Where Are All the Value Investors When It Comes to Cannabis?
The Mindset Value Fund Year End Letter
Disclaimer: The below post is my 2021 Year End Investor Letter that I sent to investors in the Mindset Value Fund last week. 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.
Mindset Value Fund 2021 Year End Results
The Mindset Value Fund finished 2021 up approximately 13% net of fees for the year.
Where Are All the Value Investors When It Comes to Cannabis?
In 2021, we had over one-third of our portfolio invested in cannabis and from the highs, these stocks fell over 50%. While we finished the year up 13% after fees, this was down quite a bit from the June 30th net returns of up 34%.
While cannabis is state legal in 46 states either for medical use or full adult use, it remains Federally illegal. The fact that cannabis is classified as a Schedule 1 drug with no medicinal value is absurd, and it will one day be either reclassified, de-criminalized or legalized in some way.
But until that happens any US company that touches the plant cannot trade on US exchanges and instead trades on secondary or tertiary Canadian exchanges. The Federal illegality means that almost no institutional investors own any cannabis stocks, there are no index investors, there aren’t even any Robinhood investors.
This results in cannabis stocks being illiquid compared to other stocks of similar market caps. But it especially means that if some investors get frustrated that legalization is taking longer than expected and they want out, these stocks can go down a lot. And it means that these stocks can trade completely opposite to what fundamentals are showing in the short term.
Where are all the other value investors when it comes to cannabis? Why do they not see what I’m seeing? Consider the following:
1. Glass House (OTC: GLASF) trades near real estate liquidation value and has the chance to go up more than 50 times in certain interstate commerce scenarios. I wrote up a deep dive research report on Glass House.
2. AYR Wellness (OTC: AYRWF) trades at 6 times this year’s cash flow estimate and 4 times next year, despite growth of 100%! In December, AYR traded down to 3 times 2023 cash flow estimates! (We bought more in December)
3. Verano (OTC: VRNOF), which I wrote up in my Q2 letter, and is down 23% since I wrote it up, is either the best managed or the second-best managed cannabis company with the best margins, cash flow generation and free cash flow conversion and yet trades at 7 and 5 times my 2022 and 2023 estimates. This after growing by over 40% compounded annually for 3+ years.
To the patient value investor, buying companies for single digit cash flow multiples growing at over 40% is a dream. Even better is when other investors are prohibited or can’t invest in this sector, and you know that will change one day. If we are patient, any short-term downdrafts will end up being well worthwhile in the end. Valuations matter and at some point, other investors, but especially value investors will catch on to the opportunity.
And it is for this reason that I have decided to increase the exposure of the fund to cannabis to up to 50% of the portfolio. I’ve simply never come across such an opportunity in my investing career of over 25 years. Please call or email if you would like to discuss more.
To read more about the opportunity in cannabis, remember that I wrote a Cannabis Manifesto and launched a dedicated cannabis fund in November.
While HireQuest and Nelnet Led the Way in 2021, Is 2022 the Year for Consorcio Ara?
HireQuest (NASDAQ: HQI) was our big winner from 2021 followed by Nelnet (NYSE: NNI). Both companies are led by phenomenal founders, who not only understand shareholder value, but live it as the largest shareholders.
Despite going up over 70% since last January, HQI trades at 12 times normalized earnings with near 60% operating margins. With new business lines, accretive tuck-in acquisitions and a return to normal work environment post-COVID, we think it has the potential to go much higher than here. (We originally started buying HQI in June of 2020 at $6 per share).
Nelnet trades for 1.1 times my end of year estimate of book value and 70% of my estimate of net asset value despite growing book value at over 17% a year since 2005. Nelnet rose over 30% in 2021 and is still undervalued. I wrote up Nelnet in 2020.
But the one I may be most excited about for 2022 is Consorcia Ara (Mexico: ARA), which is one of Mexico’s leading home builders. Ara is spectacularly cheap, trading at 40% of book value and quite possibly 25% of net asset value and it’s not even levered. The value is mostly in land and the stock trades at a 15% unlevered free cash flow yield. In a world of rising inflation, land should not only protect investors, but should rise in value. Combine that with Asian supply chain problems that is forcing American companies to re-shore production back to North America, and it is my expectation that Mexico will see increased job growth, which should drive personal income growth, which should in turn be great for a homebuilder like ARA.
The stock should pay a 4-5% dividend this year, so we get paid while we wait and our capital should be inflation protected as well. I wrote up Ara last year in a deep dive report.
The Mindset Value Way: Low Downside, Uncertain Upside
The Fund’s investment strategy is to research and invest in undervalued, misunderstood, or unfollowed publicly traded securities that offer limited downside over the long term, but also have an uncertain upside. The portfolio will consist of investments that offer a “heads I win, tails I don’t lose” strategic approach to investing. To use baseball as an analogy, we are focusing on hitting singles and doubles, but just might have a shot at hitting a homerun, but whatever we do, we don’t want to strikeout.
Summary
While we want to own great companies that have low downside and where fundamentals are improving, this doesn’t mean that our portfolio is not going to be volatile from time to time, or that we won’t experience downdrafts. Please note that we do not use leverage at all, so short-term volatility should not concern us.
I have no idea how our stocks or the stock market in general is going to act in the short run, but I continue to be very excited about the long-term prospects of our portfolio. As always, if you have any questions or comments, feel free to reach out to me anytime.
Sincerely,
Aaron M. Edelheit