I’d recently begun – and belayed – a couple of Structures in the Tier 3’s. I found that there simply isn’t much to say.

Many cannabis sector companies maintain SG&A that remains persistent; margins relatively static; and incremental deals and financing remain expensive relative to asset depth. When we look at an outfit, we look for catalysts and changes in operations that show improvements in profitability, or, for changes in capital structure that will bring impact to their cost of capital.

Next week is another earnings week. GoBlue and I are absolutely pinned during them, and next week promises to be full.

TheCannalysts have noted a reduction in revenue velocity in some outfits, and we expect incremental asset additions will eventually hit the Law of Diminishing Returns at some point. Sell-side barkers will say that that’s years off; they’ll say that total addressable market is gonna be HUGE; that saturation is nothing to worry about (again, years away).

Fair enough, there could some truth in that. But what isn’t said is the assumption behind this. The primary being is that US Federal legalization/decriminalization will leave the sector in exactly the same position as it is now.

We believe such an assumption is naive at best…..and high risk folly at worst.

And we’re looking at it to see the ultimate impact on current asset values. The #MSOGang has conviction that there’s much more upside in MSOs. Another might muse whether or not asset values are already hot due to expectations that have baked in that primary assumption.

The sideways chop we saw way back in January of 2018 in the Canadian markets has been seen in price action across most MSO’s since NY’s announcement took the polish off of the apple. What was supposed to be a growth catalyst turned into a chaperone at a party, making sure the punch wasn’t spiked…and turning off the music at midnight.

As the market seems determined to wait out regulatory uncertainty (and throw a tantrum over a standalone SAFE), I want to summarize TheCannalysts thinking about the ‘before’ & ‘after’ once cannabis becomes federally tolerated.

Catalysts

1. The End of Verticality (via 3-Tier or excise)
2. Dormant Commerce Clause (DCC) (regional price bubbles popping)
3. Social Justice Initiatives
4. New IPOs and entrants

GoBlue presented an excellent example of the impact on gross margins (GM) that losing verticality would bring, using numbers in the best State enforced verticality of them all: Florida. Net result: lower GM.

I’ve written about the DCC, and its’ potential impact upon basis differentials. Net result: lower aggregate revenue.

Social justice….well….if you have a Magic 8-ball….it’ll probably help as much as trying to predict what may result. TheCannalysts have mused if the impact might be confined to a segment (Retail? Delivery? Small Scale Production?). We’ll update as we can.

I’ve added another: New Entrants. #1 and #2 above are enough to convince me that should they come about, current MSO profitability will be impacted. Both of these items have protected 50%+ margins (and absolutely locking down $TRUL’s 70%+). GoBlue called these margins ‘bubble wrapped‘. I see no reason – given the size of the US market – that there would not be an inrush of business both small and large – willing to enter a space that has regulatory certainty. If one accepts that MSOs benefit from a relatively small pool of competition (I posit they do), then an inrush of such will alter their competitive ‘advantage’ due to price compression, but ultimately compete for the same size market.

Outcome

So. Current asset valuation – a large elephant in a small room. There would be no better value we could provide than giving you a home run, and being able to pick off running antelope at 500 yards. That’s what looking at MSOs feels to me right now. And the market is suggesting similar.

Your view should turn on whether you see current valuation based upon the here and now, or, to what extent the catalysts have been priced in. Prices look to be a tentative wait and see. Are they currently discounted, ready to accommodate all of the catalysts coming about? Are they overheated? Are they underpriced?

I did a bog standard valuation of Planet 13’s ($PLTH) assets from their first quarter of this year. I got a share price value of $3. Despite its’ lofty high of $10.37, its’ now at $6.80:

I care about the core value (cashflows) within underlying assets, and what the ‘floor’ value of what the asset held is worth. Everything else is expectation/emotion…all kinds of things. The method is not looking at upside, it’s looking for what the ultimate downside is.

If one accepts that, then one could assume that there’s a fair bit of future growth currently priced in. We looked at relative valuations in MSO’s a couple of months ago – expect some surprises next time around. And look to Blue’s MSO Roundup for the operational information that’s the engine under the hood.

One way or the other, I think that assuming that things will remain the same from the right ‘now’ to that future ‘then’ – during a period of wider (and formal) industry initiation – is a bad idea for your portfolio. And I highly doubt share prices will line up with the moment that regulatory change is enacted.

Share price is the sum total of all future expectations. Should a fundamental catalyst move from the unknown to the known, those prices will change overnight. I think the prospect alone has already changed their behaviour.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds no position in $PLTH.