Editors’ Note: This is the transcript version of the podcast we posted last Wednesday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast embedded below, if you need any clarification.
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Julian Lin: Making the tough calls, exiting very bad businesses, business segments, taking the near term hit in revenues but improving cash flows. That will be the most responsible and the most shareholder friendly thing to do.
Rena Sherbill: Hi, again, everybody. Welcome back to the show. It’s great to have you listening with us. Are you happy? Are you sad? There’s so many different things to update us all on, there’s earnings, there’s Safe Banking rumors, there’s states that did go legal, there’s states that didn’t go legal. The two biggest ones the ones that probably everybody wanted to go legal the most did. So that’s obviously great news. There’s a lot of rumors that Safe Banking will pass. There’s a lot of people thinking that those are just rumors.
And certainly, we’ve been led to believe that there’s rumors are not enough to rest our hats on, though certainly we are encouraged by any talk of progress. We certainly want progress to come.
Julian Lin, a stalwart of the industry, a friend of the podcast, a Seeking Alpha Market place contributor, who writes about many stocks, tech stocks, by focuses on cannabis with his Cannabis Growth Investor and cannabis growth portfolio on Seeking Alpha, which I would encourage all interested investors to check out a lot of really actionable stuff which is what Julian shares with us today.
You know, why he’s now bullish on the Cresco (OTCQX:CRLBF) Columbia Care (OTCQX:CCHWF) deal, why he is more convinced that it will go through. What we, as cannabis investors, should be wary of, should be looking at, gets into the MSOs. What we should be concerned about, what we should be focused on, gets into why he loves the REIT, NewLake Capital Partners (OTCQX:NLCP), He’s talked about that REIT before on the show.
He held a Twitter spaces with Anthony Coniglio, the CEO of NLCP. I would recommend investors listen to that. I did, it was very insightful. Look for more exciting developments from this space, from Seeking Alpha, from Cannabis Investing Podcast on Seeking Alpha, getting into some new things that I’m excited to share with our audience, with our CanPod family. So look for that in the coming days and weeks.
In the meantime, hope everybody as well as we move into these weeks and months of winter. Hope everybody is staying optimistic for those at MJBizCon.
Hope you are getting deals done and getting insights and sharing them and look forward to seeing what’s coming out of there. Talk to you soon. Alright, Julian, welcome back to the Cannabis Investing Podcast. Always a pleasure to have you on.
JL: Yes. Thanks for having me, Rena.
RS: I’d love to hear your thoughts kind of mid-November what you’re thinking of. We just had the midterms in the U.S. last week. How you’re thinking of this sector these days?
JL: As far as just my overall thoughts to the Cannabis sector in general, I think we’re definitely reaching a very interesting point amidst a rising interest rate environment. I think investors are right to be very disappointed obviously, the share prices keep falling down. But I think a big problem here is that while some of that reflects maybe some unwarranted multiple contraction, a lot of it may be warranted.
Just for an example, when typically, when stock prices fall so much, you really want to see these companies buying back stock. But the problem is a lot of these MSOs, they can’t buy back stock, just because they don’t have that free cash flow anymore. And maybe some investors might be thinking, oh, this is because of 280E taxes, or this is because interest rates are too high, or is it because operating expenses are too high with so many states haven’t yet come online.
While this is in part true for any — most MSOs, there’s not really so many profitable MSOs. Certain MSOs were very profitable. In particular, one of my holdings truly has been quite disappointing. That’s a stock ticker, OTCQX:TCNNF, Trulieve. They continue to be quite impressive. But at the same time, we got to think about before their acquisition of Harvest, they were a very, very profitable cash flowing operator even inclusive of 280E taxes and everything.
They were still generating robust cash flows, it’s hard not to imagine what if these MSOs did not go on a land grab, and they did not try to get bigger, but instead focus on just maximizing cash flows. In the current environment, they would be able to be repurchasing their stock at five, seven times EBITDA. This is — it would be incredible.
But instead, what happened is we see a lot of these companies, in general, all of the big MSOs over the past year or two years have been expanding their footprints to the detriment of their bottom lines. And I think a lot of our — a lot of investors, including myself, have definitely been taken by surprise at how disruptive this has been to their bottom lines.
Of course, while they were making these acquisitions, they were constantly discussing how accretive these acquisitions would be, especially on an EBITDA multiple basis. But then the problem has been, one, I mean, EBITDA may not translate to GAAP profits, but also the price compression has been far more severe than expected. So we’re seeing overall margin contraction lead to, I mean, this year, we’re seeing growth stagnate for most companies.
A lot of companies are seeing very minimal growth and cash flows are very slow or very cash flows are minimal. Right? Because these companies are still paying kind of 50% corporate tax rates. But the real kicker is that in order to fund all of those acquisitions over the past one or two years, they had to raise a lot of debt because they didn’t want to raise equity.
