Chart of the Week
The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from that week’s Deal Tracker that we believe are impactful for investors, companies and acquirers.
Viridian Capital Chart of the Week: Are Other Factors Besides Federal Illegality Keeping Institutional Investors Away?
- Cannabis companies have made progress in profitability over the years. All of the companies on the chart, except AYR Wellness (AYR.A: CSE), have positive consensus estimates for 2025 operating income. But are the companies profitable enough to cover their cost of capital?
- Viridian calculated projected 2025 ROIC (Return on Invested Capital) for each of the fourteen companies on the chart by first calculating NOPAT (Net Operating Profit After Tax) by taking consensus estimates of 2025 Operating Income and tax effecting them using a 25% tax rate, assuming that 280e will be resolved in time for 2025 taxes. We then divided NOPAT by Invested Capital (Book Equity plus Debt minus Cash. The resulting ROIC is depicted by the blue line on the graph. We also used the same procedure, substituting the market value of equity for book value, and the orange line depicts that value.
- The ROICs range from 19.5% for Jushi (JUSH: CSE) to -0.7% for AYR (AYR.A: CSE). Companies where the blue line is above the orange line, including JUSH, GLASF, and GTII, have stocks that are trading above book value. Conversely, companies where the orange line is above the blue line, including SHWZ, VRNO, and VEXT, are trading at discounts to book value.
- Financial theory tells us that if a company’s ROIC is greater than its weighted average cost of capital (WACC), then it creates value for its owners. But, if ROIC < WACC, then value is being destroyed.
- The table below the chart does some indicative WACC calculations based on Unlevered Betas and Debt/Market Value of hypothetical value of firms. Our procedure was first to calculate levered betas using the unlevered betas and Debt/Mkt Values. We used these levered betas in the Capital Asset Pricing Model to calculate the required returns on equity. We then used the following assumptions in the Capital Asset Pricing Model (CAPM):
- Risk-free rate 4.25%
- Market risk premium 5.75%
- Tax rate 25%
- For pre-tax debt rates, we used values between 10% and 18%, depending on the Debt/Mkt Value.
- The conclusion we reach is that most cannabis companies on the chart have ROIC < WACC.
- It’s not just the high tax rates or federal illegality that keeps institutional investors out of cannabis. An equally important but little-recognized factor is that most of the companies are not profitable enough to cover their cost of capital.
- The added complexity and duplicated operations of managing under multiple different state regimes weigh heavily on ROIC, reducing the attractiveness of cannabis investment.
