Cannabis on Wall Street: Fundamentals Matter with Federal Legalization on Hold
By Tom Adams
CEO, Global Go Analytics
The cannabis industry’s multi-state operators (MSOs) wrapped up second-quarter earnings season at the end of August with most of their stocks none the worse for wear. Slowing growth prompted many downward revisions in earnings forecasts by Wall St. analysts. Yet New Cannabis Venture’s American Cannabis Stock Index posted a 27% gain through August 31 from its year-to-date low on June 30.
Investors appear to be waking up to the fact that, after a year-long reset of their stock prices, the MSOs are no longer overvalued “story stocks” with values that should be tied mainly to the prospects for federal legalization. Instead, traditional fundamentals like growth and margins are starting to matter more to investors than a federal legalization narrative that is increasingly irrelevant to MSO prospects in the consumer marketplace.
How MSO Trading Multiples Compare
A Global Go Analytics study of MSO revenue and market caps shows the top 10 MSOs to be trading at 2.2x annualized 2Q ’22 revenue. That’s cheap compared to the price/sales ratios of companies operating in comparable sectors of the economy, particularly compared to tobacco, alcohol, and drug companies that recently trade above 4x sales.
Of course, alcohol, tobacco and drug companies are consumer products companies not retailers. Stocks in other specialty retail sectors trade at just 0.9x sales and retail distributors at 1.4x sales. Retailers and wholesalers traditionally trade at lower multiples than branded product companies given the competitive and thin-margin nature of their businesses. That’s the reason some of the MSOs are positioning themselves as brand marketers, only operating retail stores while required to by vertical integration rules and to familiarize consumers with their brands. Others are keeping their focus on retail as wholesale margins shrink, particularly on flower products, in rapidly maturing adult-use markets.
Both models have worked in other product categories. There are plenty of successful companies selling their own branded products out of their own stores and being valued well above typical specialty retailers: Starbucks trades at 3x its $32 billion trailing twelve-month revenue, Nike at 3.6x, and McDonald’s at 8x.
Why Cannabis Companies are Different
None of those highly valued household names operate in sectors looking ahead to a decade or more of double-digit growth in their Total Available Market (TAM) as the MSOs are. US legal cannabis companies have the fundamental tailwind of superior market growth filling their sails no matter what happens in Washington. Even with federal legalization unlikely through at least 2024, the MSO’s TAM is nearly certain to grow robustly, while the individual companies are also likely to grow their Serviceable Addressable Markets (SAM) as they enter new states, and their Serviceable Obtainable Market (SOM) as they roll-up smaller competitors.
Right now, the top 10 MSOs are doing run-rate revenue of $7 billion (2Q ’22 revenue annualized), and their combined $15.2-billion market capitalization means they are trading at a 2.2x price/sales ratio. As a group they have a retail presence in 28 states with a shared SAM of $26.7 billion in ’22 consumer spending according to the Brightfield Group. Their market shares as a percent of their individual SAMs range from 2% to 6%, a measure of success limited by the inclusion in several of their SAM calculations of the massive California market (only five of the MSOs have a handful of stores each there; in contrast, nine of the top 10 MSOs are in Massachusetts, eight have stores in Pennsylvania or New Jersey, and seven are in Illinois).
Their individual-state market shares vary from trivial in California to Trulieve’s commanding 51% share in Florida. The companies don’t disclose enough financial detail to allow a true state-by-state revenue forecast. So, in order to assess how Wall St. values them in light of the fundamental growth in their markets we calculated that the ’25 revenue of the ten companies could reach $12 billion if they continue to build and acquire their way to a uniform 5% market share across their states. Against that forecasted share, the MSOs traded on September 1 at just 1.3x their potential ’25 revenue (see table); at an assumed 10% market share, their current price/third-year sales ratio would be just 0.6X.
Price/Sales Ratios Diverge Among MSO
With investors getting over their single-minded focus on federal legalization, individual MSO price/sales ratios have diverged. Their price/current sales ratios range from 0.3x to 3.3x, and their price/third-year sales ratios (at the assumed 5% market share) range from 0.1x to 2.8x. For now, investors appear to favor size and geographic reach, with Curaleaf commanding a premium multiple with its licenses in 19 states and $1.4 billion in annualized 2Q revenue.
As federal regulation recedes in importance, state regulatory regimes are becoming of paramount importance in understanding the varying prospects of the MSOs, and every other US cannabis company for that matter. The common assumption that the best prospects for growth and profitability lie in limited license medical states is now an open question, as growth slows in many such states and state regulators make the adult-use pay-off less certain (see our “New York cannabis regulators aim to level the playing field for operators,” 7/12/22).
Hence, we’re seeing the strategies of the MSOs diverge just as investors are circling back to take another look at the sector now that irrational exuberance about imminent federal legalization has been wrung out of their stocks. Investors’ calm reaction to less-than-stellar 2Q reports suggests a more rational relationship lies ahead for cannabis companies and Wall St.
Global Go has created a map-based clearing house of information on the licensing and regulatory status of each US state, to which we’ll be linking all our future email newsletter coverage of new licensing opportunities, changes to regulatory regimes, and analysis of the impact those licensing/regulatory changes are likely to have on the companies operating in those markets. Click here to sign up to receive the newsletter.