Cannabis Investors, Fake It Till You Make It (Transcript)

Editors’ Note: This is the transcript version of the podcast we posted last Wednesday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast embedded below, if you need any clarification. Enjoy!

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Rena Sherbill: Hi, again, everybody. Welcome back to the show. It’s great to have you listening with us. Super happy to bring you today’s episode. Following up on 4:20 a great cannabis investing talk with one of our favorites Julian Lin, who writes for Seeking Alpha who runs two marketplace services there which are subscription services.

One very applicable is the Cannabis Growth Portfolio and the other is called Best of Breed, Julian’s high conviction ideas spanning different sectors aside from cannabis. We talked about earnings and the growth deceleration that we’ve seen. We talk about the Cresco (OTCQX:CRLBF)/Columbia Care (OTCQX:CCHWF) deal and consolidation in the sector.

We talk about cannabis REITs. A great take on cannabis REITs from Julian we talk in particular about NYSE:IIPR, one of the most popular cannabis REITs. And NewLake Capital (OTCQX:NLCP) one of the newer entrants into the space. We talked with NewLake Capital on CEO Interviews as well. So, if you want some background on that stock, it’s a great talk on CEO Interviews, the show we have on Seeking Alpha.

I hope you enjoy the talk with Julian today. As always, it’s great to have him on talking cannabis. Hope you enjoy it. Julian, welcome back to the cannabis investing podcast, it’s always great to talk to you always great to get your thoughts. So, thanks for coming back on the show.

Julian Lin: Yes, it’s always great to be on.

RS: It’s always great to have you and it’s especially great to have you on now with people are looking at earnings, people are looking at delayed legislation, people are looking at investors feeling the brunt of this bear market in the sector. And wondering if there’s light at the end of the tunnel or when that light is going to appear.

So, I’d love to get your thoughts just like initially, your kind of take on recent earnings, and maybe the sector in general, where your thoughts are right now?

JL: Absolutely, I think, definitely when you hear about the notion that investor sentiment follows the stock price, I think the cannabis sector shows us very clearly. Right now, the stocks keep going lower and lower, I mean, they were cheap, cheap at the highs, and then how they just keep getting cheaper.

And at these points, you start to see how investors are reacting to earnings results or reaction to delayed legislation. I think those reactions are largely driven by the stock price action. From earnings, what we’ve seen from a lot of the companies is a lot of a big slowdown in growth. Except for a couple of companies, which had a lot of assets that were just coming online, or they had some easy comparable in their previous quarters or for example, Trulieve had acquired harvest.

So, obviously their growth numbers are going to look much better, because they’re kind of lapping numbers where they didn’t have harvests. Most companies if you didn’t have anything special like that, saw their growth slow or even saw their growth decline sequentially from the third quarter to the fourth quarter.

And that could be given where stock prices are they’re really low, you start seeing growth decline, you start wondering. I mean, it’s only human, you start wondering, oh, maybe the stocks are supposed to have declined, maybe I was wrong, maybe this growth story is over. I think it’s important to try to avoid letting the stock sentiments or avoid letting the stock price drive your sentiment or drive your evaluation of the fair values.

It’s important to remember that these kinds of earnings volatility is extremely normal. And in fact, they should be expected. Because so I mean, we just got to sit back and think high level of how the cannabis business model works in terms of where the growth is coming from? Much of the growth right now is going to come when do states come online. That’s a big, big growth driver.

Or another growth driver is when you’ve invested a lot of money in building out new cultivation are building up new dispensaries and those come online for an individual company. These are the primary growth drivers. The issue here is that in if you don’t have any of those present, then what’s going on is we have to accept the reality that even though cannabis might be legalized in a state like I mean, California has been legalized recreationally for many years.

But even when it legalizes recreationally, that doesn’t mean it’s broadly accepted by society. All that means is that cannabis is suddenly legal for everyone to bite if they wanted to, but that everyone does not refer to that does not really refer to everyone. It’s not like the average person sees cannabis is legalized in Arizona and they’re like, oh, I’m going to go try cannabis now.

That’s just not the case. I mean, anyone who uses Cannabis, we might think that that’s a reasonable conclusion. It’s reasonable for someone to want to go try cannabis because it’s amazing. It’s great recreationally has all these medicinal benefits. But the average person is not enlightened, the average person does not care, the average person still thinks cannabis is dangerous.

In fact, I wouldn’t be surprised if even in like states like Arizona or states, like New Jersey just came online where adult use sales just happened? I wouldn’t be surprised if there’s so many people who are wondering if cannabis should have been legalized. Or like, oh, this was a mistake, it shouldn’t be legalized. It’s just, this is just a monograph on politics.

The reason I bring this up is because so when a state like New Jersey or Arizona comes online, everyone could buy it. But that really only refers to the people in general who were already buying cannabis. That is the main growth there is going to be shifting from the illicit market to the legal market. There is going to be some growth in the overall market just because when it’s legal, more people are willing to try it.

But that’s, that’s more of a slower conversion, right. Even in states where cannabis has been legalized, the adult usage is still around 80% or 20%. That’s extremely low. When you consider cannabis is something that has no hangover. It could be it could address I mean; it could be a substitute for alcohol, it could be used for anxiety, sleep. It’s the kind of thing that you would expect to be used in almost every single household.

I mean, just for reference alcohol. I think the average uses around like 60-70% of people who use it every month. And that’s something that doesn’t really have any medicinal use. And it’s, I mean, it’s, I mean, it’s not for me, but a lot of people like if recreational use, but arguably cannabis doesn’t really. It competes very favorably against alcohol.