And, so now we’re in a rising interest rate environment where these companies have very large debt loads. They are probably — if the interest rates remain high, which it may, these companies may have to refinance their debt builds at very high interest rates. Meanwhile, they don’t have that much cash flow to service the debt. So it’s kind of a perfect storm for the MSOs.
RS: Do you feel like Trulieve, if we’re picking on them, especially because they’re one of the few that the deal actually did go through? Do you feel like if they could do it over again, they wouldn’t do the Harvest deal?
JL: So, again, I do own Trulieve. I still retain hope, but I think I — I mean, of course, given the sentiment, I got to be careful with what I’d say. I think, we have to be worried as investors that this might be Canada 2.0 where in Canada, what we saw was a lot of these companies growing, kind of so that they could justify higher salaries for their executive teams. Just because if you have a bigger revenue base, you could pay your insiders more.
As insiders I mean, as shareholders, when you see the stocks fall, this much, especially after all these acquisitions, you have to grow worried that that might happen, U.S. Cannabis, hopefully, that won’t happen. And also, CEO came reverse and their team have shown probably arguably one of the stronger commitments to margin and cash flow in the sector. So at least we could hope that they will continue to focus on margin.
But I definitely think given how they think about cash flow, they are definitely regretting it. I think this is the kind of team that would be wanting to repurchase stock right now when their stock trading this cheap, but they can’t. And then that’s probably a really terrible position to be in as a management team in the cannabis sector right now.
RS: Yes. Do you feel, like, with interest rates rising, that’s stopping a lot of companies that may have even though there were plenty of reasons to stop the deals even before the interest rate started rising. But given the fact that that’s happening now and it seems if we’re paying attention to the macro environment that we’re seen an end to that anytime soon. Do you feel like that’s stopping deals from being done right now?
JL: Well, of course. Actually, I think a lot of deals are still going to go through. For example, the Cresco Columbia Care. That was one deal I was very skeptical on just because of how many moving parts store were.
I think on our previous podcast, I also mentioned how from the beginning of the deal to when the deal will complete, it’s going to have some implication for how they do capital expenditures, just because they don’t know which facilities they will be keeping. But then there are those news that came out over the past month that I think did he — is how he goes by.
He made a purchase of many of the assets to create the first minority owned MSO. So that’s I think that announcement kind of signals that deal probably is pretty much going to go through.
I previously expected Cresco maybe get back out of it, but it doesn’t sound like they’re going to back out of it. On the other hand, we did see Verano back out of their deal to buy business growth. It does sound like maybe some of the deals breaking apart, maybe more to do specifically with the deals, in this case, maybe they lost their interest in the New York asset New York market.
Unfortunately, this may not be the best reasoning just because, like you said, I mean, maybe in a rising interest rate environment, that should have been more of a reasoning to be stopping deals just considering how much debt these companies have, and maybe they should be focused more on improving margins in a smaller footprint rather than spreading themselves too thin.
But, I mean, here we are.
RS: Yes. Here we are. I mean, speaking of Canada 2.0, those I mean, it’s right because those were the lessons of Canada. I mean, those were the lessons that, I guess, not everybody has learned. And I understand why they weren’t fully learned lessons because it was attractive to do these deals. Do you feel that the — well, I guess, do you feel like the facts on the ground have changed? And so the strategies have changed? Or do you feel like that kind of should have been the game plan from the get go, not grab and expand, but, be really smart and conservative with your cash?
JL: Yes. I think at least from my end, I definitely overestimated or underestimated the impact of price compression and overestimated the ability of these companies to realize operating leverage. So I had anticipated that, for example, Trulieve, not to pick on Trulieve, again, there are one of my core positions in the cannabis in my cannabis portfolio.
I had anticipated Trulieve to be able to realize margin improvements through the acquisition of Harvest, just because of operating leverage. But what is increasingly becoming clear is that in the absence of interstate commerce, we’re seeing these companies having to it’s not so easy for them to generate profits in each state.
And so Trulieve has being able to do it in Florida, but there’s certain reasons why they were able to do it in Florida. They have such a dominant retail footprint. A very very dominant retail footprint that isn’t replicated anywhere else in the country. So, yes, I definitely think it’s becoming clear that investors should temper their expectations for margins.
These are not tech companies, especially in the absence of normalization. If until cannabis becomes a very normalized product where the common person uses, between now and then, demand is going to be kind of minimal. So, the price compression is a real risk. And that’s going to stand in a way of margin expansion.
So I think definitely these companies as a shareholder, I am hoping that they are going to focus on cash flow, focus on exiting unprofitable businesses, for example, I don’t see any reason for these companies to be in California along a long held view of cannabis companies. I think they have to be in California because it’s the largest market. They have to be able to — the most important market they have to learn from there. I think you could do a lot of learning without spending millions and millions of dollars doing it.
You could just kind of just learn as an observer, and that would be better for shareholders. I think making the tough calls, exiting very bad businesses, business segments, taking the near term hit in revenues, but improving cash flows, that would be the most responsible and the most shareholder friendly thing to do. And it is for that reason where I say, do I like, Trulieve, Trulieve has been taking such steps to a lesser extent.
