Disclaimer: The below post is my Q3 2023 Investor Letter that I sent last week to investors in the Mindset Value Wellness Fund. This post is NOT a solicitation. I talk about stocks that I own and my view of the future. It is imperative that you do your own due diligence and not rely on anything written below. I’m posting this in order to show how my writing translates to actual performance. With that, I hope you enjoy and gain insights.
The Mindset Value Wellness Q3 2023 Letter
The Mindset Value Wellness Fund finished the third quarter up 27.4% and is up approximately 60% for the year.
The Game is About to Start
The real cannabis “game” has yet to begin. But that may be about to change with the news that cannabis may be rescheduled. Here is what I what I wrote on August 30th:
Today, the HHS (Department of Health and Human Services) sent a recommendation to the DEA (Drug Enforcement Administration) that cannabis should be rescheduled to Schedule 3 from a Schedule 1 illegal drug.
The main takeaway from this news is the following: the Federal government is signaling to the entire world that the US government considers cannabis to be significantly less dangerous than it has in the past and is downgrading its view of its negative impact to society.
This is the biggest potential reform in cannabis history. Rescheduling to Schedule 3 is a big first step for the Federal government in righting a wrong put in place when cannabis was placed on the Controlled Substances Act by the Nixon administration, purely for political reasons.
When this rescheduling process is completed, 280e taxation (the excessive taxation plaguing this industry) will go away. But this is much bigger than just taxation. I believe this is a giant bat signal to the world and most importantly the financial industry that it will soon be safe to enter the cannabis waters.
I think that this is akin to the national anthem playing before the first pitch of the first baseball game of the season. The warmup pitches haven’t even happened, and the players have not taken the field.
We have been waiting for this moment for almost a year, when Biden asked HHS to initiate a review last October. Remaining patient has been challenging to say the least. Wild volatility and illiquidity have been the norm. However, we have used the pain and suffering to be able to invest in some fabulous companies with distinct competitive advantages.
And while this caused a big jump in cannabis stocks in September, a lot of the initial excitement has fizzled out. I wrote about how little institutional capital has entered the market since the news and speculated why: https://mindsetvalue.substack.com/p/institutional-investors-and-cannabis.
Our gains have been holding up for a few reasons. One, starting last summer, we moved up the capital structure and are invested not just in cannabis common stocks, but also preferred equity and convertible debt. Every quarter, we get inflows into the fund from these investments.
One example is the Glass House preferred investment we participated in last year. We get paid over 20% a year in interest (we also received warrants as well). I continue to think that the Glass House investment was the best risk/reward opportunity I have come across since I stood on the courthouse steps in Atlanta, GA in 2011.
But beyond interest payments, the real driver of performance is the results our cannabis companies are reporting and there is no better example than Grown Rogue (Canada: GRIN, OTC: GRUSF).
Grown Rogue Might Yet Be the Most Undervalued Cannabis Stock
Grown Rogue is an investor’s dream. It is a company with demonstrated operational and cost advantages that has a long reinvestment runway with extremely high returns on invested capital. In fact, in a Schedule 3 world with some financial protections from SAFER Banking, this is a lender or a private equity firm’s dream investment.
And the company is starting to go on the offensive with its cost advantages including entering the state of New Jersey. What happens when a company that is free cash flow positive at $800 to $900 flower prices enters a market with $2500-$3000 pricing and competition is low and so is quality? I wrote about the potential of that market.
Even in its existing markets, Grown Rogue is seeing sales and profits continue to soar, with revenue soaring by 48% last quarter and cash flow by 79%.
So, how does a company with some of the fastest growth in the industry that is now accelerating possibly trade at one of the lowest valuations on next year’s estimates?
First, not one analyst covers the company. Second, it is a microcap cannabis company and can be extremely illiquid. Third, even in cannabis, in which stocks are notoriously illiquid, buying Grown Rogue can be even harder than your average cannabis stock. For example, investors cannot buy the stock on Interactive Brokers, a major financial platform for small to medium sized money managers and investors. We have had to open two different Canadian brokerage accounts and work with sellers to buy shares. Though, we have done so happily.
Due to our early conversion of our December convertible, we crossed the 5% ownership threshold in Grown Rogue between our two funds and now own over 8% of the company. Here is our 13G filing. I expect our ownership to only increase.
Why? Because it’s not often you get the chance to invest in the following:
1. One of the best operationally run companies in a sector.
2. The fastest growth rate that is now poised to accelerate.
3. A clear and long reinvestment runway (almost too many opportunities right now)
4. Focused attention when competitors are struggling financially and distracted.
5. And then trading at 2 times my end of year 2024 unlevered cash flow estimate
The problem in cannabis is not limited licenses, but a shortage of operational excellence. The governor or limiting factor for Grown Rogue is talent and making sure they don’t bite off more than they can chew at any one time. Even though Grown Rogue is up more than 150% since the beginning of the year, I believe the upside is even greater now.
Glass House’s Operationally Excellent Quarter
Glass House (OTC: GLASF) announced yet another excellent quarter, which beat every forecast. But the most remarkable thing was the company announcing that production was much higher than expected.
Glass House announced a production increase that was at least 30% greater than my estimate and announced that they expect ongoing annual production to be approximately 30% higher than they previously thought. Instead of 270,000 pounds of annual biomass production, they now expect at least 350,000 pounds and there may be further opportunities to improve from even that number.
I don’t think it is any coincidence that the two companies with the highest growth rates in cannabis (Grown Rogue and Glass House) are also the best performing cannabis stocks for the year.
Feeling Extra High About a New Private Investment
We are feeling extra high right now and it has everything to do with the opportunity in the cannabis industry, and nothing to do with consuming cannabis. One of the reasons is that I’m working on a new convertible debt investment into a private company that follows the same principles of operational excellence like Grown Rogue.
The company is run by a lean manufacturing expert, who has built the company from scratch after working for a huge European conglomerate. The company, which has been duking it out in ultra-competitive California is heading east with its superior manufacturing and processing capabilities into markets with little competition and much higher pricing. Our investment will allow the company to grow much faster, while compensating us 9% a year, but also allowing us to convert at a very attractive valuation that offers substantial upside.
No one is talking to companies like the one we are going to invest in. And that is what is making us feel so high. The opportunity is very clear. Few institutional investors are doing due diligence, and the only capital available wants to strangle these companies with 20%+ debt instruments instead of providing the kind of growth capital that allows these companies to soar.
Stay tuned, I’m excited to announce this one.
Summary
Our companies are growing and leaning into their competitive advantages. While at the same time interest payments from convertible debt and preferred equity investments are flowing into our portfolio every quarter. And suddenly, the macro environment has radically started to shift from a headwind to a tailwind.
Thank you for your trust and support and if you have any questions or comments, feel free to reach out to me any time.
Sincerely,
Aaron M. Edelheit