Verano: A Profitable Cannabis Stock Trading At A Discount

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My five-year cannabis investment plan, published recently on Seeking Alpha, included this: “Only invest in a new name if a company demonstrates superior management capabilities. This should be a rare occurrence.

The first such event occurs just weeks after the plan was released. Recent research led to an investment in Verano Holdings, whose management, unlike most cannabis companies, has already brought it to consistent profitability.

Verano the company

Verano went public on 2/17/2021 as part of a reverse takeover of Majesta Minerals. At the same time, they merged with Alternative Medical Enterprises, which had cannabis retail assets in Arizona and Florida. Although relatively new to the national scene, Verano had been operating in Illinois since 2014 as a medical marijuana operation. Verano currently has 89 operating dispensaries and 12 cultivation and production facilities in eight states.

Verano focuses on two particular strategies. First, they want to be known for their premium cannabis, which has higher margins, less competition, and sets them apart. Second, they focus on limited license states, like New York, Illinois, and Minnesota. Operations in limited license states are generally more valuable due to reduced competition.

Verano went on a wave of acquisitions, acquiring 10 companies and three more in development. While I’m generally skeptical of the growth-by-acquisition strategy, I think it’s a plus for Verano for the reasons discussed later in this article.

Verano the company

Verano’s financial performance for the past seven quarters is as follows. All figures in millions USD.

Q1 2020

2020 Q2

2020 Q3

2020 Q4

2021 Q1

2021 Q2

2021 Q3

Income

66059

75188

100549

113043

143297

198297

206828

Gross profit

50445

43069

68956

61288

88693

100129

133369

Gross margin

76.40%

57.30%

68.60%

54.20%

61.90%

50.40%

61.90%

Net revenue

71676

25700

81612

65651

125573

6830

103715

Adjusted EBITDA

41372

24873

55648

48384

75047

81474

110697

Net income is presented because readers expect to see it, but it is not a good measure of short-term performance because accounting standards require something called “fair value of biological assets”. An explanation of this term is beyond the scope of this article, but suffice it to say that it causes large fluctuations in the net income line unrelated to underlying performance. The “gross” is evident throughout the net income line above. Accounting geeks can get the whole story at New Cannabis Ventures.

The important lines are revenue, gross margin and adjusted EBITDA. The numbers there show consistently impressive performance before and after their IPO in February 2021.

Why Verano

Verano stands out because it makes profits. This is currently my main indicator of superior management in this sector, and superior management is my main reason for investing in cannabis companies. There are very few companies that have achieved this, Green Thumb and Trulieve being the others, and this is important for three reasons. First, it shows that management has the ability to create profits. Second, it shows that profitability is a top priority for management, as it should be. Third, it reduces reliance on dilutive equity and heavy debt.

There are also other reasons to invest in Verano.

  • As a relatively new company (only four quarters since its IPO), many investors are relatively unfamiliar with it. The more attention it attracts, the more investment money it will attract, especially since it differentiates itself more by its performance. As the following table shows, companies with a similar market capitalization are followed much more:

  • The dual strategy of aiming for the premium market and focusing on limited license states seems solid. I have no particular genius for identifying winning cannabis business plans, but many experts advocate the limited-licensing state strategy. Canna Advisors’ Jay Czarkowski explains why on a recent cannabis investing show, just like Jesse Redmond at Green Giants

  • As mentioned above, the benefits allow for an extra degree of flexibility and independence.

  • The stock price is low and disconnected from company performance, making it an opportune buy.

Acquisitions

By the end of this quarter, Verano will have made 13 acquisitions in a year and a half. I’m skeptical of companies that use acquisitions as their primary means of growth without any profit (I’m looking at you, Curaleaf). Verano’s situation, however, is different. First, their growth has a strong organic component. Second, in my view, a company with profitable operations can incorporate its successful business practices into acquired businesses. That’s the theory, anyway. The growth of a profitable business is far more valuable than the growth of an unprofitable business. Third, the cost of acquisitions can be less leveraged because they are cash flow positive and can be partially self-financing. The cash position (and generally strong balance sheet) also allows for a lower interest rate on borrowed money, such as the $100 million at 8.5% just announced. Acquisitions are always a risk, but the risk can be less when approached correctly.

Specific investment strategy

Referring to my five-year plan, guideline number 2 is “Add positions gradually and slowly, with a preference for smaller positions”. I’ll start with a half position, adding more over a few months.

I will create my Verano position by buying shares of Goodness Growth (OTCQX:GDNSF). that Verano is in the process of acquiring. Based on the terms of the deal of 0.22652 Verano shares for each GDNSF share, GDNSF is trading at a 9% discount to its Verano value:

  • Current GDNSF price: $1.99
  • Divided by the conversion rate: 0.22652
  • Verano implied price: $8.78
  • Current Verano price: $9.65
  • Discount: 9.0%

If the acquisition does not go through, GDNSF shares will fall to their pre-announcement level, perhaps -20%. However, given that Verano has successfully completed ten acquisitions, the likelihood of such an event is low.

Risks

As with any emerging high-growth industry, there are significant risks. The year-long fall in stock prices could continue indefinitely. Longer term, robust growth expectations hinge in part on favorable government action on decriminalization, deprogramming, banking, and FDA approval. There can be no assurance that any of these events will occur. With regard to Verano specifically, the active expansion phase presents a certain risk. Although it has always been profitable as a small business, there is no certainty that its expansion will be successful. Even with such risks, I believe Verano is better positioned to succeed than most players in the industry.

Abstract

When a profit-making cannabis company appears, it is a rare occurrence that warrants further study. It’s a sign of a company with the right priorities and possibly top management in an industry where top management is especially important. Verano is such a company. It’s a particularly good time to invest because Verano is under-tracked, the stock can be had at a discount through Goodness Growth and prices across the sector are depressed. In an industry where volatility reigns and companies find their way in a very fluid environment, Verano is a valid candidate as a long-term investment.

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