and scale the business,” said Goubert in the earnings call.

Ayr projected operating income will grow 10% sequentially in Q4, but it declined to offer top-line guidance. 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. Ayr looks cheap with a forward price to sales ratio of 0.76. 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.”

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.

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. Medium term, management expects continued growth as seven more high-population states – New Jersey, New York, Pennsylvania, Ohio, Virginia, Florida and Maryland – transition to legal adult use. Note that the company is founder run, which can be a plus in investing. Cresco Labs has a price to sales ratio of 2.14. 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 $1.2 million worth of stock at prices up to $3.10 per share in the middle of November. This is the first insider purchase in this name since August 2020. The price-to-sales ratio is astronomical at 11, but Cronos does trade below 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 – and its price/sales ratio of 2.8 is among the highest in the group. 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 the total to 144. 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. 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), 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. 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.

Green Thumb trades at a price-to-sales ratio of 3.13, which seems reasonable given its 12% year-over-year sales growth. 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. Cantor Fitzgerald has a 12-month price target of 36. The stock currently trades in the low 13 range. BUY

Organigram (OGI): Organigram is the number three producer of cannabis in Canada with an 8.2% market share. It is number one vendor in dried flower, with its flagship brand Edison, and number three in edibles.

This company’s scorching revenue growth continued in the third quarter. Organigram reported $45.5 million in sales on November 28, an 83% increase from the same quarter the year before. It also represents 19% sequential growth. Adjusted gross margin rose to 23% from 12%, reflecting higher sales and improved efficiency. The company reported adjusted cash flow of $3.2 million, the third consecutive quarter of positive adjusted cash flow.

Cash fell to $98.6 million from $183.5 million. The lion’s share of that ($49 million) was for facility upgrades, including the expansion of its Moncton growing facility. It can now produce 85,000 kilograms of cannabis per year, up from 45,000 kilograms a year ago. The facility investments seem to be paying off since yield per plant increased 11%. Investments in automation reduced dependence on manual labor and enabled continued price competitiveness.

Organigram introduced 18 new products, and shipped $6 million worth of high margin flower to Australia and Israel. The company continues to monitor developments in the U.S. and Europe, to look for ways to angle in to those markets as legalization of recreational use evolves. It projected continued sales growth over the next year and a shift to positive cash flow, but offered no details.

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 3.37. 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 10^th-largest craft brewery in the United States. Tilray also holds convertible debt and warrants in MedMen Enterprises (MMNFF), 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 is the kind of “industry flagbearer” that could post big gains if Congress makes progress on cannabis sector banking reform, notes CIBC’s John Zamparo. Tilray is scheduled to report fourth-quarter results on January 9, 2023. The price-to-sales ratio is 3. 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. This is one of the cheaper names in our portfolio. It has a price-to-sales ratio of 2. BUY

The next Cabot SX Cannabis Advisor issue will be published on December 28, 2022.