In the past twenty months Seeking Alpha has published 28 of my articles on cannabis companies. Those articles have generally criticized the largest Canadian companies and their investment bankers for fleecing investors out of billions of dollars. I have also been extremely critical of cannabis companies dubbed multi-state-operators, MSOs, who pride themselves by operating in more than one state in the United States. This article reinforces my previously expressed views by presenting additional information.
Reallocation Recommendation
In a timely Seeking Alpha article titled “It’s Time For Buried Investors To Reallocate,” which was published on June 24, 2020, I stated it was time for buried investors to dump their Canada centric cannabis companies and buy Liberty Health Sciences (OTCQX:LHSIF) and Trulieve (OTCQX:TCNNF). Liberty and Trulieve were the only cannabis companies I recommended investors purchase.
I quickly withdrew my strong Liberty recommendation on June 29th via a Seeking Alpha article titled “A Liberty Health Update.” My sudden change from being wildly optimistic to being lukewarm about Liberty was attributable to the fact that I attended the grand opening of a much touted new dispensary and found I was the only customer. For reference, LHSIF closed at $0.360 on June 24 and $0.367 on June 29, so I did no harm to those who bought on my early recommendation then sold out when I revealed my lost enthusiasm. I personally liquidated most of my position, but I still own Liberty with lowered expectations.
From June 24 to August 14 an index composed of the five largest Canada centric cannabis company stocks declined by 8.0%. Aurora Cannabis (ACB) declined by 21.8% followed by Cronos (CRON) at 11.8%, and Tilray (TLRY) at 11.0%; while, Aphria (APHA) rose by 4.9% and Canopy Growth rose by 2.9%.
During the same span of time Trulieve rose by 103.6%. Obviously, the recommendation to make the switch was a good one.
MSOs’ Stock Performance
I continue to believe that investors are hopelessly buried in the above five Canada centric cannabis companies and they need to take their losses and reallocate the proceeds. At the same time, however, I do not share the growing belief that MSOs generally offer significant investment opportunities. In fact, I believe many of the MSOs are on their deathbeds.
Unlike Canada centric companies, most MSOs have enjoyed significant increases in their share prices since mid year. Since June 30 Trulieve has risen 99.5%, Green Thumb (OTCQX:GTBIF) 60.1%, Harvest Health & Recreation (OTCQX:HRVSF) 53.3%, Curaleaf (OTCPK:CURLF) 49.2%, Columbia Care (OTCQX:CCHWF) 44.5%, Acreage Holdings (OTCQX:ACRGF) 22.3%, and Liberty Health (OTCQX:LHSIF) 14.3%. MedMen has been the exception and its share price has actually fallen 26.1% since mid year.
MSO ETF?
This week there was a rumor that an MSO ETF was soon going to be offered. In my opinion, such an instrument ought to carry a skull and cross bones on its prospectus, since it is bound to include companies that are in the late stages of collapsing. Furthermore, MSOs are thinly traded on the OTC in the USA and on the CSE in Canada; therefore, an ETF would significantly increase volatility in the MSO sector. Trulieve accounts for the largest average daily trading volume at $3.69 million followed by Green Thumb at $3.65 million, and Curaleaf at $3.54 million. The other MSOs have average daily trading volume amounting to less that $1 million.
Many investors are attracted to ETFs, because they believe who believe a portfolio of MSO companies protects them because of inherent diversification are badly mistaken. In that regard they might want to heed the advice of the legendary Warren Buffett who has stated, “Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing.” I expect that price increases being observed for many MSO stocks will turn out to be dead cat bounces.
Benefit of Concentrating on One State
My research strongly suggests that of the aforementioned cannabis companies Liberty and Trulieve merit the most investor consideration; and, at this moment Trulieve is by far the best choice. In studying all the MSOs it became apparent that the MSO model is a seriously flawed economic model.
The reason Trulieve and Liberty standout is that they are vertically integrated seed-to-sale companies that operate cultivation facilities only in Florida. That will change once Trulieve opens its 100,000 square foot cultivation facility in Massachusetts, which is the maximum allowed in that state.