So, you could definitely see cannabis eventually reaching this the same or better adoption than alcohol, which is at 70% and cannabis is at 20%. But right now, there’s no clear reason why that switch will happen, right. There needs to be a certain event that causes the average person to be okay with cannabis. But we haven’t reached that point yet. And because we haven’t reached that point yet. We’re just working with a really small market, a really small legal market.

RS: So let me ask you this because investors are looking at the cannabis sector. And well, I think many are looking at the cannabis sector and wondering why anybody’s invested in it. And to your point I would agree and I think many people listening to this podcast would agree that we haven’t reached, even close to saturation in the cannabis market in terms of like popular culture and widespread use.

But would, I think investors could also ask the question, well, so I’m going to wait until we get closer to that point to be invested in these stocks. Because right now, nothing’s really happening. And even states going online, isn’t really making a dent in terms of valuation. It’s really like, these big-ticket events or catalysts that happen that that will catalyze the industry.

So, what do you say to somebody that says it’s worth waiting until we get closer to that point?

JL: That’s a great question. And there’s many, many good parts in that question. I like to answer. I liked how you brought up saturation, because right now, a lot of people, investors might believe that saturation is happening. And that’s the driver of why price compression might happen or margins are contracting or growth is slowing down.

And again, it is true that in legal markets, it is saturating when you’re competing against only the 20% population that actually cares about cannabis. But longer, longer term, it’s still not reaching saturation, even though you’re not going to experience the benefits of that until much later. In regards to — and further you also mentioned how a lot of people don’t want to be buying cannabis stocks.

I think that made me remember recently there was a short report on innovative industrial properties. That’s IIPR. Very interesting, short report. And at one of the things, they discussed one of the points why they were not very bullish, or they’re rather bearish IIPR was because they said the tenants are not doing well.

They said the tenants especially Green Thumb Industries truly clearly, they have seen their free cash flows go to negative and deeper negative, their stock prices are going down, they’re doing very poorly. And they cited that this is a reason why their tenants are doing poorly IIPR should be a short.

I think that kind of analysis. Kind of is a good explanation of how the sentiment is currently in the cannabis sector where I mean, anyone who really has analyzed the sector knows that these companies, these big five MSOs. They’re, they’re working very strongly, there’s financials very robust.

But to the average person looking in, they might be thinking these are very poor, financial companies, they’re not doing very well, they’re not generating cash flow. They’re really missing the point. So, which brings back to the core of your question is what if someone decides, why don’t we just wait for legalization to happen? Or why don’t we just wait for the stock to start going up?

I think that’s the beginner investors like to do that they only like to buy the stock when it is in an uptrend and they think, oh, it’s going up, I want to buy it. And it’s going to keep going up. And I’m going to keep holding it until it goes up. And once it starts going down, oh, sell it, right. That’s a very typical investment strategy.

I, this is one of the one where I want to emphasize that cannabis stocks are not different than any other stock. We don’t want to view the cannabis sector, like, oh, they trade based on their own their own ways or there’s certain ways to trade cannabis stocks that don’t work elsewhere or stuff like that. We want to just remember in terms of fundamental analysis, in general, money matters, right?

But when at some point right, these cannabis stocks, they’re going to get there. I mean, right now, they’re arguably already so cheap, that value investors will come look at the sector, right? Like when you have a name, like, you have a name like Verano trading below five times 2023 EBITDA. I mean, you really have to start wondering, like, these, there’s going to be these value investors, not growth investors, right, but value investors coming in to buy into these names.

So as for why would you want to buy into these stocks? The for legalization, the idea is that there is a clear multiple, there’s a multiple, at which point, investors worth will keep buying, and they’re not going to let the multiple go lower than that. And that’s important because as these stocks grow, right, like, if you’re saying the multiple is 5x EBITDA or 6x EBITDA as these companies continue to grow cash flows. The stock price must keep going up, if you’re going to match that multiple.

So, what that means is, if you’ve been investing in the sector for a while, a big driver, you’re thinking, oh uplisting award her or decriminalization will occur. And that that point is thoughts will go roll up a lot. The one way to think about that mathematically is that the multiples will expand and the multiples like stand from 6x EBITDA to a 30x EBITDA, for example, there’ll be fairly spectacular, there’ll be a 500% increase.

But that doesn’t mean that there won’t be returns before that happens, right? Because if you’re just assuming that multiple stay at success from here until then, you’re still going to get very good returns as the EBITDA grows.

RS: Yeah. Yeah, it’s important to keep aware of those things. Do you ever think about changing the name of your service to cannabis value investor?

JL: At some, at some point, it’s going to be, it’s going to be worth thinking and working into.

RS: So, do you feel like it’s just beginner investors that are suffering from that? Because it feels like even seasoned investors are not clear on what’s happening in the cannabis sector? Or what could happen, I guess, in the cannabis sector?

JL: Oh, so yeah, I think it’s a human emotion to that emotion drive on how you view the stock side. So right now, when stocks keep going down and again when that’s going to drive, not just how you feel about this thought, it’s also going to drive how you view the financials. Like I said, at the beginning of the program when you see growth, go down sequentially and your sentiment is very poor, you might start to, you might start to sell some stock, you might start to say, oh, maybe my thesis was broken.

But the thing is, let’s say the stocks were doing really well. They were at all-time highs, growth and we have the same exact financials. My guess is that investors will not be selling, they will not be so quick to sell their stocks, they’re going to be thinking oh longer term, there’s going to be more states coming online, like there’s going to be New York coming adult use next year. And then over the next 10-15 years, more and more people are going to use cannabis.