And so one reason why I’m not really — I still don’t hold stakes in a Trulieve or Columbia Care or stocks like that where they clearly excite themselves too thin. And it’s, and let’s put it this way. There might be a very — there may be many years before legalization happens. Between now and then, these companies are going to continue bleeding cash in the unprofitable markets.
As shareholders that it’s going to add up. You’re going to get dilution, you’re going to, you’re going to see debt increase the cash flows are going to decrease. It’s very expensive to be waiting for legalization in unprofitable markets.
RS: Case in point, Verano (OTCQX:VRNOF).
JL: Yes.
RS: They’re like, it’ll be less expensive for us to break this contract than or whatever they broke, but, to get out of it. And in terms of California, or it seems also that MSOs are taking that advice, getting out of California or not putting more money into it at the very least. Or you’re — you feel like that that’s kind of they’re kind of expressing that strategy as well.
JL: Well, not all of the MSOs are doing that, but I think at a minimum, they definitely should be exiting California. And I think, I guess it’s not clear to me that they’re being as aggressive as they need to be exiting these businesses. It seems like they’re still going on the Canada 2.0 path of trying to maintain as big of a revenue base as possible. Obviously, these are much better businesses in Canada. We’ve got positive gross margins, positive EBITDA margins.
That’s not the same in Canada even with Canadian companies trying to have a lot of alcohol businesses and non-cannabis businesses to improve margins. But at the same time, I mean, I guess put it another way with tech stocks crashing. Cannabis investors really need to be asking themselves if cannabis stocks are the best, most compelling options considering that tech stocks are available at more compelling valuation.
Like, perhaps before tech stocks crash so you can make the argument that there wasn’t a whole lot of undervalued growth available in the market. When tech stocks trash, I mean, tech stocks should undeniably, you considered a stronger secular book story than cannabis stocks just because of the operating leverage inherent in technology as well as there’s no 280E taxes. It’s much more liquidity, tons of institutional capital.
So given that there are more opportunity cost is much higher now, but now that tech stocks are so cheap. We got to be more careful with how we allocate capital in the cannabis sector. We can’t be just investing in every single MSO, because there’s no need to be — I guess there’s a greater urgency to be stricter with our money.
RS: So pay attention to where those MSOs are going. Who they are or are picking up? Would you say are salient things to look at? Where we’re sitting in this sector right now.
JL: Yes. And just being more specific right now, my country strategy is to focus on the MSOs that could generate free cash flow right now. So that’s the way I define free cash flow is you take adjusted EBITDA and you’ve subtracted again interest, tax, the maintenance expenditures. And that gives you an impression of the kind of free cash flow that it could generates right now that that’s including 280E taxes and high interest expense.
You definitely want companies that are generating cash flow right now, just because leverage is very high, interest rates are rising, and price compression is here.
RS: Makes sense. I think that’s a nice segue to talk about NLCP. One of the things is you know, they’re not focused on states like California. They’re not focused or they’re focused on limited license states, let’s say, in comparison with IAPR who is more focused on that. And that’s, I think, one of the things to like about them.
Let’s talk about NLCP in terms of you were on last time you were talking about NLCP and AYR. Talk to us a little bit about and the other thing that came up for me was the stock buyback, which they just announced a few days ago. So kind of all good things pointing to points on your strategy.
So talk to us a little bit about NLCP. You were on last time talking about them. Has anything changed for you or have you doubled down even further on something that you were talking about last time?
JL: Yes. U A Capital is definitely one of the more intriguing ideas in this sector right now. Just to refresher, it’s an internally managed cannabis REIT. So they’re the landlord of the cultivation facilities that a lot of the MSOs own and operate. For example, some of their larger tenants are, like, pureLeaf, Trulieve, Cresco Labs. MSOs make up most of their tenant roster.
And it’s very interesting. So because you lay capital trades OTC. It trades at a relative, a very large discount to innovative industrial properties. That’s IIPR. That’s a very well-known cannabis REIT. For example, at the time of recording, IIPR trades around, I think, around a 7% dividend yield. Or maybe stick a little less than that, whereas NewLake Capital is still trading at, like, a nine over a 9% dividend yield. And newly capital may even grow faster just because it’s much smaller than IIPR.
So it just gives you an idea of the growth this the valuation disconnects there. But the valuation disconnect is even more confusing when you compare the Capital to the stocks valuations of the MSOs. So I realize a lot of cannabis investors might be kind of razor focused on just the MSOs, and they’re very in love with the MSOs. They don’t want to invest in anything other than MSOs for a cannabis thesis.
But we got to understand that the landlord is higher on the capital stack than the tenants, which is MSOs. So in general, rent paid by the MSOs is a much more secure cash flow than the revenues from dispensaries.
