A lot of people still see these companies as un-investable, as the excise tax is a huge hurdle for the business model. I hope Canadian government wakes up sooner than later, but they have a pretty shitty track record of fixing things before they get really ugly, so I wouldn’t be surprised if it takes longer than expected.
Great update, hadn’t looked into Organigram lately. Question on the tobacco majors’
incentives. My guess is they’re funding companies like these two with a view to owning the best parts of the value chain in international cannabis decades from now, after most counties legalize. Cash that piles up on CRON or OGI’s balance sheets will be somewhat captive to those visions. A thing I like about your idea of owning both tickers is if one of Altria or BTI executes a bad strategy that puts them at a long run disadvantage in international cannabis, you’re a bit more diversified.
Either way, the problem is they are competing against organized crime and drug dealers. Who knows how long it will take to beat them, if ever, with a tax.
Last year they sold some $40m worth (I'm not sure what that is in terms of quantity) and I don't believe they've disclosed the extent of the expansion. I am aiming to chat with management about this and will report back.
Thanks for this write-up. One question from a comment you made - why do you think the US players are worse businesses vs. Canadian cannabis co's? Completely agree the big tobacco relationship & distribution is an edge but on a standalone basis - unclear to me why US < CA on biz quality? Many thanks!
First, brand power/R&D spend. In Canada you will find that the dispensaries are dominated, particularly in the specialty space, by Spinach and Shred. In the US, that brand dominance hasn't emerged. Two reasons for this: 1) S. 280 doesn't permit MSOs from expensing R&D spend, thus disincentivizing/limiting innovation and product development; 2) because they can only operate within state lines, you do not have national dominance and recognition -- every state has its own unique selection.
Second, and relatedly, the prohibition on interstate commerce has retarded the development of the MSOs -- they have been forced to operate in a really artificial way as a result of this constraint. One example is vertical integration of manufacture, distribution and retail all under one company. In my view, having all three segments within a business is a disadvantage vis-a-vis the Canadian LPs, which only focus on manufacturing. If you look, for example, at how the beer market works in the US - there is a 3 tiered system - producers ,distributors, and retailers are all different. Over time, focus and specialization will win, imo.
Third, first mover advantages -- cannabis has been legal at the national level in Canada for the better part of a decade now. Among other things, this has resulted Canada being at a better stage in the capital cycle -- i.e. the weak hands in Canada are dying off quickly here from bankruptcy, etc. and price rationalization should arrive sooner.
Finally, the piece you point out - big tobacco. That's not just a network advantage, but a cost of capital one. The cannabis industry has an extremely high cost of capital - debt market are largely shut, etc. So Cron and OGI have a huge edge there.
Thanks. This is a compelling thesis. Given the incremental OpEx savings - adj. net income H224 should be positive (remove similar line items taken out of Adj. EBITDA), and I like that you are paying little to nothing here for that option.
Have you seen any work outlining where we are on the path to consolidation? Been building my own market model - but have no idea how many operators in Canada are non-public/relative share etc. Can estimate with the share % data that $CRON shares but otherwise haven't seen anything.
This health Canada Data is helpful, which shows licensed production area over time (you can see its come down a lot from the highs, which obviously bodes well). Statcan also had some good data.
- positives: Altria/Distribution, Sales and Margin Growth, Market Leader with Spinach, cheap cannabis prices are outweighing
- negatives: Excise Tax, no moat, Cronos will become part of Altria
What holds me back is following:
I recognize having a lot of cash brings safety, endurance, optionality, ... BUT
1. Essentially this is a mountain of cash with a tiny business. So even if biz is performing well coming years Mcap would move microscopically.
2. There is a risk that Mgmt is not prudent with money just because there is so much available. Did you take a deeper look into Mgmt/Board checking how prudent, shrewd, experienced in capital allocation, ... they are?
It would be great if you could share your thoughts on 1. and 2.
