Verano: A Profitable Cannabis Stock Trading At Discount

My Five Year Cannabis Investment Plan, published recently on Seeking Alpha, included this: “Invest in a new name only if a company demonstrates superior management capabilities. This should be a rare event.”

The first such event is happening just a few weeks after the plan appeared. Recent research has led to an investment in Verano Holdings, whose management has, in contrast to most cannabis companies, already brought it to consistent profitability.

Verano the company

Verano went public on 2/17/2021 in a reverse takeover of Majesta Minerals. At the same time, they merged with Alternative Medical Enterprises, which had cannabis retail assets in Arizona and Florida. Although relatively new on the national scene, Verano had been operating in Illinois since 2014 as a medical marijuana operation. Verano currently has 89 operating dispensaries and 12 cultivation and production facilities in eight states.

Verano is focused on two particular strategies. First, they want to be known for premium cannabis, which has higher margins, less competition, and makes them stand out. Second, they focus on limited license states, like New York, Illinois, and Minnesota. Operations in limited license states are generally more valuable because of the reduced competition.

Verano has been on an acquisition spree, acquiring 10 companies with three more in the pipeline. While I am usually skeptical of the growth-thru-acquisitions strategy, I believe it’s a plus for Verano for reasons discussed later in this article.

Verano the business

Verano’s financial performance for the last seven quarters is as follows. All numbers in millions USD.

	2020 Q1	2020 Q2	2020 Q3	2020 Q4	2021 Q1	2021 Q2	2021 Q3
Revenue	66059	75188	100549	113043	143297	198297	206828
Gross profit	50445	43069	68956	61288	88693	100129	133369
Gross profit margin	76.40%	57.30%	68.60%	54.20%	61.90%	50.40%	61.90%
Net income	71676	25700	81612	65651	125573	6830	103715
Adjusted EBITDA	41372	24873	55648	48384	75047	81474	110697

Net income is presented because readers expect to see it, but it is not a good metric for short term performance because accounting standards require something called “fair value of biological assets.” An explanation of this term is beyond the scope of this article, but suffice it to say that it causes big fluctuations in net income line unrelated to underlying performance. The “lumpiness” is evident all across the net income line above. Accounting geeks can get the whole story at New Cannabis Ventures.

The important lines are revenue, gross profit, and adjusted EBITDA. The numbers there show consistently impressive performance both before and after going public in February 2021.

Why Verano

Verano stands out because it is making profits. This is currently my primary indicator for superior management in this sector, and superior management is my primary reason for investing in cannabis companies. There are very few companies that have achieved this, Green Thumb and Trulieve being the others, and it is important for three reasons. First, it shows that management has the skill to create profits. Second, it shows that profitability is a top priority for management, as it should be. Third, it reduces dependence on dilutive equity and burdensome debt.

There are other reasons to invest in Verano as well.

• As a relatively new company (only four quarters since going public), many investors are relatively unfamiliar with it. As it attracts more attention more investment money will be attracted to it, particularly as it further differentiates itself through performance. As the following table shows, companies with a similar market cap are much more widely followed:

• The dual strategy of going for the premium market and focusing on limited license states seems solid. I have no special genius for identifying winning business plans in cannabis, but many experts advocate the limited license state strategy. Jay Czarkowski from Canna Advisors explains why on a recent Cannabis Investing Broadcast, as does Jesse Redmond at Green Giants

• As mentioned above, profits enable an extra degree of flexibility and independence.

• The stock price is at a low and disconnected from company performance, making it a timely purchase.

Acquisitions

By the end of this quarter Verano will have completed 13 acquisitions in a year and a half. I am skeptical of companies that use acquisitions as the primary means of growth without any profits (I’m looking at you, Curaleaf). Verano’s situation, however, is different. First, their growth has a strong organic component. Second, as I see it, a company with profitable operations can incorporate its successful business practices into acquired businesses. This is the theory, anyway. Growth in a profitable company is much more valuable than growth in an unprofitable one. Third, the cost of acquisitions can be less leveraged because they are cash flow positive and can partially self-fund. The cash flow situation (and generally strong balance sheet) also allows a lower interest rate on borrowed money, such as the just announced $100 million at 8.5%. Acquisitions are always a risk, but the risk can be lower when approached correctly.

Specific investment strategy

Referring back to my Five Year Plan, guideline number 2 is “Add to positions incrementally and slowly, with preference for the smaller positions.” I will start with a half position, adding more over a couple of months.

I will create my Verano position by purchasing shares of Goodness Growth (OTCQX:GDNSF). which Verano is acquiring. Based on the deal terms of .22652 Verano shares for each GDNSF share, GDNSF is trading at a 9 per cent discount to its Verano value:

• Current GDNSF price: $1.99
• Divided by conversion rate: .22652
• Implied Verano price: $8.78
• Current Verano price: $9.65
• Discount: 9.0%

If the acquisition doesn’t go through, GDNSF shares will drop to their pre-announcement level, perhaps -20%. Given that Verano has successfully completed ten acquisitions, however, the probability of such an event is low.

Risks

As in any high-growth emerging industry, there are significant risks. The year long slump in stock prices across the board could continue for an indefinite time. In the longer term, expectations of robust growth are dependent in part on favorable governmental action on decriminalization, de-scheduling, banking, and FDA approval. There is no assurance that any of these will occur. Regarding Verano specifically, the active expansion phase presents some risk. Although it has been consistently profitable as a smaller company, there is no certainty that its expansion will be successful. Even with such risks, I believe Verano is better positioned for success than most of the industry.

Summing Up

When a company making profits in cannabis appears, it’s a rare event worth further study. It’s a sign of a company with the right priorities and possibly superior management in a sector where superior management is especially important. Verano is such a company. This is an especially opportune time to invest because Verano is underfollowed, shares can be obtained for a discount through Goodness Growth, and prices throughout the sector are depressed. In an industry where volatility reigns and companies are finding their way in a very fluid environment, Verano is a worthy candidate as a long term investment.