And this is an important distinction because it means that like, capital should trade at much higher valuations than their tenants just because, I mean, another way to put it is, like, would you rather be the landlord of the McDonald’s or would you rather operate the McDonald’s Obviously being the landlord is going to be a much more coveted, a much more secure, much more predictable stream of cash flows.
So it deserves a higher multiple. But there’s a huge discrepancy because we have stocks like Trulieve trading around 13 times EBITDA. That’s not earnings. This is EBITDA. And again, Trulieve has a lot of — not to pick on Trulieve, but a lot of these MSOs have a lot of debt.
So actual income is very, very low, if not negative, but they’re trading at 13 times EBITDA. U A Capital Partner on the other hand is trading at around 10 or 11 earnings, not EBITDA, earnings. So you get this idea that NewLake Capital is trading significantly cheaper, and again, U A Capital does not pay 280E taxes.
They have basically no debt. I think they have, like, $3 of debt. And again, this is a cannabis REIT. So this is actually a business that can support a lot of leverage. Just to give an idea, realty income that’s not to grow, they have debt-to-EBITDA around 5.5 times to 6 times. That’s NewLake Capital has no debt. So that’s a future catalyst.
So NewLake Capital Partners is trading at 10 times earnings, whereas the MSOs are trading at like, more than 10 times EBITDA. if there’s a clear discrepancy there, NewLake Capital should be trading at a huge, huge premium.
And I’m not even sure you should be comparing earnings and be your EBITDA to begin with. But kind of, I guess, we could discuss the numbers that NewLake Capital posted. For example, in the latest quarter, they grew earnings, not revenue, but earnings by over 20%. That’s earnings per share, for real estate purposes, it’s adjusted funds from operations for sure. Just for those who are not familiar with REITs, FFO or funds from operations is very commonly used in the REIT sector as especially the net lease REIT sector.
Because for GAAP accounting, you have to write off depreciation and amortization of real estate assets, but NewLake Capital is a net lease REIT, meaning that the tenants pay for maintenance expenses interest and taxes of the real estate properties. So they don’t actually, depreciation and amortization is kind of — it’s really a non-cash charge for these REITs.
So it makes sense to be adding that back to get true earnings for Formula capital, and that’s whole FFO. So NewLake Capital grew their FFO by 20% sequentially or around 55% year-over-year. And — that’s incredible. So, they’re paying, they were able to grow their dividend for five straight quarters, basically, every quarter since they came public just because they keep growing. And this the growth machine is very impressive. All this thesis has about 2.7% annual lease escalators, meaning that every year these leases increase in rent by 2.7% automatically.
That’s significantly higher than the around the 1% to 1.5% annual lease escalator that’s typically seen at, like, royalty income or spare royalty in the traditional net lease REIT space. But they also have a very outsized 13% cap rate on acquisitions. That’s very high because cannabis is remains illegal on a federal level. So, the MSOs have very limited access to capital, so they have to accept very high interest rates on both debt as well as sell or leasebacks.
In comparison, royalty income, they’re acquiring properties at a 6% cap rate. So being able to acquire properties at such a high cap rate, 13%, It means that these companies can go really, really fast. You could just look at how fast IPR grew over the past couple years. There was many years where IPR was growing at a triple digit, every single year. Obviously, they were able to do that because their stock was so high, but it just gives you an idea for how fast they could grow.
And maybe a takeaway therefore investors in these MSOs is that, NewLake Capital could provide very similar, if not, faster growth in the MSOs just because MSOs cannot grow without real estate, they cannot grow without growth capital. They have to invest in more controlled cultivation facilities. They have to invest in more dispensaries. So NewLake Capital is going to go alongside with them while paying this huge 9% dividend yield.
It’s almost to a point where I would say that NewLake capital at these valuations offering that opportunity that MSOs investors were looking for the whole time.
RS: And I would say you spoke about this last time. And I see that this is kind of the next question that a lot of people have about REIT. And I think it behooves us to mention it at the very least is because it’s in the news so much, especially with, like, how the elections have been going is that a lot of people think Safe Banking is going to pass before the year ends. And a lot of people think or some people think I don’t know if it’s a lot of people.
Some people think that a Safe Banking passing won’t be good for these REITs. But as you mentioned last time, some of the reasons why it will be good for REITs or why it won’t matters because of how long their leases are. Is because of what that in terms of the tenants, there’s many years before, kind of Safe Banking, kind of would preclude the need for an outfit like NLCP that’ll be years down the line before they’re not needed.
So it’s — and also it ups the creditworthiness of the MSOs themselves. So maybe if you want to speak just if there’s any more points to add or more color to add to that in terms of with all this talk of Safe Banking, again, again, again, that people are starting to think about this. How do you see it playing in to REITs? And then also people that are allocated to the MSOs or the stocks?
