After a miserable year for the cannabis sector, one Wall Street firm focused on the industry said investors should prepare for more of the same in 2022.
Viridian Capital Advisors, a New York financial and strategic advisory firm dedicated to the cannabis market, released a report this month outlining its predictions for the U.S. cannabis market.
Valuations will remain depressed
Cannabis stocks are cheap on 2021 and 2022 projected results and may get cheaper next year, said Viridian
Valuations for U.S. cannabis companies have compressed so much that companies are trading at an average enterprise value to sales multiple of 2.3 for 2022 and an enterprise value (EV) to EBITDA (earnings before interest, taxes, depreciation, and amortization) multiple of 8.0. This is a significant drop compared to the forward-looking multiples a year ago of 4.1x and 16.4x, respectively, said Viridian.
It blamed the price compression on a lack of institutional investment. Viridian said until this is resolved there will be few catalysts for broad- based upside.
Before there will be any significant institutional investment, federal legislation must pass giving the cannabis industry access to the U.S. banking system. Not only will banks provide capital from institutional investors, but will also accommodate trading and custody for assets. Viridian said it doesn’t expect to see such federal legislation until late 2022, possibly after the midterm elections.
Viridian expects valuations to remain compressed for at least the first three quarters of 2022. Possible reasons for this compression include concerns over slowing growth because of delays setting up of new recreational cannabis markets in New Jersey and New York, and the pricing pressure in still developing markets, such as Arizona, Illinois, Massachusetts and Michigan.
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“We expect execution on expansion initiatives will be a key factor driving returns in the near term as some companies struggle with integrating acquired assets and construction projects, in some cases due to challenges beyond their control,” Viridian said in the report.
The firm said investors should focus on two areas to find outperforming stocks: undervalued operators able to gain share by executing on growth initiatives, and likely M&A targets that can provide a short-term pop on takeout.
The stocks Viridian expects to outperform based on execution of growth initiatives include: Ayr Wellness (AYRWF), Goodness Growth Holdings (GDNSF), Harborside (HBORF), Marimed (MRMD), Jushi (JUSHF), and TILT Holdings (TLLTF). All these stocks trade on the over-the-counter market, which can be illiquid and very risky.
The firm believes the following companies could be acquisition candidates in the near term, while also having attractive growth opportunities in their own right: 4Front Ventures (FFNTF), Cansortium (CNTMF), Goodness Growth, Harborside, Lowell Farms (LOWLF) and Planet 13 Holdings (PLNHF). These also trade over-the-counter.
Viridian said, “the cheap valuations become even more compelling when considering a longer-term outlook and the upside potential as we look to the future years and what the space could be valued at when institutional investors are eventually able to invest without issue and as operators see the fruits of their on-going expansion efforts.”
Longer-term upside potential for investors
Viridian’s conservative forecast for 2023 and 2024 assumes revenues will grow 25% both years with flat margins. The firm estimates U.S. cannabis stocks will trade at EV/EBITDA multiples of 5.7x for 2023 and 4.6x for 2024.
“These multiples represent valuations commensurate with more mature industries without high growth opportunities or legislative catalysts ahead,” said Viridian. As for the conservative projection of 25% sales growth, the current consensus estimates for 2022 revenues project year-over-year growth of 58%. Meanwhile, 2023 and 2024 should see higher growth given looming launches of recreational cannabis.
The firm said given the projections of meaningful upside, “investors should be buying today even in the face of near-term pressure in order to capitalize on the reasonable two-year potential return. There are not many other sectors where investors can justify a two-year upside doubling in public companies as we can with cannabis.”
Here are Viridian’s other predictions for 2022:
1. The largest multi-state operators (MSOs) will lose share to smaller operators.
2. Industry consolidation will accelerate.
3. Significant legislative progress at the state level, including recreational use in populous states, will not matter for stock returns.
4. Declining flower pricing will continue to be a problem. However, this pressure presents opportunities for brands and service providers.
5. Software plays continue to garner mainstream institutional investment. Institutional interest represents a harbinger of what will come for plant-touching operators post banking legislation.
6. Debt will becomes cheaper for even smaller operators. Capital access will fuel growth, and mergers and acquisitions (M&A).
7. International opportunities will become a focus for U.S. operators.
8. Smart operators will hedge interstate sales opportunity.