First thing I would say is that I disagree there is no moat. 1) There are significant economies of scale at work here, which leads major cost advantages, which is a big deal given how tough the industry is at the moment. 2) Those cost advantages work together with a high fixed cost of entry/valuations way below replacement cost that make its very difficult for anyone to come in reach profitabilty and earn their cost of capital 3) there is the "brand" moat - the Spinach brand is pervasive in Canada and because consumers are very sensitive to what they consume (due to psychoactive effects), many like to stay with what they are comfortable with; and 4) cost of capital advantage -which is absolutely key. That's not really a moat per se, but it will faciliate the moat, as presently no one has access to cheap capital (other than OGI) - that coupled with the excise tax making it near impossible to turn a profit, means that none of these entities can fund their growth and are destined to die unless and until the industry becomes rational; the low cost of capital guarantees cron's survival. I'm not suggesting this is a MasterCard quality moat, but saying no moat I think is unfair.
Second, I am not sure that Cronos becomes part of Altria. It might, but that's looking increasingly less likely as time goes on. Why do you see this as a negative, though? curious on your thoughts.
On the items holding you back, 1) yes this is accurate, but it's also why the opportunity exists. As I wrote in my piece today, it's helpful to think of Cron as two parts 1) a growing microcap and 2) and cannabis SPAC. 2) That's a risk, but I note they have been completely restrained in spending any of it (the frustration many have is not that they are wasting it, but rather that they refuse to spend it). The other thing to consider is just relative valuations -- Everything in cannabis is trading at distressed valuations, so its not hard to create value, especially given the synergies Cron can create with its scale (can spread the fixed costs across a larger revenue stream - look at what OGI and Motif are accomplishing). On the other side, Cron is not getting its cashed fairly valued. Put those two discounts together, and you're not setting a very high hurdle for the capital allocation to create value.
Ok, I hear you regarding moats, but would call it “weak” moats .. but sure you could argue it sums up. :) I respect Cronos quick success with Spinach and hope they are successful with this brand for long time.
@ Cronos becomes part of Altria:
Of course I am not sure, but it is very plausible. Altria has over 40% (since 2019) and if Cronos is successful it is easy for Altria to get them .. Why? … to present Wall Street a new, growing segment within Altria.
I appreciate your thoughts on #1 “growing biz and Spac” and #2 “cash”. There are some nice interviews of Mike (CEO) on youtube, which I will consume to get a better grasp. But what gives me some good hope is Mikes vita working at some investment firms (e.g. Alphabet Partners) which tend to show good capital allocation skills.
Just came across your Substack after listening to your Business Brew interview. Looking forward to going through your posts and will start following you on Twitter. Everything looks really interesting. In regard to CRON, do you think there is a risk that when U.S. rescheduling finally happens there will be an oversupply of product and a drop in prices and margins?
Jake, for OGI - don't you think the 25% yy growth rate is less impressive when you consider Q3'23 was a (14%) yy growth quarter. So lapping to Q3 2022 - $38m net revenue; the $41m from the most recent quarter signifies very tepid growth -much less than what you're making it out to be?
Think I know what your answer might be - price v volume?
Separately, I’m thinking what could break this thesis. The only points I could come up with :
1. Tail risk of cannabis legalisation trends doing an about turn. You seem to imply that it will inevitably follow in the footsteps of tobacco and alcohol, but anecdotally there are many I know who see cannabis as very detrimental to social productivity
2. Not really a thesis breaker, but you also seem to imply a couple of times in your write up a hypothetical situation of no excise tax. Wouldn’t the more realistic outcome be a smaller excise tax as opposed to zero excise tax completely ?
Maybe what ties both those points together for me, is I’d like to know that both businesses can thrive and survive in a scenario where current excise tax persists and is never reformed
So on #1, I can tell you as a Canadian that the odds of a regulatory u-turn are virtually zero. It's been a huge tax windfall for the government and legalization/mass availability of cannabis is widely popular. There's no political will to regulate it more strictly.
#2. Yes that's probably fair. The current tax is the greater of $1/g or 10% of sale price , which results in $1 per gram, because prices have been well below $10. Would be a sensible compromise to have a 10% flat rate. That itself would be a huge boon given we are currently paying upwards of 30%.
"The demand had increased so much after 1776, that many farmers were unable to meet the demands for exports, which increased the prices of tobacco even further. With a desire to increase the amount of tobacco available, many American farmers took out credit loans from the British to increase the size of their landholdings as well as increase the number of slaves they owned. Much of this credit went to gentleman farmers, but the desire for tobacco was so strong that even middle class farmers found it easy to receive loans to increase their farm production. Many of these farmers opted not to pay back these loans however, and many in turn found themselves jailed toward the end of the century for not paying their debts.[13][14] Many of these debtors were small farmers, causing a further consolidation of smaller farms into larger ones."