So right now, there’s some volatility doesn’t matter, right. You’re going to see people look more than just one year, or more than just one quarter in advance. So, I think it’s very normal for even the experienced investors to have poor sentiment when the stock goes down.

But the key thing to understand is, if you want to be a good investor, you have to really work on being able to manage your own emotions and being able to look at the same exact numbers with you try to do that with the same standards regardless if the stocks are really low or the stocks are really high.

RS: So, let’s maybe get into one stock in particular. And one of the stocks that you mentioned was Verano. And I feel like it’s a good stock to get into because it’s a lot of, I think thoughtful people’s favorite stock or one of their favorite stocks in the sector. I’m curious what you think of it, especially in light of kind of recent announcement or lack of announcements?

JL: Yeah, Verano (OTCQX:VRNOF) is, has been my topic for quite a while. And we could just kind of summarize again, that quick investment thesis on Verano is one of those big MSOs they have strong profit margins. But not only that, they have arguably the best footprint in the cannabis sector. If you if you’re thinking about limited license, states that are going to drive strong profit margins for many years.

They have arguably the best footprint and the entire sector, when you think about how they have exposure to New Jersey. And once they complete their acquisition, the pollutants growth of New York, and they have very low exposure to stage the core profit margins now like I mean, they’re in California, but not they’re not really emphasizing California or Colorado, like, a purely for Columbia Care might.

So that’s the quick investment thesis. But what is the recently they had not released their fourth quarter financial results? Or I mean, depending on their fiscal year is third fourth quarter? And they said it’s because their auditor had some questions regarding a 2019, this dispensary results from 2019. I mean, the actual reasons won’t be apparent until they finally released the results.

They said they will release the results together with the next quarter. So that should be probably in three weeks or so we should get two quarters worth of results. And this kind of it’s very interesting that this presented a huge gift. I like Verano before this happened. But after they announced that they were not going to release their earnings on time, I heard that they’re going to delay it for three months, the stock curiously just kept going down.

I mean, the stock already was underperforming peers, just because of the arbitrage spread with the goodness grope. But after this auditing announcement, the stock suddenly I mean it’s below $8 at this point, it’s incredible. At this point, it’s really important to remember, I mean, not only when you buy stocks, we’re not just buying prices, right?

We’re not just buying stock prices, we’re also not just buying valuations, like we’re not just looking at raw another thing, oh, this is 5x times EBITDA, this is really cheap. More important that we’re buying the underlying business, the underlying assets, right? If those, if they’re just buying the valuations, the danger there is that maybe the business is not very good business.

And this is not a very sustainable number, or maybe the number you don’t believe. But in this case with Verano, we know that a are one of the best operators in the sector, right? We know that, especially in New Jersey are one of the stronger position operators. They have one of the best supplies, they’re ready to meet the adult supply.

So, there’s they should have a huge performance in New Jersey that’s going to be like Illinois. This is not showing in the numbers. But this explains why we should continue to expect strong numbers, right. This is reason why you should not think that they’re the result is audit is going to be like catastrophic to their financial results.

I mean, the reality is that this is a really strong operator with a very deep footprint, right. They’re deep in all the states they’re in, or I mean all the states they cared to deepen, joining strong margins, that’s not going to change after they convert from IFRS to GAAP. So, I mean, it’s not positive that they didn’t release their earnings on time.

But I think this is just this is an example where if you’re willing to accept little hair on the investment thesis, you get to buy the best of breed operator at a huge discount. Now it’s I mean, it’s trading lower than Trulieve (OTCQX:TCNNF) and I think it’s like 30% lower than Curaleaf (OTCPK:CURLF), Green Thumb (OTCQX:GTBIF) at least 30%-40% based on estimates.

RS: Can you speak to why you think they’re such a strong operator? Is it because of their margins, because of how deep they are in the states that they’re in?

JL: Yes so, I mean, of course all you can make the argument that all of the operators are strong in different respects of the Verano definitely a big one is going to be their margins. As well as the way I look at Verano is like they focus on margins like Trulieve, but they care about forward thinking and what they care about growing that footprint, like Green Thumb.

Right well one of the issues with Trulieve that I had before. And again, I really like Trulieve I really think CEO Kim Rivers with their team, they’ve done a wonderful job. So, it’s there just for allowing me to pick, I mean, nitpicking a little bit. The only thing is, they focus a lot on Florida without maybe they could have worked a little harder and did what they did in Florida and many other states as well, right.

I think Trulieve could have been like, and that they had a huge Florida like margins everywhere. But I mean, they focus only on Florida. So that’s the thing with Verano is that not only did they have strong margins, in Florida, but they also tried to do this everywhere, right. So, they had, they have a very, very large footprint, where they didn’t have to do a huge acquisition, I truly did have harvest help in order to become a true MSO. They’ve done that from the very beginning.

So, I think Verano was public from the very beginning. They’re going to, they would have had the same kind of multiple that Green Thumb, or Curaleaf would have. Especially Green Thumb would have because it Green Thumb’s multiple is well justified they’re able to be profitable on a GAAP basis, while still focusing on growing our footprint.

So, thinking more multiple years ahead, trying to think about being in the right states. Verano is very similar, right. So, I think, even though the multiple doesn’t show it, the multiple seems to imply that they are a substantially worse operator than everyone else. But in reality, after they get New York, and Minnesota, right, they’re going to be you could argue that they are one of the top tier operators, and they should be having multiple in line with Green Thumb or even higher.

