Description

Executive Summary/Investment Thesis

• Best of breed

• Highest margins and profitable since inception

• Recently public but one of top 5 players in US

• Stock down more than peers despite cheapest valuation and best-in-class assets

• Strong management team that is not promotional

• Recent insider purchases

• Focus on vertical integration and limited license states with less competition

• Growth potential in markets is enormous – especially as states bring on Adult Use

• Opportunity exists due to recent share unlock

Background

Verano Holdings is one of the country’s largest, most profitable, and well-managed cannabis multi-state operators (MSOs). Only Curaleaf (109) and Trulieve (100) have more stores than Verano (85) and the company’s footprint currently spans 14 states – only Curaleaf (23) and Columbia Care (17) serve more. But equally as important, Verano is one of the top 3 players in each of those 14 states, with growing scale in three strong markets including 37 in FL, 10 in IL, and 11 in PA.  (https://mjstocktrader.com/us-cannabis-dispensary-count)

Verano went public earlier this year with a reverse takeover of an existing publicly held company after acquiring Florida-based Alternative Medical Enterprises.  At the time of the acquisition announcement, AltMed had become one of the fastest growing operators in FL, with 26 dispensaries and 220k square feet of cultivation. AltMed now has 37 dispensaries in FL (same as Curaleaf but behind Trulieve’s 92).  Verano is also expanding in its core markets of Illinois, NJ and PA and a recent acquisition in July will enable expansion into Nevada.

While cannabis licensing requirements differ by state, they represent a barrier to entry that benefits the larger players in the space. Verano currently has 85 stores, should end 2021 with 90+, but should reach 140+ by YE22 ensuring strong year-over-year growth and creating a multi-billion dollar business.  Verano also focuses on being vertically integrated, which guarantees supply and drives margins and on limited license states.

The company generates almost 80% of revenue from retail and ~20% from wholesale. This number is skewed given FL is considered to be all retail due to the lack of a wholesale market and vertical integration in PA unlocked after Q2 given AgriKind closed in July. The company projects a more balanced level of 60% retail and 40% wholesale, and feels it can be a leader in both verticals. The average number of daily visits increased to 18k from 7k across the entire retail network. In store efficiency also showed material improvement as same-store transactions increased 76% y/y. 

Cannabis is a growth industry that remains in the early stages and Verano is well positioned to capture share in some of the largest and best growth markets. The company’s eight core states are expecting strong multi-year growth.

Peer Comparison

In Q2, the ten public MSOs all grew nicely sequentially, however, three things are clear – industry growth is strong, certain companies have reached scale ($200mm+ quarterly revenue) and only half are able to produce true net income. Each company has a growth story, and there is likely more m&a to come, but the largest companies are reaching scale and gaining efficiency, and as some reach their license limits in certain states, the m&a is likely to turn to buying brands and products and driving even more profitability.  Verano stands out as not only one of the scale players, but because of their growth and profitability—neither of which is reflected in the valuation.

Economics/Financial Profile

Verano, despite its strong growth, is one of the most profitable store-level players in the space. Reported revenue for Q2 21 was $199mm and adj. EBITDA was $81mm (~40%). Despite expectations of 50+ new store growth in 2022, the company has guided zeroing in on mid 40s Adj. EBITDA.  Annualizing the Q2 revenue would produce revenue of ~$800mm run rate, and analysts have forecasted over $1.3B for 2022—which seems reasonable. Giving the company no margin increase from Q2, would mean 2022 adj. EBITDA of ~$520mm and if they can hit management’s guidance, it could be $600mm+.

With size and scale, the cost of capital has fallen for many of the large players. Recent debt deal was done at 9.5%, relative to mid-teens rates for other smaller competitors.  Verano also owns most of its real estate, which was necessary in the early days, but now can easily be monetized through a sale leaseback transaction.

Verano ended Q221 with cash of $150mm and debt of $134mm, of which $3mm is due in next year and they are free cash flow positive.

Valuation

The peer group of Tier 1 MSOs trade at over 10x 2022 EBITDA, while Verano trades at 6.7x EBITDA.  Using an EBITDA estimate for 2022 of ~$600mm, a peer group multiple would create a stock upside in 2022 of 50%. If Verano can reach the multiple of a GTI/Curaleaf, then the upside is close to 100%.  With a growth rate tha5 can continue to exceed 20-30%/year, it won’t take long for the stock to reach a price of $40+.

Management

The Verano management team has broad experience across multiple industries, and has already demonstrated they can drive 40% adj. EBITDA margins.  CEO George Archos recently bought $1mm worth of shares last week and was joined in the buy by other insiders.

Regulatory

On the Q2 earnings call, the company highlighted that it does not need federal legalization to be profitable as it has a proven ability to do so under the current environment. However, any movement towards legalization or access to the U.S. capital markets will only be a tailwind for the business. The SAFE act passage would most likely allow the company to bank at the federal level, gain access to credit cards and operate efficiently like other U.S. public companies. 280E tax treatment is also something that could be eliminated through the passage of some form of legalization or reform which would instantly increase the bottom line. Lastly, access to the U.S. exchanges and institutional investors would even the playing field to where the Canadian LPs operate given inclusion to the NASDAQ/NYSE. 

Reasons for Underperformance

MSO stocks have been lousy stocks for the last six months or so for a host of reasons unconnected to earnings.

• Lack of progress on Federal marijuana legalization is keeping the stocks in a holding pattern and preventing some institutional investors from participating in the space.

• Restricted access to MSO stocks by certain brokerage firms, wire houses and big banks because despite state laws, marijuana remains federally illegal.

• Low trading volume.  MSOs trade over-the-counter in the US, but don’t generate large daily volumes. This makes them particularly susceptible to short sellers and to volatility

Verano is also suffering from two company-specific issues.

• Recently public, the company lacks the following and earnings reporting history of competitors GTI and Curaleaf

• A significant lockup expiration at the end of August (related to previous acquisitions) Limited visibility on these unlocked shares, but believe it’s a transitional issue that trumps the obvious fundamental strength.

** LOOK PAST THE NOISE!

Catalyst

Working through lock up shares

Federal legalization or movement towards it

Brokerage firms allowing custody of shares

Continued performance