Yann, appreciate it. -- Getting taken out for an insufficient premium by tobacco is an open ended/longer-term risk but that won't be possible until there are major changes to the legal landscape in the US, as it would jeopardize the tobacco cos US exchange listings among creating other issues. Down the road, that may occur but getting taken out for a premium, even if a lowball, isn't the worst outcome ever.
That impairment was related to the Moncton facility. Shouldn't be an issue moving forward.
Your link to the "Global beer, the road to monopoly" spurred me to research the history of Tobacco since Cannabis and Tobacco seems more similar physically than beer.
I was going to ask about this, but then I read these comments. I think along the same lines.
BATS.L will buy them at slight premium (assuming Cronos is mostly cash as is now). Why would they pay high premium, unless the Cronos shares run higher. No?
Organigram, similar thing, they may fetch a higher premium.
Yeah it isn't the worst outcome but I am not sure there is 10x or so here BEFORE getting taken out, so the question is opportunity cost. How do you size these two? 3%?
And that’s fine, it’s just going to kill off the weak hands faster
Thanks for the update!
A lot of people still see these companies as un-investable, as the excise tax is a huge hurdle for the business model. I hope Canadian government wakes up sooner than later, but they have a pretty shitty track record of fixing things before they get really ugly, so I wouldn’t be surprised if it takes longer than expected.
Great update, hadn’t looked into Organigram lately. Question on the tobacco majors’
incentives. My guess is they’re funding companies like these two with a view to owning the best parts of the value chain in international cannabis decades from now, after most counties legalize. Cash that piles up on CRON or OGI’s balance sheets will be somewhat captive to those visions. A thing I like about your idea of owning both tickers is if one of Altria or BTI executes a bad strategy that puts them at a long run disadvantage in international cannabis, you’re a bit more diversified.
Agree with all that.
Is the excise tax 10%?
Either way, the problem is they are competing against organized crime and drug dealers. Who knows how long it will take to beat them, if ever, with a tax.
How much flower does GrowCo grow right now and how much will it increase with the expansion?
Last year they sold some $40m worth (I'm not sure what that is in terms of quantity) and I don't believe they've disclosed the extent of the expansion. I am aiming to chat with management about this and will report back.
"GrowCo has consistently demonstrated exceptional cultivation performance, contributing significantly to Cronos’ portfolio. In 2023 Cronos purchased approximately $21 million of biomass from GrowCo, and GrowCo sold approximately $20 million to third parties." https://thecronosgroup.gcs-web.com/news-releases/news-release-details/cronos-group-announces-expansion-growco-fuel-global-growth
Thanks for this write-up. One question from a comment you made - why do you think the US players are worse businesses vs. Canadian cannabis co's? Completely agree the big tobacco relationship & distribution is an edge but on a standalone basis - unclear to me why US < CA on biz quality? Many thanks!
So I'd point to a couple things.
First, brand power/R&D spend. In Canada you will find that the dispensaries are dominated, particularly in the specialty space, by Spinach and Shred. In the US, that brand dominance hasn't emerged. Two reasons for this: 1) S. 280 doesn't permit MSOs from expensing R&D spend, thus disincentivizing/limiting innovation and product development; 2) because they can only operate within state lines, you do not have national dominance and recognition -- every state has its own unique selection.
Second, and relatedly, the prohibition on interstate commerce has retarded the development of the MSOs -- they have been forced to operate in a really artificial way as a result of this constraint. One example is vertical integration of manufacture, distribution and retail all under one company. In my view, having all three segments within a business is a disadvantage vis-a-vis the Canadian LPs, which only focus on manufacturing. If you look, for example, at how the beer market works in the US - there is a 3 tiered system - producers ,distributors, and retailers are all different. Over time, focus and specialization will win, imo.
Third, first mover advantages -- cannabis has been legal at the national level in Canada for the better part of a decade now. Among other things, this has resulted Canada being at a better stage in the capital cycle -- i.e. the weak hands in Canada are dying off quickly here from bankruptcy, etc. and price rationalization should arrive sooner.
