In the most desirable neighborhoods across America, Not In My Backyard advocates, commonly referred to as NIMBYs, have done everything in their power to restrict development and to kill new housing development from ever being built in their area. Investors don’t shout this from the rooftops, but NIMBYs are simply a real estate investor’s best friend as they generally cause prices and valuations to soar by constricting supply.
Most cannabis investors are laser focused on any Federal legalization development and trade stocks up or down in anticipation of legislation that might change the Federal status of cannabis. The whole sector has been in a bear market as hopes have dimmed that Biden would lead a legalization effort.
Something interesting happened yesterday, when the House of Representatives voted to attach a SAFE banking amendment to the annual defense spending bill. The SAFE banking amendment basically shields financial institutions from prosecution if they are working with state legal cannabis companies. This caused a jump in prices of US cannabis stocks on hopes this might lead to an ability to lower debt costs, allow credit card processing, and possibly allow these stocks to list on US exchanges.
But investors who have been trading cannabis stocks on legislative movements are missing a very important point: the longer it takes for legalization and the slower the legislative process takes, the better it is for the leading US public cannabis companies. Why? Because unlike their smaller competitors, they are the only ones with access to capital. This means they can grow, solidify footprints, invest in their infrastructure, acquire smaller competitors, and gain size and scale advantages.
Consider that the top US cannabis companies have accessed the debt markets at sub 10% rates with Green Thumb even borrowing at 7%, while smaller companies are borrowing at rates that are effectively 15% or more when you consider the equity dilution and warrant coverage.
Even beyond the advantage of lower capital costs, is the advantage that with size and scale comes massive cash flows to reinvest in your business. With a tough regulatory landscape and tight availability of capital, the larger companies can grow faster and invest in scaled projects which will lead to the lowest costs and accessing the best locations.
One example is the foot race going on in Florida to open dispensaries. Many Florida cities may only allow a handful of cannabis dispensaries inside their jurisdiction, so it is important to open dispensaries as fast as possible before there are no more spots available in each municipality. But Florida requires vertical integration, meaning you can only sell the cannabis you grow. So, you not only need to marshal the capital to fund the opening of a dispensary, but the cultivation capacity to support it. The capital expenditure requirements in addition to capacity to manage people, systems, and the ability to comply with rigid regulatory compliance could not be harder, except for the largest and most sophisticated companies.
Meanwhile, all the barbarians at the gate, like Big Tobacco, leading alcohol companies or consumer packaged goods companies are holding off on entering the industry due to fears of the Federal government. Leading US cannabis companies are left all alone to create footprints and moats that will be very hard to dislodge.
British Tobacco (NYSE: BTI) will generate tens of billions of dollars in free cash flow over the next five years. They also have a strategic initiative called “Beyond Nicotine.” Please do tell me what besides cannabis could possibly come after nicotine?
I love that my favorite cannabis companies like AYR Wellness (OTC: AYRWF), Verano (OTC: VRNOF), Glass House (OTC: GLASF) and Cresco Labs (OTC: CRLBF) are wildly advantaged without having to worry about British Tobacco. Consider that AYR Wellness just closed on an acquisition in New Jersey, where there are only 15 licenses for the entire state. They paid an estimated 4 times 2022 EBITDA for this business. It’s possible that a few years down the road the real valuation might be 2 times EBITDA. In a legalized world or even in a world in which the legalization process was moving faster, there is no way AYR could have captured such a steal.
While cannabis stocks may be down, investors need to realize they are compounding their true value at an incredible rate right now. Cannabis investors could learn a thing or two from NIMBYism and slow regulatory movements. They add incredible value in the long term. To get really high, cannabis investors should want things to go real slow.