Ivan-balvan
The following segment was excerpted from this fund letter.
We are invested in small and microcap stocks. Despite not using leverage, these stocks can whip around, especially if there is a lot of volatility and if there is a big selloff. Further, we have investments in cannabis stocks that “touch the plant.” This means they are even more illiquid and have an abnormally large retail investor base, since most institutions cannot own cannabis stocks.
I believe the market is wrong about one of our investments: Glass House Brands (OTC:GLASF). The company reported in November soaring revenue and margins for their third quarter as they turned on their “Ferrari” of a greenhouse. Even though, they reported losses, the fact that they reported soaring gross margins at a time of such deep distress in California when other companies were reporting negative gross margins, proved our thesis that their unicorn of a greenhouse gave the company significant competitive advantages. But even further, our thesis is also that cannabis prices in California were far below the marginal cost of production and that California cannabis was going through its “negative crude oil price” moment. The stock with this as a backdrop nearly doubled from its lows as of the end of November.
We have done a tremendous amount of due diligence on the California cannabis market and are very confident in our understanding of the supply and demand situation. I was surprised when Glass House fell 51% in December due to the broader SAFE Banking related news. Why was I surprised? Because California cannabis prices were rising in December when they should have been falling. December is normally a time when prices should be falling due to excess supply from outdoor harvests that have been cultivated in what is known as “Croptober.”
And here we are near the end of January, and prices are bouncing materially higher. Multiple private operators tell me that prices are up at least 30-40% from the lows in September. If you read most commentary from brokerage reports or other investors, there is a belief that prices are “firming” and that prices are increasing slightly.
Here are a few quotes I heard from various cultivators in California in the last week:
“I wish I had more inventory. I don’t have any.”
“I am selling flower faster than I’m growing it.”
“I think we see $800 greenhouse flower by June.” (Note, it was around $375 in September)
I wrote a post about the looming inventory shortage of cannabis in California on January 12th. and wrote that we should be seasonally awash in cannabis flower inventory right now. We are not and there will not be any material supply response until at least November or the next major outdoor crop harvest.
But because prices are still not where they need to be for most farmers to make money and there is still no capital available (especially after SAFE failed to pass), farms are still going out of business, cutting back and not renewing licenses. Since I wrote my post two weeks ago, another 700,000 square feet of cultivation has not renewed their licenses and I estimate another 6 million square feet will leave the market by September, though it could be as much as 18 million square feet! In summary, the supply situation continues to worsen, as prices bounce higher.
On the other side is Glass House, which should produce 300,000 pounds of cannabis biomass this year and is only utilizing 20% of its available capacity. Every $100 per pound increase in biomass pricing goes straight to Glass House’s bottom line in the form of an additional $30 million in cash flow. In September, Glass House was selling biomass for around $200 a pound. I estimate that they are now selling it for approximately $275 a pound, and with prices that will have to keep rising or much more supply will come out of the market. At some point, something has to give, and you could have soaring prices.
And Glass House will doubly benefit from flower prices rebounding because there has been tremendous competition on the CPG side of their business, which has struggled mightily. Smaller startup CPG companies have popped up and profited from the extremely low-priced flower, thus enabling them to offer inexpensive CPG products made with that flower. Since those newer CPG companies don’t control supply, these competitors will be squeezed as prices go higher, which should finally provide relief to Glass House’s struggling CPG business.
Finally, Glass House completely re-engineered and reformulated its PLUS line of gummies, introducing a nanotechnology fast acting gummy, a solventless gummy, strain specific gummies and substantially improved packaging and branding. Remember that PLUS was a distressed asset when Glass House took the company over, and they have finally finished its overhaul. The PLUS re-launch was completed late in December, and we should start to see real benefits of the new, improved PLUS line as the year progresses. Early consumer feedback has been positive, especially from their strain specific line of gummies.
But then on top of this, right before I was to send out this report, news broke that California was moving on interstate commerce. Specifically, California’s cannabis department that reports directly to Governor Newsom asked the California Attorney General Rob Bonta to issue a decision to allow cannabis interstate commerce sales. There is a lot to this news, which I plan to write on soon, but the summary is that I think this news spells the beginning of the end of interstate commerce restrictions. This of course has enormous implications for Glass House, which cannot sell cannabis across state lines. There are interstate commerce scenarios, in which Glass House could earn more than $5 per share in annual cash flow. That’s twice the current price of the stock.
For all those reasons and despite being frustrated at the panicked selloff in Glass House, I remain resolute in not only that things are getting better for the company, but the upside remains enormous despite how the stock performed in December. We not only own Glass House common shares, we own warrants (which increase our volatility up and down but give us significant upside) and preferred equity which is paying us 20% a year.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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