Finally, the piece you point out - big tobacco. That's not just a network advantage, but a cost of capital one. The cannabis industry has an extremely high cost of capital - debt market are largely shut, etc. So Cron and OGI have a huge edge there.
Thanks. This is a compelling thesis. Given the incremental OpEx savings - adj. net income H224 should be positive (remove similar line items taken out of Adj. EBITDA), and I like that you are paying little to nothing here for that option.
Have you seen any work outlining where we are on the path to consolidation? Been building my own market model - but have no idea how many operators in Canada are non-public/relative share etc. Can estimate with the share % data that $CRON shares but otherwise haven't seen anything.
This health Canada Data is helpful, which shows licensed production area over time (you can see its come down a lot from the highs, which obviously bodes well). Statcan also had some good data.
https://www.canada.ca/en/health-canada/services/drugs-medication/cannabis/research-data/market/licensed-area.html
https://stratcann.com/insight/canadas-wholesale-cannabis-market-shifting-from-buyers-to-sellers/
Hi Jake,
thanks for 2nd part!
I am thinking starting a position because
- positives: Altria/Distribution, Sales and Margin Growth, Market Leader with Spinach, cheap cannabis prices are outweighing
- negatives: Excise Tax, no moat, Cronos will become part of Altria
What holds me back is following:
I recognize having a lot of cash brings safety, endurance, optionality, ... BUT
1. Essentially this is a mountain of cash with a tiny business. So even if biz is performing well coming years Mcap would move microscopically.
2. There is a risk that Mgmt is not prudent with money just because there is so much available. Did you take a deeper look into Mgmt/Board checking how prudent, shrewd, experienced in capital allocation, ... they are?
It would be great if you could share your thoughts on 1. and 2.
Thanks in advance!! :)
Hey Max,
Thanks for the Q.
First thing I would say is that I disagree there is no moat. 1) There are significant economies of scale at work here, which leads major cost advantages, which is a big deal given how tough the industry is at the moment. 2) Those cost advantages work together with a high fixed cost of entry/valuations way below replacement cost that make its very difficult for anyone to come in reach profitabilty and earn their cost of capital 3) there is the "brand" moat - the Spinach brand is pervasive in Canada and because consumers are very sensitive to what they consume (due to psychoactive effects), many like to stay with what they are comfortable with; and 4) cost of capital advantage -which is absolutely key. That's not really a moat per se, but it will faciliate the moat, as presently no one has access to cheap capital (other than OGI) - that coupled with the excise tax making it near impossible to turn a profit, means that none of these entities can fund their growth and are destined to die unless and until the industry becomes rational; the low cost of capital guarantees cron's survival. I'm not suggesting this is a MasterCard quality moat, but saying no moat I think is unfair.
Second, I am not sure that Cronos becomes part of Altria. It might, but that's looking increasingly less likely as time goes on. Why do you see this as a negative, though? curious on your thoughts.
On the items holding you back, 1) yes this is accurate, but it's also why the opportunity exists. As I wrote in my piece today, it's helpful to think of Cron as two parts 1) a growing microcap and 2) and cannabis SPAC. 2) That's a risk, but I note they have been completely restrained in spending any of it (the frustration many have is not that they are wasting it, but rather that they refuse to spend it). The other thing to consider is just relative valuations -- Everything in cannabis is trading at distressed valuations, so its not hard to create value, especially given the synergies Cron can create with its scale (can spread the fixed costs across a larger revenue stream - look at what OGI and Motif are accomplishing). On the other side, Cron is not getting its cashed fairly valued. Put those two discounts together, and you're not setting a very high hurdle for the capital allocation to create value.
Hi Jake,
Thanks for your profound, quick reply.
Ok, I hear you regarding moats, but would call it “weak” moats .. but sure you could argue it sums up. :) I respect Cronos quick success with Spinach and hope they are successful with this brand for long time.
@ Cronos becomes part of Altria:
Of course I am not sure, but it is very plausible. Altria has over 40% (since 2019) and if Cronos is successful it is easy for Altria to get them .. Why? … to present Wall Street a new, growing segment within Altria.
