Big things are afoot in the marijuana industry. Having long been considered a taboo industry, cannabis is no longer that.
Last year, Canada became the first industrialized country in the world to give the green light to recreational marijuana, and a handful of U.S. states continued a trend of state-level medical and/or adult-use legalizations. Throughout North America, Canada is legal medically and recreationally; Mexico is legal medically and is seriously considering adult-use legalization this year; and two-thirds of all U.S. states have approved some form of pot legalization, despite the federal government maintaining its Schedule I classification on the drug. It's a dramatic turnaround for the industry in a short time frame, and it bodes well for long-term pot stock investors.
The big question is: What marijuana stocks to buy?
One of the most popular names, especially downstream in the cannabis supply chain, is MedMen Enterprises (MMNFF -3.39%). MedMen, which operates roughly 20 dispensaries spanning five states at the moment, but has far bigger aspirations, offers plenty of reasons to be a buyer. Then again, there are a fair number of reasons to avoid such a high-profile, vertically integrated dispensary. Let's take a closer look at the arguments from both sides of the aisle.
Three reasons MedMen is a smart long-term buy
Arguably the most compelling reason to buy into MedMen is the company's proposed $682 million acquisition of privately held PharmaCann. Once the transaction closes, pending regulatory approval, it'll leave MedMen with 77 retail licenses, 16 processing facilities or grow farms, and a presence in a dozen states. Prior to this deal, it was on track for around 50 retail licenses in six states, with five processing facilities or grow farms.
The reason acquisitions are such an attractive pathway to growth in the vertically integrated dispensary space is simple: Time is money. The dispensary space relies on legalized states to issue cultivation and processing licenses, as well as sales permits. In some instances, it can be quite costly and time-consuming to go through the approval process for these steps. Knowing this, MedMen did the smart thing by scooping up PharmaCann, which already has a number of retail, grow, and/or processing licenses in place. This is going to save MedMen time and money as it attempts to expand across the United States.
A second reason to consider MedMen as a stock to hold for a long time is the company's successful branding. One of the hardest things to do in the early stages of the legal cannabis movement is stand out -- and MedMen's stores are having little trouble doing that. MedMen is normalizing the cannabis buying experience and has, in many instances, targeted a more affluent consumer who is less likely to be impacted by fluctuations in the U.S. economy. This strong branding has led MedMen to higher sales per square foot than retail monsters like Apple, Tiffany, and Starbucks.
Third and finally, even though Canada beat the U.S. to the punch and legalized recreational marijuana first, investors might be overlooking the fact that the U.S. is a considerably larger market with roughly nine times the population of Canada. This means MedMen is positioned in a market that offers much higher long-term annual sales potential ($80 billion in the U.S. versus $10 billion in Canada). With the company expected to push heavily into Florida's lucrative medical marijuana market and expand its existing base of nine locations in California, sales growth should remain high for MedMen.
Three arguments that'll have you fleeing MedMen's stock
Then again, there's plenty not to like about MedMen. To begin with, investors are going to be putting up with significant losses for quite some time. Sure, opening new stores means sales head higher, but MedMen (and its peers) are busy expanding their retail footprint without regard for bottom-line results at present.
When the company reported its fiscal first-quarter operating results in November, they were ugly. Even with sales growth of close to 1,100% from the previous year, MedMen lost $63.3 million on an operating basis. This included a more-than-tenfold increase in general and administrative expenses tied to construction and new store openings, and a substantial jump in sales and marketing expenses. It would not be in the least bit surprising if MedMen was to lose in excess of $200 million on an operating basis in each of the next two years as its growth-at-any-cost strategy takes shape. That makes it off-limits for fundamentally focused investors.
Secondly, acquisition-based strategies, such as that being implemented by vertically integrated dispensaries, could backfire. We witnessed last week the dangers of overpaying for a business and lugging around significant amounts of goodwill on a balance sheet. The same could prove true for buyout-focused U.S. dispensaries.
For instance, iAnthus Capital Holding (ITHUF) recently completed the largest U.S. deal to date by purchasing MPX Bioceutical for around $600 million. (This deal will be eclipsed by MedMen's purchase of PharmaCann, once that deal closes.) Though it's unclear what sort of premium iAnthus paid for MPX Bioceutical as of yet, a quick glance at iAnthus Capital's balance sheet shows that 55% of its total assets are currently tied up in goodwill. Since the dispensary space will presumably have plenty of competition, it's unclear if iAnthus (or other acquisition-hungry dispensaries) will be able to recoup the premium it's paid to buy other businesses. This leaves the door open for hefty future writedowns.
Last, but not least, the black market is a bigger problem than most folks might realize. California, which had initially projected tax revenue of $643 million in its first full year of recreational weed sales, managed to only net about half that amount. Some of the state's issues are tied to regulatory red tape, with a potentially bigger part of the problem being the Golden State's exorbitant tax rate of up to 45% on retail sales, depending on the locale. This tax rate on legal weed is clearly chasing some consumers back into cheaper black-market channels. If these illicit producers don't cede nearly as much market share as expected, sale and profit projections for MedMen and its peers could come way down.
Now that you've heard both arguments, the only question left to answer is: Which side of the aisle do you stand on when it comes to MedMen?