JL: Yes, I think that’s definitely one of the more ironic things is that maybe a lot of MSO investors are avoiding investing in NewLake Capital or IAPR because of Safe Banking. So it’s ironic because Safe Banking is extremely, extremely bullish for NewLake Capital and IPR. Perhaps one could even say that the benefit that Safe Banking could have for MSOs has been overblown, but the benefits it has for the landlords has been barely underappreciated.
So, for the MSOs from our Safe Banking, it’s not going to necessarily bring in institutional capital. It just means that they could federal banks could work with these companies without fear of federal prosecution. But unfortunately, it does not. If same thing passes, it does not mean that debt just comes down all the way to 5% or 6%. It does not mean all of a sudden investors are going to buy the stocks like institutional capital or buy the stock. And I’m taking regardless about this thing.
Because a lot of the institutional mandates are not saying, oh, if say banking passes, we could do this, they’re saying, as long as cannabis is illegal federally on the federal level, we cannot invest in either the debt or the equity of MSOs. Safe banking does not necessarily fully address that. You’re definitely going to get some institutions that may be more willing to work and invest in MSOs, debt and equity stack.
But it’s not going to be the full wave that you might see upon a full decriminalization or a full rescheduling. But in regards to NewLake Capital, Safe Banking is something different. So, for starters, these lease terms have about 13 or 15 years left. Meaning that these companies, they can’t just walk up and leave and stop paying their capital. They’re on the hook 13, 15 years. And just to give you an idea of how these leases work, let’s say their property stops performing.
You can’t just be like, I’m going to give the property to you and leave. That’s not how these leases work. NewLake Capital already owns a property. So the leases are tied to the corporate. At the end of the day, the companies have to keep paying rent regardless. They would have to, like, file bankruptcy in order to avoid paying these leases.
And again, you can’t file bankruptcy in the cannabis sector. So, let’s say banking will do, but the benefits may be more modest for MSOs and we never know if it actually will pass. We’ve been on the hook for that for a very long time. For NewLake Capital, what it does is improves the tenant quality — the credit quality of the tenants.
And this is and very important when we’re looking at a multiple rerating. Because realty income is trading around a 5% dividend yield. The realty income is going to grow much much slower than NewLake Capital, a NewLake Capital is growing. It’s paying a 9% dividend yield. So what happens when the tenant credit quality of NewLake Capital improves, and it becomes clear that these tenants are going to keep paying rent, and NewLake Capital is going to keep paying a 9% and growing dividend yield.
Money talks. At the end of the day, like, NewLake Capital trades OTC, but it’s paying a growing dividend, people want yield. I see it rerating at least two royalty incomes trading or even better even higher just because it’s going to grow much faster than those traditional lease REITs.
So it’s just ironic whereas institutional capital, the smart money when they’re investing in IIPR or NewLake Capital, they’re viewing Safe Banking as a very bullish signal, but the retail investors for some reason view it, Safe Banking is very bearish for NewLake capital when in reality, they’re going to be the biggest beneficiary than the MSOs from Safe Bank.
But on the other hand, if Safe Baking doesn’t pass, you just get these the 13% acquisition cap rates continue, And I should also note that as interest rates rise, that 13% acquisition cap rate might continue rising. So something that investors might have heard is that REITs don’t do well in inflation. The REITs don’t do well when interest rates rise.
That’s only partly true. That is because REITs tend to have a lot of debts and their income doesn’t grow fast enough, as fast as their debt, their cost of capital increases. But in the case of NewLake Capital, remember, they have no debt. So rising interest rates is actually extremely positive for NewLake Capital Partners just because they’re not going to get hit by the increasing interest expense they have no debts, but they’re going to be able to acquire properties at much higher interest rates.
So you can almost view NewLake Capital as being a perfectly positioned. If interest rates continue rising, they’re going to grow even faster just because there’ll be more demand for sell these stocks.
And it’s going to be more accretive. And if interest rates fall, I mean, that 9% yield was just become super, super attractive in a low interest rate environment.
RS: And I think the other thing also to point out is that, something Anthony mentioned on your Twitter Spaces is that they have no defaults. Is that a lot of people point to the tenants and are they going to default or is there going to be a lawsuit? We’ve seen a little bit of that start to happen. Would you say that you like the tenants better?
And, again, this isn’t just to compare NLC to IIPR, but IIPR was a little bit in the news in terms of a lawsuit from a tenant. Would you say that you like the tenants better at NLCP than IPR?
JL: That’s a really good question. So, to be clear, I also like IIPR. That’s not as much as the increase the valuation. But IIPR is having some issues just because they unlike, NewLake capital, they did not focus unlimited license states. They had — for some reason, they’re very bullish on California. They still think that the low cost producers in California will be able to do very well. So they’re very rolling to allocate a ton of capital in California.
And you’re getting in trouble for that. And then when you — but let’s think about what’s going to happen to IIPR. So they were able to sell off, I guess, an underperforming asset in Pennsylvania at above their cost basis. As and in California, they’re already signed a letter of intent for a replacement tenant for one of the properties under development from Kings Garden and the tenant that’s not paying rent.