RS: It’s clear from listening to speak, and maybe if, for investors that have a little bit more experience in investing. I think it’s clear that the most important thing in investing unless you’re shorting the stock, is the quality of the company as a business.

But in terms of looking at the fundamentals, what do you think is something that investors should be paying attention to like one or two things, in addition to kind of the general thesis of the business?

JL: Yeah, I think, especially considering all of these companies have been operating for many years already. This is not like 2018, when we just started when a lot of these companies just started operating, and we were using pro forma revenue, not performing margin or float pro forma revenue numbers.

Sorry about my time, there’s a couple of good things to focus on fundamentally, right. We got it at some point, especially because cannabis stocks have very high interest expense, and they have high tax expense, because of 280E taxes, it means that they, they are very, it’s very hard for them to generate free cash flow.

So, with that in mind, we have to keep in control how tolerant we are about operating losses. So, like for example, when some names continue to generate low profit margins, quarter after quarter. For example, like Curaleaf continues to generate poor profit margins, quarter for quarter, whereas Verano continues to generate strong margins, every single quarter. That’s indicative of perhaps a greater attention to being able to generate that kind of margin, right.

Of course, you make the argument that Verano is going to see some margin compression moving forward, and maybe Curaleaf might be able to see some margin expansion going forward because of the might scale up a little bit. But it’s not going to come to the point where they have equivalent margins, right.

Just going to be looking at the DNA, where if you’re able to generate strong margins right now, in spite of everything thrown at you in the cannabis sector, that’s really indicative of what’s in your, in your operational DNA, you are able to generate strong margins right now, right? So I think when you focus on profits, even though there’s a clear argument that you want to focus on maybe EBITDA instead or not necessarily get profits.

But when you focus on GAAP profits, it could show which are the strongest operators. And especially right now, when the stock price is so low. And a lot of these companies just finished raising a ton of debt, you have to wonder where it is, where’s the next money going to come in. When they’re trying to, because they still need more money to fund all their future growth projects, right.

You’re not going to get growth without building out more cultivation facilities or building out more dispensaries, you still going to have more capital. So, when the leverage is high, and your stock price is low, it means maybe these companies are going to have a hard time raising more debts or issuing stock, right? So, they’re going to have to start relying on free cash flow.

So that that’s why in our portfolios, we’ve emphasized stocks like Verano and Trulieve, which are profitable on a GAAP basis already, because they’re not going to have the same risk that the other cop operators might have. That the current environment persists, right? Like, it’s going to be it’s hard to imagine a name like Curaleaf or Columbia Care/Cresco, that their merger which we’ll discuss an on date, it’s gonna be hard to imagine them raising more debt.

I mean, in fact, if they start raising more debt, you got to, you really have to start wondering if you have to start wondering about their financial risk, right? And if they start issuing stock at this point you got to wonder is, is it really worth issuing stock at two- or three-times sales, right to be funnier growth projects.

And that’s, that’s pretty sad state to be to be in. But when you have these companies like Verano or Trulieve or even Green Thumb, right, or they’re generating real cash flow on a GAAP basis. They’re going to they’re going to be able to potentially grow even faster than the peers who are more capital constrained.

RS: So, can you want to get into it the Cresco/Columbia Care deal? I mean, got a lot of release to a lot of fanfare. I think Columbia Care is a, was some people’s like, favorite mid-tier, I would say. And Cresco is for anybody listening, I think they probably know who Cresco is, and an unknown brand in the industry. What What’s your take on? What’s your take on that? That merger?

JL: Yeah, that merger was the first big deal and many years, right. You got these, you got the acquirer and the acquiree, both being household names in the cannabis sector, right. That’s typically, it’s been like a very big operator digesting, like a really small operator. But this time, it was two big operators merging.

And at first glance, I mean, I could understand why a lot of investors were really optimistic because it looks like oh, the puzzle pieces just work in. But I actually sold a lot of my position in both Cresco and Columbia. Why so all my Columbia Care on that announcement, just because I don’t hold I tend not to hold these kinds of arbitrage situations. That’s just not my thing.

But then, the next day, I still own microscopes. I was completely out of this entity completely within once I digested what was going on. So, a couple of issues I had with this is, for starters, it’s as you’re when you’re investing in the sector, we M&A is a huge growth driver. Typically, these companies have been able to acquire companies much smaller than them at really low multiples. Like they would sell their stock at like six times sales to buy smaller companies at like five times EBITDA.

I mean, you can see just how accurate if that’s going to be it. And so, it’s accurate immediately, and they’re going to drive some synergies. I mean, it’s just, they make a ton of money this way. But in this case, it seems like Cresco was trying to take a shortcut, right? I mean, like so if you’re going to buy all these small companies, it takes a lot more work for you have to find all of these operators gets put all the time into making sure each individual small acquisition works.

But in this case, when they by Columbia Care, they kind of just do it all in one go to get all of these, they get this huge footprint, all in one, right. But the problem here is that it’s just not going to be nearly as accurate as how these kinds of smaller M&A deals typically have been just not nearly as lucrative.

I mean, like I said before, you might have been doing six times sales for like five times EBITDA in this case, you’re just talking about it was like a 30% discount or something for Columbia Care, in terms of comparable valuations. And then, but then you got to, in addition to just financial questions, you also have to start running about operationally, what is this going to mean for their businesses?

Because cannabis is the kind of sector where right now is a huge demand grab, right. Now, these companies, they’re not just sitting back and buying back stock, because there’s just so much they have to do, right. They just have to invest so much money in all of their markets to make sure that they’re ready to continue taking market share, or to take market share ones that don’t you sell what happens.

