Some marijuana multistate operators have weathered the perfect storm of macroeconomic headwinds, cannabis-specific challenges and legislative disappointments better than others, as evidenced by full-year and fourth-quarter results reported this spring.
Analysts and cannabis industry executives said they underestimated the impact of a multitude of challenges in the fourth quarter, which included:
- Inflation driving up the cost of operations, many of which are business expenses that don’t qualify for tax breaks because of Section 280E of the federal tax code.
- Inflation driving down consumer spending in many state markets, causing some shoppers to forgo premium products in favor of less expensive value brands.
- Soaring interest rates, which increased the cost of raising capital.
- Falling wholesale cannabis prices driven by glutted markets.
- Lack of progress on banking reform or other key efforts at the federal level.
While most of those factors aren’t expected to shift any time soon, there’s hope that prices are stabilizing in some markets and that lobbying efforts to relieve the industry of 280E will eventually prove fruitful.
For the time being, however, at least some marijuana MSOs have proved to be more successful in confronting the financial and economic headwinds.
Jesse Redmond, managing director and head of cannabis research at Florida-based investment analyst group Water Tower Research, singled out Green Thumb Industries and MariMed for reporting strong results in spite of the headwinds.
Chicago-headquartered Green Thumb Industries reported $1 billion in revenue in 2022, a 14% increase from 2021.
Cash flow from operations was $159 million, and the company reported a net income of $12 million.
Massachusetts-based MariMed grew revenue to $134 million in 2022 from $121.5 million the previous year.
The company also reported a net income of $13.6 million, up from $7.6 million in 2021, and positive cash flow from operations for the third year in a row.
Morgan Paxhia, a co-founder and managing director of San Francisco-based Poseidon Investment Management, also flagged Green Thumb’s results for being impressive and added both TerrAscend Corp. and Ascend Wellness Holdings to his list of solid performers.
New York-based Ascend Wellness grew its net revenue to $405.9 million in 2022, a 22.1% increase over to 2021.
Ascend reported a net loss of $80.9 million in 2022 compared with $122.7 million in 2021.
TerrAscend, which has offices in California, Pennsylvania and Ontario, Canada, grew its revenue to $247.8 million in 2022, a 27.6% increase from 2021.
The company's net loss was $299.4 million in 2022 due to a non-cash impairment charge recorded against goodwill and intangibles for its Michigan business.
“You look at TerrAscend, and today they have one of the higher growth rates in the industry, and forward-looking too,” Paxhia said.
“Same thing with Ascend,” he said. “They have good growth prospects, and we are a growth industry.”
Underestimating the challenges
But among the bright spots were plenty of companies reporting lackluster results.
Analysts and cannabis industry management teams underestimated the impact of the combination of factors working against them.
Multiple analysts anticipated that banking reform would pass in the fourth quarter, which it did not.
“The analyst community has been a little late in bringing down expectations,” Redmond said, with many multistate cannabis operators reporting earnings below analyst consensuses.
“I am guilty of being too optimistic.”
Florida-based Jushi Holdings, for example, reported $76.8 million in revenue in the fourth quarter versus consensus of $77.1 million and adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $6 million versus consensus of $4.1 million, according to a report by Canada-based ATB Capital Markets stock analyst Kenric Tyghe.
Chicago-based Cresco Labs also missed consensus estimates, “primarily due to much weaker than expected margins and EBITDA,” analyst Andrew Semple wrote in a report for California-headquartered Echelon Partners.
In addition, management teams underestimated the impact of macroeconomic headwinds and the lack of federal cannabis reform.
According to Ernst & Young's Cannabis CEO Survey - which asked chief executives of U.S. and Canadian marijuana companies to reflect on 2022 and make predictions for 2023 - 51.5% of respondents said their business strategies performed below expectations.
While 69.7% of respondents said their companies performed in line with expectations from a top-line perspective, 57.6% of respondents said they performed behind what they planned to from a bottom-line perspective.
Price compression, competition and regulatory complexity were the top three reasons cited.
“All of this had a negative impact on performance and profitability,” the EY report noted.
All eyes on free cash flow
EBITDA is losing ground to free cash flow, or operating cash flow, as a reliable metric to gauge a cannabis company’s progress, Redmond said.
On SeekingAlpha’s Cannabis Investing Podcast on March 29, Jerry Derevyanny, a partner at Los Angeles-based venture capital firm Bengal Capital, said EBITDA is a “dangerous number in cannabis.”
For one, EBITDA is misleading for cannabis companies that are deferring their tax payments to the IRS because they reason that “borrowing” that money comes at a lower cost than borrowing from lenders, Derevyanny said.
There are also maintenance capital expenditures on cannabis real estate, he said.
“These facilities, especially some of the first-gen facilities, are going to start to see, I think, major retrofits in the coming years, and some of them honestly might need to be shelved completely and be written off, like some of the facilities in Canada,” he said.
EBITDA also glosses over the cost of capital, he said, which can be even more material in cannabis.
Among the top five multistate cannabis operators, Redmond said, only Green Thumb Industries generated tax-adjusted operational cash flow of $154 million.
MariMed reported $12.3 million in tax-adjusted operational cash flow.
On the other end of the spectrum, New York-based multistate operator Columbia Care reported minus $119 million in tax-adjusted operational cash flow, he said.
‘Bad M&A’ takes a toll
Mergers and acquisitions slowed in 2022, and the size of transactions also decreased.
M&A in 2021 was characterized by megadeals, such as Florida-based MSO Trulieve Cannabis' acquisition of Arizona-headquartered Harvest Health & Recreation, which was initially valued at about $2.1 billion.
Paxhia called that price an overly high amount.
“I think Trulieve is a poster child for a bad M&A deal,” Paxhia said.
Now, he said, the company is struggling to cut costs and grow its core business.
On the company's fourth-quarter and full-year earnings call on March 8, CEO Kim Rivers noted the unfavorable "timing" of the acquisition.
"The timing of this major expansion at Trulieve coincided with a reversal in favorable economic trends brought about by the unwinding of COVID-related tailwind and a decades-long period of global excess liquidity," she said.
"The goal of 2022 was to digest and integrate Harvest, while transforming the company into a scaled multistate operator."
But Trulieve is hardly alone.
The industry has had a disproportionate number of bad M&A deals, according to Paxhia.
Redmond estimates that capital expenditures among the top five Tier 1 cannabis MSOs have decreased by about 60% in the past year, and he expects that trend to continue across the board in 2023.
Florida-based Ayr Wellness, for example, canceled its acquisition of Chicago-based retailer Dispensary 33 in January.
“You can't just magically turn on more revenues, unfortunately,” Redmond said. “And so, it's easier to cut costs.”
Small signs of relief
If recreational cannabis were legalized in Florida, an initiative Trulieve is financially backing, the company is well-positioned to capitalize on the influx of both local and tourist dollars, Redmond said.
Prices are also showing signs of stability in some markets, such as California, Michigan and Oregon, he said.
In California, prices have rebounded in part because more than 800 cultivators have let their licenses expire rather than renew them, he said.
Maryland’s adult-use market, which is scheduled to launch in July, will also be beneficial to the multistate operators that are already set up in the medical market.
But what will really move the needle is federal reform.
"280E has got to go," Paxhia said, pointing to the punitive federal tax code.
Allowing cannabis companies to deduct business expenses would be beneficial to all in the industry, he said, not just multistate operators.
"If you want to do things that are bullish for small companies in cannabis, you've got to get rid of 280E," Paxhia said.
"It is just sucking the cash out of these things."
Kate Robertson can be reached at email@example.com.