In general, that lease rates, when a tenant defaults and start paying stops paying rent, very important margin of safety is the fact that these landlords own the property. So it’s not like these properties value goes to zero. They could either find a replacement tenant which is the best outcome or sell off the property for some recovery.
And what we’re seeing at IIPR, even though they are in these weaker markets, they’re probably still going to get a pretty decent recovery on that on those struggling assets. And then let’s if we switch back to NewLake capital, they have greater exposure to MSOs. If you remember, these tenants, they can’t just cherry pick certain properties that did fall on.
So that’s why it makes a lot of sense to have greater exposure to MSOs as tenants. So because they have a greater focus on a limited license states, it’s much more unlikely for these tenants to stop paying rent. But even if they do stop paying rent, the recovery rate will be much higher just because these limited license state assets will be much more in demand.
So there’s a greater margin of safety on NewLake Capital. You can even make the argument that NewLake Capital should trade at significant premium to IIPR due to its greatest greater exposure to limited license states. But of course, for technical reasons, that may not happen just because IIPR is listed on the major exchanges.
RS: Just wanted to pinpoint the share buyback. I would assume you’re very bullish on that?
JL: So the share buybacks are quite interesting and very unexpected. Also, I mean, as a shareholder, I was already very happy with how NewLake Capital was reforming. I mean, I mean, look, if we want to talk about greed in the cannabis sector and talk about how, like, how all these companies, including them I mean, we already know about Canadian companies having very egregious salaries even though they’re losing so much money.
Even in the U.S. sector, a lot of these executives seem to they’re paying themselves very fat paychecks, okay, all while not really generating cash flows. When you look at NewLake Capital, they’re generating an 80% net margin. Tech companies, not even tech companies come close. If a tech company generates the 40% net margin, they are king of the hill, but NewLake capital is generating an 80% net margin.
Every property they acquire, it just flows through the bottom line. They don’t have to — remember, this is not, like, a business where they have to hire more people to grow the business. This is basically, it’s a bank. And just, like, underwriting loans and collecting rents. It’s a perfect — it’s a very lucrative scenario and you’re going to be a shareholder. But, so what NewLake has been doing every quarter is they just they grow earnings and grow the dividend.
I’m not sure how much better it could be. But then they announced a share buyback. So they announced this $10 million share buyback and just to give you some numbers. Based on the current that basically cash flow run rate and their current dividend run rate, incidentally over the next 12 months, if NewLake capital does not grow their dividend and does not grow their AF, their cash flows, they will have $10 million excess cash flow.
Basically, after paying a dividend, at $10 million of extra cash they could use to maybe repurchase shares. I’m not sure if that’s the reason they chose $10 million or just 10 is a nice number. It’s probably just because 10 is a nice number. We’re probably just, the idea that you get this idea that this company is super committed to investing in limit license states, returning cash to shareholders, and then they also recognize that their stock was cheap.
And they’re willing to occasionally repurchase shares instead of paying a dividend. I mean, this is just capital allocation, like, 8 plus 101. It’s incredible. Of course, it’s unclear they have to actually do it. Just announcing our repurchase is not the same thing as doing it. Given that the stock is already up around 10% 15% since earnings. It’s not clear if they will repurchase the stock.
But I think having the repurchase available is great, because when — I guess put another way. If the stock wouldn’t trade back to where it was trading before earnings, at some point, it was trading around $14.50. Or it was trading at, like, at 11% dividend yield. That dividend yield is very comparable to those 13% cap rates they might get on acquiring new properties. So they could repurchase stock and not really lose out compared to growing the business.
Basically the impact to the bottom line on a per share basis will be very comparable when they buyback stock versus acquire any properties. But on the other hand, if you get a company that’s paying a dividend, growing the dividend and repurchasing stock, in my experience, that tends to be a very efficient recipe for multiple expansion.
You don’t — there’s very, very, very few companies that, again, not to be repetitive, they pay a growing dividend. They have a very high dividend yield and they’re repurchasing stock. There’s very few companies like that that stayed cheap. Like, it’s almost like the law of physics in stocks.
Like, if you do all those three things and you could do sustainably and you do it over the long term, your stock must go up, if it doesn’t go up, then at some point, your stocks start yielding 25% or something. And, I mean, everyone’s spending in money. So yes, I was quite pleased to see the $10 million share repurchase, and I’m eager to see if they actually implement it.
RS: So a lot of bullishness. What do you — what prix the pin in this bullishness for you?
JL: Yes. So a lot of bullishness and definitely, we’ve been accused on sort of being a pumper. But this I was…
RS: I will still say, tell the people now. We’ve heard you on talking about them twice on Seeking Alpha. You’re on Twitter spaces. People are like, what does this guy want from the stock? Tell the people why you have invested, Julian.
JL: In some context, you got to understand that as an alternate Seeking Alpha, I’m probably one of the more passionate authors. I write very frequently on Seeking Alpha just because I love investing. When I find the stocks I like, I like a lot of undervalued stocks. I like to write about them, I like to talk about them. I like to recommend them.