If they take, you can take one quarter off, you take one quarter off, you’re going to be behind your competitors. Once everything happens, but then you can start wondering, so Columbia Care and Cresco had overlapping assets. So, they’ve already they’ve confirmed they’re going to have to, they’re going to have to get rid of the New York.

New York license are going to, they’re going to have to get rid of some dispensaries in several states or some cultivation facilities. So, what does that mean? And so, from now until the time they closed a merger, and they might not close the merger until the third fourth quarter of this year.

How does that mean for capital expenditures? Which, which facilities do you invest money in? Right, like, are you going to is Columbia Care going to think, oh, we’re not going to invest so much because this facility is going to be sold off or get we’re gonna get rid of it once the merger happens.

I mean, this is a weird question or because you get you either get this situation where they under invest in assets because they didn’t want to invest in the properties before, they get rid of it or they over invest or they put have all this money into assets that they were going to get rid of anyway. So, you get this problem where even if the merger closes, it’s very likely that they’re going to be under invested.

I think that’s what’s going to happen, you’re the you’re going to hide or you’re going to, they’re going to be behind competitors, just because they didn’t know where to invest the capital, or the merger falls apart. And then they’re also under invested, because they were waiting for the merger to happen.

So, this merger just creates a lot of weird uncertainty. And typically, if this was not the cannabis sector, and you had all this institutional capital, what would have happened is that both Cresco and Columbia Care would have dropped a lot on this news. They would have traded at a huge discount to peers. Because of that uncertainty. Everyone knows everyone who’s been investing for a long time knows that Wall Street hates uncertainty.

But what’s curious, what happened in the said is that Cresco and Columbia Care have traded better than peers, they actually significantly have outperformed, Verano and others cannabis stocks after this merger. This is very unusual. This is there’s no reason that this should have happened. But it’s happened.

So, it kind of makes it a very easy decision that you’re like, okay, these companies, they’re more expensive and appears and there’s going to be a lot of uncertainty. So, I mean, it’s very easy to me, it was a very easy decision to make the switch to get out of those two names and go to the other names.

RS: What do you think the likelihood is of the deal going through?

JL: So right now, the arbitrage spread. Like if you were to buy Columbia Care, you would make I think, like 15 or 16, 17%. If you own Cresco that could that’s a really high discount. That indicates out Wall Street’s quite pessimistic that the deal is going to go through for reference, the discount spread at Verano and goodness growth is only around 2 to 4%, depending on the day, right.

So, they’re very clear that that’s going to go through but they’re still skeptical that’s Columbia Care/Cresco labs still is going to go through. And the issue is that even with 17% discount, Cresco still trades so much more expensive than Verano and Trulieve added so you got to wonder why are you paying extra for a name? That’s likely going to underperform operationally over this time while they’re waiting for the deal to go through?

What is my opinion? I mean, I opinion is that if Verano could digest goodness growth, then I mean, this deal probably could go through. So, I’m not too worried that the deal is not going to go through. There’s to me, I think they can make the sales happen if they want. But I would say that because these two stocks trade more expensive then peers. It’s just not worth my time thinking whether or not it’s going to go through and trying to get a 70% spread.

RS: Why do you think I mean, the reasons you outlined, I think are compelling reasons to be bearish on the deal. Why do you think they did the deal?

JL: It’s very curious, because one thing I didn’t mention is like, you got these two names, and they both were highly leveraged beforehand, right? So, when these two names coming together, it’s not like the leverage got better. It got it got quite worse, their leverage position is going to be even worse after this deal.

It just becomes a more risky situation. And I mean, not to keep grinding into this. I mean, before the deal, right. I mean, Cresco Labs was saying that they are going to be the best wholesaler. That is their thing right there. They’re so focused on wholesale. And they’re going to continue because they believe that’s going to be the most dominant strategy long term. But then all the press on the presentation.

With Columbia Care, they said they started emphasizing that they’re going to have a huge retail presence. So, to me, I was kind of curious, right, that was like a change of strategy, so quick. That didn’t quite make sense to me. So, honestly, I don’t I can’t explain why this deal happened. I, at least I can’t say anything good about it. So, I mean, I’ll just, I’ll just not answer a wide make this deal happen.

RS: Like our mother’s always taught us if you don’t have something good to say probably best… Speaking of good things and bad things to say one of the good things that people have had to say about the cannabis sector, the past couple of years, maybe not this year in particular but for the past few years is the REIT the stock, you mentioned IIPR towards the beginning of the show.

I’m interested you mentioned the short report. I’m interested to hear like what your take is on that short report and how IIPR has been doing this year, but then also another REIT that we’ve talked about on the show we’ve talked about on CEO interviews, and you’ve talked about briefly as NewLake Capital, which is kind of a new a newer into this space.

Anyways, that’s kind of like a few, a few pronged questions. But if you want to give your thoughts on that, that would be awesome. I know, sorry, but I know REITs are something that investors that might not be interested in the cannabis sector and might be like, Oh, away in.

JL: Yes, and REITs are highly compelling. Just again, when we talk about human nature, for some reason, there’s a human nature to like income. Like when we buy stocks in my view, I mean capital appreciation is still passive income. I mean, I bought the stock, I didn’t do anything, I made money.

But for human nature, for the average human, they may not think that way. They’re going to, they’re going to view the dividend income as being, quote unquote, true passive income. So, they’re going to be very, very attracted to like REITs. So, when I think about investing in cannabis, a lot of investors might only be investing in IIPR and only be investing in the REITs.

So, when we talk about that short report. Oh, I did write a rebuttal of that full report for my subscribers, just because it was a very interesting report, to say that say the least, I encourage anyone interested in IIPR. Anyone invested in IIPR to read and really carefully understand that short report?

