VIRIDIAN INSIGHTS

• AN IRRATIONAL RALLY IN CANADIAN LP STOCKS?
  • The chart below shows the weekly percentage gain in the top five U.S. MSOs versus the top five Canadian LPs. There are three proximate causes for the intense rally in Canadian LPs:
    • After 18 months of study, a panel of experts analyzing Canada’s adult-use legislation rendered its report containing 54 recommendations. Some could be material, like allowing pharmacies to sell medical cannabis products and recommendations for lowering excise taxes. The market was disappointed, however, that the proposal maintained the limit of 10mg per edibles package. The recommendations are not binding, and it remains to be seen what final actions will be taken. Conclusion: this cannot be the cause for the rally
    • Germany passes legalization. The law chiefly decriminalizes personal possession, allows for home grows, and legalizes cannabis clubs. However, the law does nothing to create a legalized supply chain for the commercial production and sale of cannabis. Although these aspects will likely be brought into further legislation, Germany is treading lightly to avoid violating international treaties. Conclusion: the final passage was widely expected, and its provisions do not provide for any near-term massive boost in exports from Canada. Unlikely to be the cause of the rally.
    • Hopes of US legalization: Perhaps increased hopes of further legalization in the US raised anticipations that Canadian firms could consolidate US holdings (like CanopyUSA). However, this seems to be a rather far-fetched anticipation, and the likelihood that Canadian LPs would compete successfully against entrenched US competitors is questionable. Conclusion: It is unlikely to be the cause of the rally
    • Short covering: Short covering is a significant cause of the rally in Canopy Growth. On a fundamental basis, we still view the company as heading toward eventual insolvency and question whether its US investments will be able to save it, when and if it can benefit from their earnings.
  • Conclusion: we may have finally found where the enormous excess supply of cannabis in Canada has gone. Canadian LP investors are smoking it!

• VALUATION, LEVERAGE, AND LIQUIDITY
  • The two graphs below show the Enterprise value to 2024 EBITDA multiples against two leverage measures. In the first graph, we have calculated an Adjusted Net Debt/ 2024 EBITDA figure by adding any accrued taxes over 90 days of tax expense to debt before subtracting cash to arrive at Adjusted Net Debt. We would expect any regular company to have accrued taxes equal to their last quarterly tax expense and consider that a standard working capital item. Several companies on the chart have far greater than 90 days of accrued taxes, and we consider the excess to be debt. Verano’s excess tax liabilities equal nearly 40% of its debt. Other companies with relatively high imputed tax debt include Curaleaf (CURA: CSE) and 4Front (FFNT: CSE) at 19%, and Terrascend (TSND: TSX) at 17%.
  • The first graph shows that ten of the seventeen companies have net debt/ 2024 EBITDA over 3x, which we view as the cutoff of sustainability in a 280e world. We view 4x as sustainable in a post-280e environment, and five companies are now over that threshold.
  • The second graph looks at leverage through the lens of total liabilities to market cap. This measure separates the companies into two groups that relate to the market’s belief of whether a company can discharge its liabilities without highly dilutive actions, like discounted stock sales or refinancing debt with a heavy warrant or share consideration.
  • Companies that have too much debt but have low liabilities to market cap are candidates for stock sales or debt for equity exchanges. These companies include Cresco and TerrAscend. Alternatively, these companies may delever by using their high valuation to buy cash flow. TerrAscend spoke to this possibility on its earnings call.
  • Goodness Growth is in precisely the opposite situation. It is not as levered as Curaleaf on an adjusted Debt to EBITDA basis. Still, its stock is trading at such low multiples that the prospect of issuing equity to reduce debt seems unlikely. Goodness Growth will likely have to sell assets or sell itself to work out of its overleveraged situation.
  • Jushi, AYR, Cannabist, and 4Front appear significantly overleveraged in both an EBITDA and Market Cap sense. However, each has some element of optionality that might prove 2024 EBITDA estimates too conservative. For Jushi, it is Pennsylvania and Virginia. For AYR, it is Florida. Cannabist is in Ohio, New York, Pennsylvania, and Florida. 4Front is levered to Illinois.
  • The third graph introduces the free cash flow adjusted current ratio liquidity measure into the mix. Companies with less than 1x on this measure will likely have to raise capital next year.
  • Looking at leverage in two ways and having a comprehensive measure of liquidity can give investors a good idea of possible scenarios for today’s overleveraged companies. Companies with low valuation metrics, high EBITDA, market cap basis leverage, and low liquidity include Jushi, 4Front, AYR, and Goodness Growth. Cannabis appears to have reasonable near-term liquidity; however, it is very highly levered and trading at discounted multiples.

• • • CANNABIS STOCK LIQUIDITY FAILS TO REBOUND SIGNIFICANTLY DESPITE PRICE GAINS
      • The Days to Trade Market Cap (DTTMC) series depicts the number of days it would take to trade the market cap of a stock or group of stocks. Its most recent reading of 434 days is above the downward trend line shown on the graph. A 434 DTTMC implies that an investor who acquired a 5% position in the stock, assuming he wanted to be less than 25% of the average daily dollar volume, would require 87 days to trade out of his position.
      • The reality is that very little new institutional capital has come into the cannabis market. The investors are still the same, and many are not committing additional funds to the industry until some of the regulatory smoke clears. Will rescheduling change this? Perhaps, but not directly. Still, at the margin, the cash-flow-enhancing impacts of Schedule 3 will make cannabis more investible and attract more capital.

• • • GIVING CREDIT WHERE CREDIT IS DUE
      • negative number suggests credit deterioration, while a positive indicates improvement.
      • The blue squares show the offered-side trading yields for each company. Trading yields have declined significantly since the HHS rescheduling announcement.
      • We have made two substitutions this week. We replaced American Green (ERBB: OTC) and Blum Holdings (BLMH: OTC) with 1933 Industries (TGIF: CSE) and LEEF Brands (LEEF: CSE)
      • The rankings spread between Trulieve and Curaleaf widened again this week, with Trulieve gaining two spots to #3 and Curaleaf dropping two spots to #8
      • 4Front dropped two places to #24 due to its outlier leverage.
      • Based on this week’s rankings, Cresco’s debt appears significantly undervalued.

• THERE IS STILL CONSIDERABLE UPSIDE POTENTIAL
  • The chart below shows enterprise to next-twelve-month valuation multiples now compared to previous times when positive regulatory/legislative news hit.

• The chart demonstrates a healthy investor skepticism regarding positive regulatory/legislative events in Washington, DC.
• EV/NTM EBITDA Multiples were up sharply this week and are now 11.6% below the levels after the 5th SAFE Act passage in the House in February 2022. Still, the rescheduling news is more significant as it dramatically impacts cash flows. If valuations multiples rose to where they were after the announcement of the Schumer-Booker bill, the incremental gains would equal 102.7%. We view a DEA announcement ratifying the HHS recommendation to be much more significant than introducing the Schumer-Booker bill, which most observers viewed as DOA and had no immediate impact on operator cash flows. Accordingly, we believe there is considerably more runway for price increases, perhaps reaching the 5/7/21 multiples of 18.35x, producing 100.0% returns from current levels.