We’re here in early October folks—time to start thinking about tax loss buys. That’s where investors cut their losses on stocks they didn’t think performed, often sending them down to bargain level pricing.
I would argue American Multi-State Operators (MSOs) cannabis stocks look like a great tax loss buy already. Here is a sun-rise industry (as opposed to sunset—dying industries) growing at 50% plus a year, with positive EBITDA and further growth being extrapolated out to the end of this decade.
After a brutal six months in the market these MSO stocks currently offer a good combination for investors.
1—They are incredibly cheap
2––They are growing incredibly fast and PROFITABLY
These stocks had a huge run on Democratic US President Biden’s victory and optimism of federal legalization. Since then, the hoped-for regulatory change to full cannabis legalization has not happened—which has cratered the stocks. But the businesses have flourished, growing incredibly fast.
Now folks, let me be clear—without full US legality, trading multiples here can stay really low. But with many of them growing so fast, the stocks can now move up with their cash flow growth. It’s a very cheap call on US legality.
The chart below clearly shows how much of an outlier the MSOs now are on a growth to valuation basis——and this chart was prepared a couple of months ago before MSO valuations declined further.
The sales and EBITDA growth rates are just incredible. If these were tech stocks these companies would be trading at 50 times EBITDA——instead most of them are now trading on single digit 2022 EBITDA estimates.
The MSOs are valued like dying newspaper businesses but are growing like Amazon in its early days.
“From a fundamental business standpoint, the space has never been better,” says Gage Cannabis (GAGE-CSE) CEO Fabian Monaco. Gage is building a cannabis franchise in Michigan, and was just bought out by Jason Wild’s Terrascend (TER-CSE).
“The companies have never been better. Our record over record quarter growth, and yet, it’s being punished from just a regulatory standpoint; by the fact that some sort of legalization did not appear as quickly as people anticipated.”
Here is a look at how fast this group has grown in 2021:
The legal cannabis industry in the United States is expected to have sales of $25 billion this year. Meanwhile cannabis sales in the entire country (both legal and illegal) is more like $85 billion.
US brokerage firm Stifel estimates the North American regulated category grew 45% in 2020, and they suggest the U.S. state licensed market will grow to nearly $35 billion in 2023 sales—a 21% CAGR.
“The margins are getting better,” says Monaco. “And the product is getting better. There’s a more reasonable cost of capital available to these companies so they can scale up.” He pointed to two new large debt deals by Trulieve (TRUL-CSE) and Green Thumb Industries (GTI-NASD) in the eight percent range as proof.
So, where is the catch? And of course you are right……there is one. More than one actually and they are BIG ISSUES.
First—while legal in many states (with many more to join soon) cannabis is still illegal at the federal level in the United States…and that is A Big Problem.
Specifically, what that federal illegality means is that all U.S. MSOs are subject to the 280E tax rule. In short, Section 280E disallows companies that engage in illegal activities to deduct operating expenses (like building cost, salary expense, advertising) from their taxable income.
That means that MSOs are taxed on the gross (not net profits) and therefore have tax rates that are astronomical relative to their true bottom line——in some cases more than 100% of net income!!!
It also means that while these companies are incredibly cheap relative to EBITDA, they aren’t cheap at all relative to after tax earnings because the huge income tax hit eats up those earnings.
Second—these companies can’t list in the United States and because of their federal illegality many institutions are unable/unwilling to own them. That means that the only people really buying these stocks are retail investors who have to buy them on the Canadian exchange or over the counter.
Therefore, there is basically no institutional money involved here and as long as this business is illegal federally that is going to put a cap on stock valuations.
Third—large banks have restricted their clients from trading shares of these companies because they are involved in the federally illegal business of touching marijuana plants.
Also, the big banks don’t cover the MSO stocks so there is very limited sell-side involvement in this industry——currently all of the mega-cap US banks do not cover a single MSO operator.
Fourth––these incredibly fast growing and state legal businesses are desperately underserved operationally by banks who can be punished federally under anti-money laundering laws for providing services to federally illegal businesses.
They are locked out of the federal banking system. Currently these companies deal in cash because they can’t get credit card processing and incur huge extra security and logistical challenges.
But Are These Problems Or Just Future Catalysts?
The problems are big–really big.
But are they really problems? Or are they just massive future catalysts waiting to happen?
The reality is that society now overwhelmingly supports full legalization of marijuana.
Support for legalization is at 70% and climbing. The only holdouts are seniors so the simple passage of time will keep this chart moving up and to the right.
It seems very likely to me that all of those problems listed above are going to disappear one by one…….and as they do, they are going to be huge catalysts for this sector.
To me the only question is when those catalysts come…..SAFE Banking Act, 280E removal, and eventually Federal legalization.
The SAFE Banking Act was just passed for the fifth time by Congress and is going to be taking another crack at getting through the Senate.
I would actually even suggest that the longer cannabis remains federally illegal the better for the big MSOs.
Currently these are the only companies that can access capital at reasonable rates and have a huge advantage now to go out and lock down a massive market share before 280E is removed, institutional capital can flow more freely into the sector and more competition (like big tobacco) arrives.
By the time these problems are removed the handful of big MSOs could already own the entire massive cannabis market.
If I could sum up my thesis as MSOs as top tax loss buys, what I would say is this:
This is the perfect kind of investment for a patient investor. Really the only thing that you need to do is be patient.
These stocks are trading at single digit multiples, but growing EBITDA at 40% plus year on year——with years of quite certain growth.
Even if the multiples don’t expand you still get 40% year on year growth.
But then one day some sort of SAFE banking, 280E relief or legalization happens and those multiples blow out 4 times on top of that 40% annualized EBITDA growth.
That could mean a triple/quadruple on multiple expansion plus 40% per year growth rates!
The one I’m looking at closely is Terrascend—for a few reasons. Most importantly, they have a huge net cash position—US$187 million post the Gage takeover–in a market where most players have net debt. If all the in-the-money options and warrants come in—just at today’s stock price—that equals cash of over US$500 million.
Second, they have operations in Maryland, Pennsylvania, New Jersey and Michigan—four of the Top 8 markets in the USA. You can expect more from me on this as we get closer to year end.
But there is still one caveat, being—you just need to be willing to wait for potentially a very long time——which is not exactly my personal area of strength.
DISCLOSURE–GAGE CANNABIS has been a paying client of the OGIB Corporate Bulletin in the last 12 months