Because I think it’s important to be able to understand that business model, and then investment thesis and IIPR I mean, if you’re invested, you better be able to understand why you’re still holding inside of that kind of short report. So, some of the things the short report discussed, were quite curious to me it’s it seemed like this the sperm and egg and I, there’s no reason not to respect the firm. But every firm can make a bad call.

In this case, it seemed like they were not so familiar with net lease REITs, right. So, one of the things they mentioned was, they didn’t think IIPR was a real estate operator, they thought it was more like a financer of cannabis stocks, right of like the MSOs. But to me, that’s, that’s not a bad thing. That’s exactly what it is. I mean, anyone investing in debt net lease REITs, not just cannabis REITs but any of the triple net lease REITs.

You should note, they’re not really real estate operators, they are exactly real estate banks. The whole point of a net lease transaction is that you’re giving your customer the tenants capital, right. And they’re basically signing a lease, the only difference between a normal debt, like a normal personal loan, or in this case, a corporate loan.

And the net lease is that the bank in this case IIPR, they get ownership of a property. That’s only difference, but in reality, and other clear differences that this is a lease, it’s not a debt, so the debt doesn’t mature, but you have to renew the lease every time. But it’s very closely resembles of bank. This is not new. This is nothing anything new. This is just how it works.

So, I was quite surprised to see the hedge fund this debt as a negative reason and a negative point of IIPR. That’s just how it is. And then they also mentioned that, given that it’s a financer of cannabis stocks, they said that it should trade on in line with a with a name like AFC Gamma. And that’s not a name that I’ve discussed much publicly.

But again, this should not trade in line with AFC Gamma (AFCG). The reason why AFC Gamma trades so cheaply AFC Gamma trades like a double-digit dividend yield very popular also. But that company’s externally managed, right. And externally managed means that the company is incentivized to grow total assets, but not necessarily total assets per share.

So, if anyone was following AFC Gamma, right, this is a company that’s issuing stock right when it’s yielding 10-12%. But they gave I think it was like $75 million from Verano at 8% yield. You have to wonder, why would you do that there’s no way you’re making money on this, when you’re showing stock at a 10% yield to get 8% yield from Verano. The exact numbers might be might be slightly off.

So historically, externally managed REITs tend to trade at a discount just because of this misalignment issue. And I also note that the management team of AFC Gamma, they own a lot of AFC Gamma stock, but most of their money is an external manager. I’m sad to see where their incentives are right? They’re going to benefit when they make the fees. They’re not going to benefit more of an AFC Gamma with this role.

But in any case, that just explains why we shouldn’t be expecting IIPR to trade in line with AFC Gamma. But that was one of the key points of the short report. So, I think I mean, I think it’s definitely worth carefully looking at the actual report. But I think the hedge fund greatly underestimated the fundamentals of the cannabis sector right from the outside looking in you, you see these really low margins.

And you think, oh, these companies are just not profitable. But if you’re in the cannabis sector, you know that this is all because of 280E taxes, and because of there’s no safe banking. And that as more states come online, these tendons are going to be more and more profitable. As normalization happens, they’re going to be more profitable.

It’s just the way they looked at IIPR was kind of like a drum so familiar with net lease REITs. And the way they looked at the cannabis sector was just, it seemed like this was the first time they look at the cannabis sector. I typically am not so dismissive of other people’s reports, when in this case, it was just very, very curious. I think he also asked about new like capital, but I wasn’t sure if you any questions of IIPR before I move on.

RS: No, I mean, I think that’s a pretty good take of like a rebuttal. Do I guess my follow up would be and you can like include this in discussing NewLake Capital like investors looking at REITs in this space, what do you think is worth them looking at or paying attention to?

JL: Yes, so as I was discussing with AFC Gamma, definitely you want to make sure you really understand what kind of REIT it is, right? You want to make sure it’s internally image so that the management team is just 100% on your side. IIPR annually capital both internally managed. Typically, typically, net base REITs are internally managed.

There are some exceptions, but typically they are. And in this case, they are in regards to what to look for in these cannabis REITs. The big one, especially with the cannabis sector, you got to think about credit quality, right. Another cannabis REIT would be like power REIT, that’s the ticker symbol PW that’s also very popular.

And that’s when I had looked into the stock has dropped a lot. It looks really cheap. It’s trading at like 10 or 12 times FFO, right. That’s, it’s cheap. But when you look at the Cannabis assets, they’re basically all in Colorado, and he kind of wonder, is that really going to be the most profitable tenant base? Not, not to mention, they’ve also had their drama recently where the CEO of power reach was doing something related party transactions are the insight of the CEO.

He’s also CEO of another company, and then this company and power we are doing some sale leaseback transactions. And then a director resigned because she said she was getting pushback from mentioning that this is a conflict of interest. And it’s, it’s kind of ugly there. But I think my general thing about power is just the high exposure to Colorado. And I think that is why also I liked NewLake Capital so much.

Because I mean, IIPR is great. It’s a stock that I’ve doubted in the past and I’ve been wrong. Wrong to doubt I think they’re going to do great right now. I think that these REITs in general are very interesting spot. They didn’t drop as much as the MSOs. By Ironically, when the MSOs dropped so much, they’re not going to issue stock, which means that they might be more open to doing sale leaseback transactions, right.

So, it means that these IIPR and NLCP they might, they probably will continue to have really strong financials. And not to mention, as I mentioned before, growth in the cannabis sector is really capital intensive. If you have to bring dispensaries and cultivation facilities online. This isn’t a software sector.