And NewLake capital just happens to be it’s one of my largest positions. It’s an idea that I’m very optimistic on. Just typically, you have to sacrifice for a perfect investment. You can’t get both growth and yield. Or you can’t get both growth and value, then it’s very — or if you have growth and value, you might have a management team that’s not paying a dividend. It’s very rare to have everything there.
But I think you, like, has everything there, and that’s why I’m so bullish. But in regards to risk, I guess first we could discuss the risk of NewLake Capital relative to MSOs and then the risk overall. So, or maybe I first discussed the risk overall, the main risk to nearly capital is actually it’s not legalization, it’s not the criminalization. It’s going to be two things.
The first one will simply be, if cannabis in the U.S. ends up just being like cannabis in a candidate, where no one can make money, maybe you get these government officials thinking to themselves that cannabis is just helpful for everyone. So let’s just legalize it general, we don’t care about the illicit market, we just let everyone play in self-candidates. I mean, to be fair, that wouldn’t be all bad. I mean, for in terms of, like, the medical applications of cannabis, she cannabis, even if it’s sold by list operators, would be I mean it’s helpful for everyone.
But obviously, if you’re a shareholder like we are in the MSOs, you don’t really want your government officials to be allowing a listed operators to sell so much. And you want robust margins. You want your margins to be protected.
So, yes, it would be very bad for NewLake Capital. If their tenants stop start being so I’m being able to fill their rent obligations and they start having a lot of defaults.
Of course, I’m of opinion that cannabis is viewed upon as a growth sector, but I do think that over time, margins will stay stable just because Again, I’ve spoken many times before about how cannabis has helped me with my anxiety and insomnia. I view cannabis as being more prolific than Tylenol or alcohol. It’s just it’s better than anything we’ve ever seen.
When that happens, of course, I can see margins being very strong. But that may not happen for many years. And it’s possible that the tensile defaults. That would be the worst — that would be one of the worst cases. That’s one of the bare scenarios. The other bear scenario is if cannabis is not a pain anymore, which sounds weird. If these companies learn a way to grow THC, not to cannabis, but instead synthetically.
And this is an interesting one that I actually got through a call, call with a CEO, Coniglio, a private call with him. Where I had asked him what is the better scenario Again, he didn’t he said legalization is very bullish, but he said that for the main Black Swan event is if cannabis becomes, like, something you just grow synthetically. Because then you wouldn’t need cultivation facilities. I mean, obviously, for 15 years, these companies need to pay rents.
But after 15 years, no one needs a cultivation facility because they’re just growing these Cannabis THC in a lap. That would, again, that would be very good for consumers like myself, but it would be bad for investors and the real estate. And it probably will also be bad for the MSOs just because that would imply cost of the price a lot of water price compression.
But kind of returning back to relative risk of NewLake capital to MSOs. So there — if you think about it, there isn’t really a situation where NewLake Capital goes under, goes bankrupt, or does poorly, and the MSOs do well. Could ask the landlord, if the landlord is not doing well, it implies that the MSOs are not paying rent. If the MSOs are not paying rent, their stocks are probably really, really close to zero.
So at the downside, NewLake Capital has a lot less downside because even if the MSOs don’t do well, let’s say the MSOs, they just tread water. They can’t grow their bottom line. Revenue growth is kind of okay, but because of price compression, EBITDA never grows. In that scenario, they would suck to be a shareholder of these stocks just because they’re dead money.
But if you’re a shareholder of NewLake capital, you still get rents and you still get paid and the rent keeps growing and it still get paid a growing dividend.
The bullish thesis for NewLake Capital remains intact even if the MSOs do very poorly. And it’s like if MSOs do very well, then NewLake Capital also does very well because their tenants are doing well. So it deserves a greater multiple.
And again, NewLake Capital will keep growing in line with growth. I would say the one way that NewLake Capital underperforms the MSOs is by hype. That is — we saw an example of that a couple weeks ago when President Biden announced some intentions to reschedule cannabis. We saw that many MSOs like, for example, AYR was up 50% that day. And Trulieve was up, like, 30%, 40%. Just I wouldn’t even say that day, I would say in an hour. These stocks soared, and that that’s pure hype.
NewLake Capital. Even though I am super hyped on it and even though I think the fundamental picture is great on it, I mean, I am going to admit that other people may not have to may not share the same hype for the stock. So there is that one scenario where let’s say, maybe, say, banking passes or something happens that drives a lot of hype.
U. A. Capital may not it’s not going to it’s I won’t say, may not. It just won’t soar, like the MSOs would for that split seconds, I would say. That that that could be a risk.
Yes. I would say, like, if you’re really just hoping for that Hail Mary, you’re hoping for MSOs to suddenly soar 200% overnight. In that scenario, NewLake Capital is not going to go up 200% overnight. That would be the one scenario, I could see NewLake Capital underperforming MSOs. But if you just think about how I think NewLake Capital will perform over the long term, you get this you have a 9% yield. I can see the yield growing sustainably at maybe average, let’s say, average 25%, 30% — 20% 30% rate annually, at least for a decade.
