Got EBITDA?
Well regardless, if you are in operator in the Cannabis sector in 2025, it almost assuredly matters not…
Let’s all agree that 2024 will go down as one of the worst years in the history of the cannabis industry and spend not a minute more reflecting on it or its’ multiple failures and shortcomings. By the same token, let us collectively agree to stop gazing forward and convincing ourselves that Washington D.C. will deliver some panacea by way of re-scheduling, de-scheduling, safe banking or otherwise that will cure the industry of all its’ ills. As operators and/or investors in the sector, let us instead deal with the present circumstances and agree what we should expect from the industry’s top performing businesses.
From my perspective, the sole and exclusive focus of managers in the sector should be the maximization of “after-tax cash earnings”. For a host of reasons that I am happy to debate with anyone offline (as it requires a longer conversation), earnings before interest, taxes, depreciation and amortization, or “EBITDA,” and worse, its delinquent little brother, “Adjusted EBITDA,” are not useful metrics in the cannabis sector at this point in time. A cursory perusal of the financial statements of the industry’s publicly traded companies makes it painfully obvious how little EBITDA, adjusted or otherwise, converts into cash flow available for investors, either by way of principal payments on debt or dividends to equity holders.
Of course, it is true that companies across the industry have used different financing sources to build out their businesses, and these capital structure choices do affect after-tax cash earnings. By way of a simple example, assume three companies identical in every material respect but Company A started with a $30mm equity investment, Company B started with a $30mm debt investment and Company C started with a $30mm leased operation (e.g., sale leaseback). In this simplified case, Company A will have higher after-tax cash earnings as compared to Companies B or C, as A’s earnings would not be burdened by either interest or rent payments.
But how we got here no longer matters. Company A that was financed with all equity is indeed more financially sound and consequently more valuable than the other two, period, full stop. Company A may not have been the best steward of capital, and its investors may be disappointed with the “return on capital” they receive relative to their initial expectations, but that is neither here nor there. In this world, one in which literally only the strongest will survive, I personally would only bet on those businesses with the most after-tax cash earnings compared to their competitors.
The industry is maturing and our expectations of it need to evolve as well. Can the U.S. Cannabis market still even be considered a high growth industry? The answer is probably NO in regard to “state-legal” cannabis. For the near future, growth in state-legal cannabis will come almost exclusively from new medical markets (e.g., Nebraska) and markets transitioning to adult-use (e.g., Ohio). These revenue gains will be largely offset by revenue declines in mature markets (e.g., all legal markets west of the Mississippi) driven by price compression and unfair competition from “Farm Bill Weed.” Therefore, we can not simply grow our way out of this mess, we need to earn our way out of it. Marginal players need to face facts, take their losses, and fold up shop. The strongest players need to consolidate their markets, stop whining about “Farm Bill Weed” and focus on how to broaden their customer base and increase the share of their customers’ wallets... think new product offerings focused less on THC content per dollar spent and more on customer utility per dollar spent...
The good news is the industry should have relief from 280E this year which would materially increase after-tax cash earnings for nearly every industry participant. Moreover, even without a legislative fix such as SAFE Banking, the cost of capital in the industry will continue to decline as markets mature and “perceived” risk improves as a consequence. But none among us should rest on our laurels. Live in the present and be the best you can be as measured against the only score that really matters – after-tax cash earnings.
In our next edition I will force rank the sixteen or so publicly traded plant touching operators in the US based on their after-tax cash earnings. Stay tuned….