So in regards to newly capital specifically, this is a company that trades at a huge discount to IIPR it came public in ’20, late 2021. The reason for the discount is because IIPR was the last cannabis REITs to be allowed to trade on the big exchanges. NewLake Capital is still trading over the counter. But I mean, it’s still not plant touching.

So, there’s not really any difference between NewLake Capital and IIPR besides the openness thing. That’s important to note because a lot of institutional capital can’t invest in the multi state operators that’s not really because of uplisting, that’s more because there plant touching but nearly capital is not plant touching.

So, there’s as long as it issues as long as it institutions okay with investing you know, OTC they could buy you NewLake Capital. But still it’s led to a discount NewLake Capital is trading around 30-20 times, 18 times a real estate earnings, but they still have $100 million of cash they raised from the IPO, if you assume that they deploy that at 12%, average cap rate, their average portfolio CapEx 12.5%.

So, but so if you assume they invest $100 million and they committed to doing that by May, okay, May of this year, and suddenly they will be trading around 12 or 13 times FFO, that’s real estate earnings.

Based on that annualized number by May and this is a really cheap multiple. Here’s some reference. So, if you look at the broader net lease universe, don’t just look at IIPR. You got these other names like Realty income, that’s a stock ticker, oh, it trades at 20 times fo. But that’s just a normal net lease fee, it’s not a cannabis REIT.

So, their same store growth is like point, it’s like a 1%. In other words, they’re able to raise rent on their tenants by 1% every year. Sounds okay, doesn’t really keep up with inflation. And that’s the point, right? But the point with those thoughts is to not keep up with inflation so that their tenants keep renewing their lease when the lease expires.

So that that’s part of the business model. But in the cannabis REITs, right. Their annual these escalators are more like 2.5% or 3%. That’s, that’s like three times faster organic growth. Then, and Realty income. So, these names, they should actually treat a huge premiums and IIPR does trade at a huge premium.

But NewLake Capital, like I said, it’s trading at like 12 or 13 Times reporting has FFO, it’s trading at a huge discount to Realty income. So, if Realty income stays where it where it is, and it’s arguably, it’s already pretty, fairly priced at the stage where it’s trading at 20 times earnings, I could see NewLake Capital trading at least at least 30 times earnings.

That’s on the basis of the fact that it’s it has those higher internal growth, that 2.5% – 3% internal growth, but also their acquisitions are going to be at a higher cap rate, right? Realty income acquires property that like at a 5% or 6% cap rate. NewLake Capital acquires companies at a 12% cap rate. The reality just mathematically it’s going to grow much faster.

So, I could see NewLake Capital rerating Verano at least three times a foe I mean, so you’re looking at the kind of stock that could deliver triple digit returns, even without legalization. So, for like cannabis investors, that sounds great, you’re able to diversify within the cannabis sector, in a strategy that’s going to work counter that’s going to, they’re going to grow alongside the MSOs. But it could do well, even if MSOs do poorly. I think that’s something that’s valuable to investors.

RS: And then also is the yield, which is unique in the industry.

JL: Because MSOs I mean, some of them have earnings, right, like a Trulieve, Verano they have GAAP profits. But even if you didn’t have earnings, none of them, none of them are returning capital to shareholders. I don’t expect any of them to return capital shareholders just because one they have so much capital needs, right. They need to invest in the cultivation facilities and dispensaries.

And two, I mean, to be frank, these are kind of immature management teams that even if even if it came to, I strongly believe that even if it came to the point that the stock was cheaper than investing in M&A and capital expenditures. I have a feeling that these MSOs are still favor capital expenditures over share buybacks.

And that’s something that a more immature management team will do. But with the REITs, the management team doesn’t get inside, right. They’re pretty much required to pay dividends, they’re required to pay 90% of taxable income out of dividends. In the case of case of NLCP, their management team is like fully on board this dividend.

They’re really, they’ve targeted about 90% of the cash flow, paying us dividends, and remember, they’re not plant touching, so they don’t pay 280E taxes. They and unlike the typical landlord, remember, you really want to think about them as a real estate bank. Like when you think about a mall landlord or shopping center landlord, you think about all of these like renovation projects or maintenance stuff you have to do.

But when you’re a net lease REITs you don’t renovate, your tenant pays for the maintenance. So, they generate surprisingly, strong margins. I think for newly capital; it was around like 75% right 70% net margin. It’s a very, very high margin. That’s it’s higher than tech stocks.

There’s no 280E taxes they can they will return that cash to shareholders now, right. So, I think if you want to invest in the cannabis sector and get paid now, right literally get paid now not by multiple expansion, but literally get paid by dividends now, these REITs and IIPR and NLCP is much cheaper, they offer a very compelling way to do so.

RS: And do you have any thoughts on NLCP uplisting to a major exchange?

JL: So that’s something that they mentioned on the earnings call. That they, I mean, I’m not sure that was more just kind of hinting or if it was serious, but they did say that they were looking into it, to me data, they devoted a lot of a long part of the earnings call to discussing. Basically, they’re trying to work with NASDAQ, they’re trying to find a way to get onto the NASDAQ.

And they also said there’s no guarantee. I mean, whenever they talk like this, I mean, I don’t think any investors are expecting them to say this. So, it was kind of implying that it was in talks. That’s hard to know. In my view, I think NewLake Capital has a higher has a better-quality tenant roster than IIPR. So, they arguably should trade at a higher multiple.

