MedMen: Searching for value in a bull market for cannabis
Before digging into the topic at hand, it is important to make certain things clear. Call it a confession if you will. To begin, I don’t own any stocks that I am discussing today. Also, nobody is paying me to promote any stock or stock group. I enjoy the luxury of choice.
Equally important, I am a value-oriented investor. As opposed to a momentum investor that simply looks for what is hot at the moment, I look the same hot group and try to find good companies that have been overlooked.
Ask anyone close to cannabis and they will confirm that so far nothing could have made the start of 2019 any better than to have a boat full of cannabis stocks on New Year’s Day. Since then the NASDAQ has gained 7.7 percent and the S&P 500 7.5 percent. The HMMJ Index, however, has gained nearly 30 percent. The performance of the stock market, in general, has been punctuated by extreme volatility while cannabis stocks have been pretty much smokin’ hot and straight up.
Of course, this raises the question: is it possible that the cannabis stock price momentum will continue? Based purely on probabilities, the answer is no.
But considering the positive momentum in legalization, the accelerating pace of consolidation and the huge prices being paid for deals, there is a very good chance that cannabis stocks will be one of the best places to be this year.
Searching for value
In a deal driven environment financed largely with equity, companies whose stocks lag the performance of their peers are vulnerable to take over. Most deals thus far in the cannabis industry have been very friendly. But that cannot rule out hostile takeovers either.
The point here is that cannabis stocks, in general, are priced on their long term potential, not current profits. On this basis, it can be argued that virtually all cannabis stocks are overvalued. For our purposes, it doesn’t matter either way: the key is the value differential. This is what makes lagging cannabis stocks so interesting.
MedMen Enterprises Inc.
There are several reasons for MedMen (MMNFF) standing out. So far this month the stock has gained just 13.3 percent. That is good enough to beat the market but less than the performance of its peers. So a big price differential exists. During last years spike, the shares sold for over $7.00, twice the current price.
MedMen’s current market value at $1.4 billion represents a digestible size for the industries big guys like Tilray (NASDAQ:TLRY) at $6.7 billion, Canopy Growth (NYSE:CGC) at $15 billion, or Aurora Cannabis (NYSE:ACB) at $6.23 billion. The recently announced Aurora deal paying $132 million in stock for Whistler Medical Marijuana is a perfect example of effective use of overpriced equity.
FYI this translates to over $26.40 per gram of Whistler’s 5000 kilograms of production. Clearly, Aurora is paying dearly for the Whistler brand.
The Tilray deal with Authentic Brands was far more reasonable. Nevertheless, it only served to underscore the importance of the recreational cannabis market and the value of brand names. As a former Wall Street consumer products analyst, I am in awe of the power of brand names like Coca Cola, Levi’s, Apple, and Amazon.
This is where MedMen fits into my bias. Somehow the brand name resonates. Even though the brand is unknown in the vast majority of the world, somehow it touches all of the points that spell solid, healthy and hip providers of medical and recreational cannabis. Headquartered in the cannabis legal Culver City, CA, MedMen covers the vertical from cultivation, production, and retail distribution.
MedMen’s business is growing very nicely through 69 retail outlets in 12 states. Last June the company opened a store on trendy Abbot Kinney Blvd in Venice, CA. This is a showcase location, where the rents are so high that it is debatable if any retailer on the street earns much. It is a good example of solid brand building.
Fast growth means burning cash
In the first quarter of FY 2019, revenues grew tenfold to just over $20 million. Second quarter results are due any day. The average forecast is for a further doubling to $40 million reaching nearly $190 for all of 2019.
The company is sitting on $64 million of unrestricted cash. So you can’t ask for much more. But every company has their weak points and MedMen has several.
As of the first quarter balance sheet, there were $60 million in notes payables due in coming months. So all that cash is spoken for. Next is MedMen’s spectacular growth comes at a price. In the first quarter operations lost $63 million. This is not an indictment of management or its business model. Most young rapidly growing companies are no different.
But growth requires capital, and in the case of cannabis, MedMen’s style of vertical integration and brand building takes a bundle. None of this is to suggest that we have knowledge of deal talks, simply to point out value differentials. Oh yes, there is one other thing to keep in mind. There are only two Wall Street analyst publishing on the company so caution is advised. These two bulls have a one-year price target just about double the current $3.06 level.
Now that could offer some value.