Ready or not, the marijuana industry is budding before our eyes. Just 13 days ago, Canada made history by becoming the first industrialized country in the world, and only second overall behind Uruguay, to wave the green flag on recreational marijuana. When the industry is fully ramped up, it could be generating $5 billion or more in added annual sales, above and beyond what it was already bringing in via medical cannabis sales and exports.
This legalization also marks what's expected to be a notable shift in marijuana stock investing. Long gone are the days of pot stocks ascending to the heavens on capacity expansion and deal announcements. With adult-use weed now legal in Canada, the time has come for publicly traded marijuana stocks to deliver tangible top- and bottom-line results that investors can sink their teeth into.
Last week, on Thursday, Oct. 25, upscale cannabis retailer and grow-farm operator MedMen Enterprises (NASDAQOTH:MMNFF), which is focused on the U.S. market, became one of the first pot stocks to report its operating results in this new investing environment. While MedMen delivered impressive top-line growth, certain aspects of its income statement could have some investors bolting for the exit.
MedMen delivers rapid top-line growth
For the company's fourth quarter, MedMen recorded $20.6 million in sales, a more-than-1,300% increase from the $1.5 million in sales it reported in Q4 2017. The reason for the big jump? Aside from increased demand in existing retail stores, a number of the company's retail locations came online over the past year (13 were operating by the end of Q4). In total, MedMen reported average sales of $6,257 per square foot in its stores, which handily tops the $5,546 per square foot that tech kingpin Apple brought in, according to a 2017 report from eMarketer and CoStar.
For the full year, sales increased by 1,390% to $39.8 million (mostly thanks to its eight California locations), with the company reporting more than 700,000 sales transactions.
But what's arguably the most exciting recent development for MedMen is the company's announced acquisition on Oct. 11 of PharmaCann in an all-stock transaction valued at $682 million. The duo have similar business strategies, which includes growing medical cannabis and opening retail locations in states where medical pot is legal. Since the U.S. federal government maintains its restrictive Schedule I classification on marijuana, interstate transport of cannabis isn't allowed. This means vertically integrated retailers like MedMen and PharmaCann have had to operate grow facilities within the states they also have a retail presence. Assuming regulatory approval of the deal, which is expected to close in six to 12 months, MedMen will have licenses for 67 retail location in 12 states, along with 14 grow facilities.
Two fundamental figures that should worry marijuana investors
From a strictly growth perspective, which is how most marijuana stocks have been judged up to this point, it was a pretty solid report. But when we also take fundamental performance into account, it was a train wreck.
To begin with, pretty much everyone knew that it was going to cost MedMen a pretty penny to construct new retail locations and expand its presence into new states. But when the ink is finally put onto paper, it's surprising just how much the company lost on an operating basis in fiscal 2018.
As noted, MedMen generated $39.8 million in sales for the year, and its cost of goods sold was $26.7 million, working out to a gross profit of $13.1 million, up from $0.9 million in fiscal 2017. However, operating expenses soared, with general and administrative costs rising to $98.2 million from $14.1 million year over year; sales and marketing costs hitting $7 million, up from $0.3 million; and depreciation and amortization expenses quadrupling to $5.3 million. All told, MedMen logged $110.4 million in operating expenses, not counting the $5.3 million it had in interest expenses. Its net loss for the year hit $112.3 million, before one-time adjustments. That's a lot... and it probably signals that MedMen isn't going to be profitable anytime soon.
Just as worrisome is the company's cash flow statement. MedMen ended the year with $79.2 million in cash and cash equivalents and $81.4 million in current liabilities (i.e., payments due within the next 12 months). Although the company closed a $77 million senior secured loan in early October and generated $65.7 million from a bought-deal offering on Sept. 27, 2018, it wasn't on track to have enough cash to make ends meet had it not taken these capital-raising steps. And, mind you, selling common stock is a dilutive means to raise money since it can weigh on the value of existing shares and make it that much more difficult for the company to earn a meaningful per-share profit.
In short, MedMen is spending -- and losing -- a lot of money right now, and this probably isn't the last time we'll need to see the company turn to a stock sale in order to raise capital.
Making matters worse, the PharmaCann transaction is an all-stock deal, which means MedMen's 441 million outstanding shares could soon balloon much higher. This is a company with a business model and strategy I can appreciate but that has far too many fundamental flaws to be investment-worthy right now.