Trulieve has achieved economies of scale as a result of having 1.8 million square feet of cultivation around Quincy, Florida capable of producing 74,000 kgs which are processed and distributed to 56 dispensaries in Florida. It also delivers products to the 344,293 customers in its database via a fleet of 200+ vehicles. These numbers dwarf any of its competitors in Florida and provide obvious advantages.
If Trulieve operated at 100% of its capacity in Florida it would produce gross revenue of $621.6 million based on its reported average sale price of $8.40. Trulieve plans to end 2020 with 1.9 million square feet of cultivation and that extrapolates to a maximum revenue of $656 million in Florida alone compared to its guidance of $465-485 million for 2020.
The size of Trulieve’s Florida operation is unmatched in the United States. Its size provides economies of scale not possible in Massachusetts where its cultivation will yield only about 4,111 kgs. Furthermore, Trulieve is limited to operating only three medical marijuana and three recreational dispensaries in that state. If its Florida sales price is applied to Massachusetts and Trulieve retails all its possible production, then it will generate $34.5 million per year in revenue. Such an amount would be 7.3% of the $475 million mid-point of Trulieve’s revenue guidance for 2020, so Massachusetts should not be expected to provide a significant earnings boost in 2021 when it is supposed to become fully operational.
Measuring Economies of Scale
Other things being equal, the most efficient companies should have greater profit margins and lower operating costs per dollar of revenue. The following Exhibit has been prepared using data obtained from the most recent audited annual reports and is designed to shed light on the subject of economies of scale.
Six well-known, true MSOs with operations spread over many states are shown along with Trulieve, Liberty and Planet 13. Trulieve and Liberty are Florida centric operators and are included as examples of non-MSOs. Liberty is only in Florida and Trulieve is not yet a full-blown MSO. Planet 13 was included to get a sense of what pure retail margins are like in the cannabis business.
The above exhibit shows that Trulieve and Liberty gross profit margin percentages of 64.5% and 60.3%, respectively, were significantly above all the other companies. It also shows that the other expenses of Trulieve and Liberty amounted to smaller percentages of revenue. For their most recently reported quarters Trulieve had an incredible gross profit margin of 75.9%, while Liberty had 58.0%. The vast majority of SKUs sold by Trulieve are its own branded products, while Liberty has favored selling others branded products. As a result, Liberty has much higher royalty payments to make and that raises its cost of goods sold and lowers its gross profit margins.
This exhibit shows clearly that MedMen, Acreage Holdings, Columbia Care, and Harvest Health are at the bottom of the barrel as shown by their paltry gross profit margin percentages and the fact that their operating expenses alone exceed their revenue. These companies sorely need a financial ventilator!
It is worthwhile to take a closer look at Curaleaf and Green Thumb. Curaleaf shows a respectable gross profit margin of 53.8% and operating expenses equal to 69.1% of revenue; while Green Thumb shows a gross profit margin of 49.4% and operating expenses of 62.2% of revenue. For their most recently reported quarters Curaleaf had a gross profit margin of 54.3%, while Green Thumb had a 53.2%. While these numbers pale compared to Trulieve and Liberty, they do indicate that Curaleaf and Green Thumb are not hopeless.
Interestingly, Planet 13 has a 57.5% gross profit margin and operating expenses of 54.2% of revenue. These are impressive numbers for a pure retailer.
Conclusion
Without question, at the present time Trulieve is the most efficient of the publicly traded cannabis companies operating in the United States as measured by its gross profit margin percentage and its operating expenses as a percentage of revenue. Liberty Health Sciences is a distant second among the cannabis companies reviewed in this article.
The fact that these two companies are the most efficient as measured by these metrics clearly illustrates the existence of economies of scale that favor companies focused on a single state such as Florida that does not restrict growth. This article has demonstrated that cannabis companies which are laser focused on one state are more efficient and therefore more profitable than MSOs. If Trulieve implements its plan to expand into other states, investors should expect its gross profit margin percentage and operating expenses as a percentage of revenue to decline.
Disclosure: I am/we are long LHSIF, TCNNF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
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