And I see the multiple — I see the dividend yield compressing to 5%, 4%, 3% over time. So when you combine the high yield, the growth and the multiple expansion, and just basic mathematics. I mean, you’ve been looking at over 10 times returns in 10 years. And that’s just how the math will work. And that kind of return profile is very similar to what you might expect from the MSOs.
If you’re investing the MSOs at this point, you are hoping for some big returns, but if we’re being realistic, if you’re not focused on hype and you’re, like, you’re assuming these stocks these MSOs trade at maybe three times EBITDA. I think that might be generous at this point considering how much debt they have and so forth.
Even if you’re assuming that the MSOs trade at three times EBITDA at some point, when you factor in, how slow the growth is seen. It’s not clear that the MSOs won’t even generate that kind of return from here. So again, I am sounding extremely bullish on NewLake Capital. But I guess another way to put it is everyone knows you can’t have higher returns with lower risk. That’s, like, that’s an important theory in in investing.
But in this case, if you’re just comparing NewLake Capital to the MSOs, it’s potentially offering higher returns and it’s without it as old as just because it’s a landlord. When you have this idea for higher returns, lower risk, or simply higher returns from a majority of scenarios. Again, excluding the one hype scenario where it might underperform, perhaps you start to understand why I’m just so bullish on NewLake Capital.
And NewLake Capital for full disclosure is the largest position in my Canada’s portfolio. I mean, for obvious reasons, honestly.
RS: Yes, definitely want to watch and keep our eyes on. We’ve had our eyes on it for a while, keep our eyes fastened to it, see where it goes. Thanks, Julian. I appreciate you sharing all your insights about it and trying to get the message out there.
Anything you want to say before we leave things this time.
JL: Like I said, again, I apologize if I came off very bearish on MSOs. I emphasized I do I still own a sizable stake in certain MSOs. But I think considering where NewLake Capital is trading relative to MSOs, my bullishness is definitely much more focused on that landlord.
RS: And would you say aside from it being your biggest, the biggest part of your portfolio, would you say in your eyes it has the best risk reward ratio?
JL: Oh, easily. Yes, I think considering that it’s — I see it delivering higher returns most of the time and farthest downside, just because it’s the landlord. I can’t stress enough how unusual it is for the landlord of these MSOs to be trading so cheap relative to the tenants. That’s something that just does not quite add up.
RS: And sorry. I said that I would let you go, but let me ask you this. How do you think it gets back to, like, a fundamental price? What do you think checks the stock?
JL: Sure. So I think that at the end of the day, for example, some people when they think about a catalyst, or they’re invested in maybe an Apple stock or something. They’re hoping for some great innovation to lead to some to be a great catalyst. They’re hoping for company to invent water or something. But in the case of NewLake Capital, no innovations needed. I said this before, at the end of the day, money talks.
They’re paying actual dividends. The dividends are fully supported by growing earnings. That the most important catalyst over the past centuries of investing in stocks has always been a growing dividend.
You’re not going to find, I challenge to any listener. You can’t find a stock that pays a growing dividend a sustainably growing dividend, and it stays cheap over or forever. That just that never happened. I’m quite able to say that just never happens because at the end of day, cash — money talks.
So between the growing dividend and the share repurchase program, I think those are going to simply those factors are enough to meet the stock to be raised.
However, if I’m pressed for, like, a specific technical catalyst, I think the election I think it’s possible that the elections and just time will be the issue. It’s possible that some investors were hoping for greater clarity in regards to how, like, legalization might happen or how much controlled democrats might have of the chambers.
I mean, even again, even though, again, this is ironic, sort of how — if you ever noticed how stocks kind of go up regardless of which party wins the government. So, they might have gone down — they might have went down before elections, but they go up regardless if Democrats to or Republicans when it’s very similar.
I think in this case, regardless if, say, banking passes or if it doesn’t pass as long as there’s a resolution on that, that actually might be the main catalyst for NewLake Capital to go higher. That’s probably going to be that’s. I would say that’s the most likely catalyst.
RS: Thanks so much for listening to The Cannabis Investing Podcast. Subscribe or follow us on Seeking Alpha, Libsyn, Apple Podcast, Spotify or Stitcher and we’d really appreciate it if you left us a review on Apple Podcast. It helps other investors find our show and makes us feel fantastic.
If you have feedback or questions, we’d love to hear from you at rena+canpod@seekingalpha.com. Nothing on this podcast should be taken as investment advice of any sort. I’m long Trulieve, Khiron, Isracann Biosciences, The Parent Company, Ayr Wellness and the ETF MSOS. Subscribe to us on Libsyn, Apple Podcast, Spotify or Stitcher. Thanks so much for listening and see you next time.
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