I think, when it’s all said and done, right. When they’re allowed uplisting when saving passes, I think NLCP will trade at a higher multiple than IIPR. So, I don’t think obviously is necessary. Very similarly, with MSOs, I think we should be buying ahead of that listing. And this is the opportunity.

I mean, once you start it, again, with human emotion, if you’re going to like wait for up this thing, or you always think about the market timer, the kind of person that says you only want to buy stocks when they crash. But ironically, what happens when you do that is when the stocks crash, they don’t buy, they end up saying, oh, I think they’re going to trash more. And these kinds of people, they just never end up buying.

So, with IIPR, and NewLake Capital, they’re very interesting. And that, the longer it takes no, for safe banking, or for a blessing to happen for the MSOs. They could keep growing, maybe they might grow at 20-30%, every year, you might be looking at the kind of stocks like to give you 5x returns, if they do it over 10 years you get 5x to 10x returns, just from growth.

And you got to do this. Regardless if that our politicians finally figured out figure out their issues and legalize cannabis. It’s very interesting. So, they’re not trading nearly as cheap as these MSOs and so straight at like 5x EBITDA NewLake Capital, before their investments are trading like 20 times a FFO. So, but, but they pay you cash immediately. So it’s a tradeoff.

I think it makes sense to hold some and NLCP especially if it becomes clear that legislative performance not coming, right, because I think it’s possible. Like, just as people are hoping for a huge balancing of huge big. I don’t want to sound like AMC. But you know, that more threat, a huge, a huge big explosion in share price, on the MSOs. Once out this thing happens. It’s possible that you get this kind of smaller scale, huge bump in IIPR and NLCP.

Once say baking doesn’t pass this year or once Democrats lose control in the midterms, or if Biden loses in 2024. Because I mean, contrary to I mean, when you look when you’re on Twitter, and you’re looking at the Cannabis, it’s some investors seem to think Republicans are better for cannabis. But I think they’re kind of miss they’re kind of the FCC, you have short memories, right.

Right now, Chuck Schumer is he’s delaying say banking is delaying legalization, that sucks. But before Democrats had any say in this, the Republicans didn’t even want to consider it, right. So, like you just go from worse to worse.

So, I think if it becomes clear that Republicans are going to take control of politics, investors should count on legislation, legislative reform regarding cannabis being delayed another four, eight years. And that could be a huge catalyst for the cannabis REITs, right. They might have the kind of big bounce that people were hoping from the MSOs.

RS: Yeah, that’s a great point. That’s a great point. I think you’ve given listeners myself a lot to think about in terms of like really actionable concrete, things to pay attention to in the market. Is there anything else that you would encourage investors to be paying attention to or avoid thinking about or do you feel like there’s words of caution or advice that you would want to share with them or anything we missed here?

JL: Oh, I mean, I think the cannabis sector is wonderful. And that is one of the only sectors where market inefficiency is so evident, right? Like, there’s no other sector, where you’re going to be able to have all these companies with similarly long track records, but they all trade at different valuations, right. And sometimes to a huge degree.

So, I think this is the kind of sector where it will pay off to do a lot of study that you can get better at investing, learn from fundamental analysis, and then you could be able to apply that to see if you should be investing just popular names are investing in some of the much deeply discounted names.

I think this is definitely I mean, in the future, hopefully, and invest in a sector, which produces a lot of profits. But for now, it’s definitely a sector, which investors want a lot of fun, just practicing good investment principles.

RS: Do you feel like, I’m curious because you’re, you don’t just play an investor on TV, you actually are an investor. Do you feel like frustrated when you look at share price? Or are you able to be patient like it, like, take the advice that you gave today? Is that something that’s easier? Because it more clearly? Or do you find yourself struggling just as much as any investor?

JL: So, it’s like the saying, fake it till you make it, right. When the stocks are doing great, I was very, very confident, like, even as stocks fall, I am keep buying, as the stocks keep falling, I’m still buying, I’m still very confident. But of course, I’m human. So of course, I will feel the same. The same frustrations, that the fundamentals are not following the stock price.

It’s part of being a better investor, part of being a better investor is not just making sure you can read an income statement accurately. It’s also being able to being able to manage your emotions and how your emotions affect how you look at the fundamentals and make sure you could do that every day. Right, I think? I think, yeah.

So I mean, to answer your question, yeah, I am human, I feel the frustrations. But I like every investor, should I continue to work on managing that and reminding myself that, especially for the names like Verano, Trulieve. They’re not needing to issue stock, right. Some of the MSOs do need to issue stock because of the leverage, but mains like Trulieve, Verano, they don’t need to issue stock. So, when the stock price fall, it’s more of a buying opportunity than a risk.

RS: Yeah, great points Julian. I’m super psyched to get this episode out. Because I have a feeling a lot of people are going to enjoy it. And take heed to a lot of things you said. Really appreciate you joining us again. Look forward to the next one as I as I do at the end of every conversation with you, already looking forward to the next one.

JL: Yeah, same. Great. Thanks for having me on.

Thanks so much for listening to The Cannabis Investing Podcast. Subscribe or follow us on Seeking Alpha, Libsyn, Apple Podcast, Spotify or Stitcher and we’d really appreciate it if you left us a review on Apple Podcast. It helps other investors find our show and makes us feel fantastic. If you have feedback or questions, we’d love to hear from you at rena+canpod@seekingalpha.com.

Nothing on this podcast should be taken as investment advice of any sort. I’m long Trulieve, Khiron, Isracann Biosciences, The Parent Company, Ayr Wellness and the ETF MSOS. Subscribe to us on Libsyn, Apple podcast, Spotify or Stitcher. Thanks so much for listening and see you next time.


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