kmatija
Glass House Brands (OTC:GLASF) operates enormous cannabis greenhouses in California. Their product is high-quality, but also well positioned on the cost curve, with a target cultivation cost of $100/lb (currently around $130/lb). They believe they can produce around 270,000lb of biomass a year on their current run rate. However, they plan to continue to grow their production footprint to closer to 500,000lb by 2024 and perhaps beyond that to around 1,000,000lb as they build out six vast greenhouses in Southern California.
Monte Carlo Model Valuation
The economics here appear compelling but are hard to estimate with certainty. Here are some assumptions I have used in a Monte Carlo model for estimating annual profitability.
- Wholesale pricing: $1,000/lb-$350/lb (current averaged spot is $1,000lb)
- Cultivation costs: $140/lb-$90/lb (company’s target is $100/lb)
- SG&A costs: ~60% of sales today (+/20%), but falling to ~25% (+/-20%) of sales in future with increased scale
- Tax rate: 25% (cannabis producers have several tax disadvantages)
That model yields the following estimated net income:
| Production scenario | 270,000lb (current) | 500,000lb (~2024) | 1,000,000lb (full build out) |
| Net Income (average) | $30M | $101M | $293M |
| Implied P/E (adjusted for full dilution) | 8.3x | 2.5x | 0.9x |
source: author’s analysis
So on the above analysis, Glass House appears inexpensive, especially if they can continue to scale out their production and achieve greater unit cost efficiency as they do it and pricing does not collapse.
I am also excluding any value for Glass House Brands’ retail footprint and consumer brands. Those are well-regarded assets and could be worth another $50M-$200M or so, $0.75-$3/share on a diluted basis. I am most interested in the low-cost production operation for the investment case, so let’s assume we’re getting the non-wholesale assets for free today.
California Economics Improving
There are three reasons that the economics of California cannabis may improve. All are playing out currently.
First off, recent pricing has been a disaster for producers. Many with higher cost bases than Glass House have failed to make a profit, scaled back, or left the market entirely. Clearly, that cuts supply.
Secondly, part of the problem in California is not enough dispensaries. That too is changing over time, increasing demand.
Lastly, California is estimated to have a pretty large illegal cannabis segment (i.e., growing under the radar and not paying taxes, etc.) recent tax changes (effective July 1st) have reduced the tax burden on legal growers either by removing them entirely or collecting them at the point of retail sale. This change appears to have translated into lower pricing for consumers.
However, it has especially harmed the economics of illegal growers compared to legal ones and may help better position the legal California cannabis market to take share from the illegal market which still exists.
I don’t have a great sense of timing here, but it seems pricing for California wholesale cannabis may improve from recent lows over the coming years. That helps Glass House Brands.
Legal Changes Coming?
President Biden has requested a review of the scheduling of cannabis under the Controlled Substances Act. The current classification of cannabis as a schedule 1 drug (the same category as heroin) makes little sense. Still, it’s unclear where cannabis will end up after the review.
Rescheduling may improve access to cannabis and reduce the tax burden on producers, but it could also introduce onerous federal controls and regulations for the industry, similar to pharmaceuticals today. Though, that can help create barriers to entry, which could help Glass House Brands.
The important thing here is the President (and the relevant agencies of the U.S. government) should be able to drive this process without any approval/action from the House and Senate. Hence, this may be able to move forward regardless of what occurs in the midterm elections.
Senate leader Charles Schumer separately thinks legislation may be close that could help the cannabis industry and improve access to banking. Though this sort of legislation has been rumored to a greater or lesser degree for several years now. The important thing here is Schumer believes the measure has bipartisan support, that’s important if Republicans gain power in the midterms as polling suggests is likely.
Nonetheless, a majority of Americans now support some form of cannabis legalization, so it seems likely some legislative changes occur in the medium term. This may also broaden the investor base for cannabis stocks, some institutional investors won’t touch them today.
Many people are reticent to say that federal changes for cannabis are coming due to past false starts and dead ends, but it does seem likely on a 1-3 year view given the change in the public mood and recent statements.
The Positioning Of Glass House
It’s important to remember that though Glass House Brands can be thought of as a lowest cost cannabis producer, cannabis is not a commodity product. Pricing differs between outdoor, indoor and greenhouse product (greenhouse product is typically middle-tier).
Importantly, Glass House Brands products have high market share (in a fragmented market) and enjoy positive reviews. GLASF has managed to create efficient cultivation but without sacrificing quality. Their greenhouses enjoy some of the best natural growing conditions anywhere in the U.S. This also helps energy efficiency as more light comes from the sun rather than electric lighting.
Secondly, if we do see inter-state commerce for cannabis, it’s likely California benefits as the largest cannabis market with a strong reputation, i.e., consumers from New York may seek out California cannabis just as they do California wines.
Risks
- As much as Glass House Brands is a low-cost producer, the pricing of cannabis may continue to decline as the industry becomes more efficient and taxation is reduced, consider (illustratively) that cannabis wholesales for around $1,000/lb and tomatoes are $2/lb. Clearly, these are not the same agriculture product, and hopefully, cannabis is viewed more like a fine wine than a tomato by consumers, but if barriers to entry come down, so may production costs for all.
- Glass House Brands went public as a SPAC while there’s nothing wrong with that, many SPACs have failed to deliver on expectations and SPACs are maybe viewed as a second-tier option to an IPO, Glass House Brands maybe hasn’t been as scrutinized as it would have been during an IPO.
- Glass House Brands is currently not making money and as such may require future funding.
- Regulatory changes, which may be beneficial, are uncertain in both scope and timing.
- Cost reductions in the industry have mainly been passed on to consumers rather than improving industry margins. This is in part due to the fragmented market (Glass House is a leading player, but has only a 2%-3% share)
- With a limited public history, rapid production scaling, and volatile markets, the normalized economics of Glass House Brands are somewhat opaque.
Conclusion
It’s hard to fully pin down the economics of Glass House Brands today, but if they can produce cannabis at $100/lb at scale and manage SG&A costs, then the company may have a great position in the U.S. cannabis market either as a standalone play or an acquisition candidate by a corporate entrant if regulatory barriers ease.
Additionally, there are plenty of catalysts in the company’s favor as California supply/demand may improve, and federal regulation potentially eases, opening the door to ultimately allow inter-state commerce which could really benefit Glass House Brands.
There are no guarantees and plenty of risks, but Glass House Brands could have multi-bagger potential over the coming years if events play out in their favor, though likely with many ups and downs along the way.
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