I appreciate your thoughts on #1 “growing biz and Spac” and #2 “cash”. There are some nice interviews of Mike (CEO) on youtube, which I will consume to get a better grasp. But what gives me some good hope is Mikes vita working at some investment firms (e.g. Alphabet Partners) which tend to show good capital allocation skills.
All the best!
Just came across your Substack after listening to your Business Brew interview. Looking forward to going through your posts and will start following you on Twitter. Everything looks really interesting. In regard to CRON, do you think there is a risk that when U.S. rescheduling finally happens there will be an oversupply of product and a drop in prices and margins?
Jake, for OGI - don't you think the 25% yy growth rate is less impressive when you consider Q3'23 was a (14%) yy growth quarter. So lapping to Q3 2022 - $38m net revenue; the $41m from the most recent quarter signifies very tepid growth -much less than what you're making it out to be?
Think I know what your answer might be - price v volume?
Separately, I’m thinking what could break this thesis. The only points I could come up with :
1. Tail risk of cannabis legalisation trends doing an about turn. You seem to imply that it will inevitably follow in the footsteps of tobacco and alcohol, but anecdotally there are many I know who see cannabis as very detrimental to social productivity
2. Not really a thesis breaker, but you also seem to imply a couple of times in your write up a hypothetical situation of no excise tax. Wouldn’t the more realistic outcome be a smaller excise tax as opposed to zero excise tax completely ?
Thanks and great write up as always
Maybe what ties both those points together for me, is I’d like to know that both businesses can thrive and survive in a scenario where current excise tax persists and is never reformed
So on #1, I can tell you as a Canadian that the odds of a regulatory u-turn are virtually zero. It's been a huge tax windfall for the government and legalization/mass availability of cannabis is widely popular. There's no political will to regulate it more strictly.
#2. Yes that's probably fair. The current tax is the greater of $1/g or 10% of sale price , which results in $1 per gram, because prices have been well below $10. Would be a sensible compromise to have a 10% flat rate. That itself would be a huge boon given we are currently paying upwards of 30%.
Jake, thanks a lot for the very insightful and researched write-ups.
Do you have any fear of the Big tobacco company taking Cronos/OGI private before much of the upside is realized?
Specifically about OGI, I saw in their Annual report 2023, they recorded a significant asset impairment. What are the consequence of this adjustment?
I think you'll like this one:
"The demand had increased so much after 1776, that many farmers were unable to meet the demands for exports, which increased the prices of tobacco even further. With a desire to increase the amount of tobacco available, many American farmers took out credit loans from the British to increase the size of their landholdings as well as increase the number of slaves they owned. Much of this credit went to gentleman farmers, but the desire for tobacco was so strong that even middle class farmers found it easy to receive loans to increase their farm production. Many of these farmers opted not to pay back these loans however, and many in turn found themselves jailed toward the end of the century for not paying their debts.[13][14] Many of these debtors were small farmers, causing a further consolidation of smaller farms into larger ones."
Source: https://en.wikipedia.org/wiki/History_of_commercial_tobacco_in_the_United_States#Introduction_of_the_cigarette
Beautiful
Yann, appreciate it. -- Getting taken out for an insufficient premium by tobacco is an open ended/longer-term risk but that won't be possible until there are major changes to the legal landscape in the US, as it would jeopardize the tobacco cos US exchange listings among creating other issues. Down the road, that may occur but getting taken out for a premium, even if a lowball, isn't the worst outcome ever.
That impairment was related to the Moncton facility. Shouldn't be an issue moving forward.
Thanks again for your detailed answer.
Your link to the "Global beer, the road to monopoly" spurred me to research the history of Tobacco since Cannabis and Tobacco seems more similar physically than beer.
In the end, I think beer is the better historical precedent due to regulation, but maybe you'll find this read interesting: https://sites.duke.edu/collardwexler/files/2015/01/origins-of-american-tobacco-company.pdf
Interesting read. Thanks for sharing.
I was going to ask about this, but then I read these comments. I think along the same lines.
BATS.L will buy them at slight premium (assuming Cronos is mostly cash as is now). Why would they pay high premium, unless the Cronos shares run higher. No?
Organigram, similar thing, they may fetch a higher premium.
Yeah it isn't the worst outcome but I am not sure there is 10x or so here BEFORE getting taken out, so the question is opportunity cost. How do you size these two? 3%?