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Listen to the podcast below or on the go via Apple Podcasts or Spotify.
Alan Brochstein and Julian Lin join us to discuss investing in cannabis stocks and mistakes made along the way (3:00). Why companies should be more aggressive in paying down debt (9:00) Investing timelines and federal legalization (19:00) Cannabis REITs and Canadian LPs over MSOs (23:45).
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Transcript
Rena Sherbill: I am absolutely thrilled and honestly honored that this is the platform though, I suppose it makes a lot of sense that it is the platform to bring together Julian Lin, who runs Cannabis Growth Investor, and one of the people to start the whole cannabis investing thing for real, Alan Brochstein, 420 Investor. It’s so great to have you both on Investing Experts and Seeking Alpha in general, great to have you both on.
Alan Brochstein: Thank you. It’s great to be here.
Julian Lin: Yes. Thanks for inviting us.
RS: I always enjoy talking to both of you. I’ve been talking to both of you for a number of years. And that in itself is a big privilege because I definitely feel like I have a front row seat to the best analysis in the cannabis industry, and also broadly speaking.
So having said that, and I think anyone following the cannabis industry knows both of your names. I think anyone on Seeking Alpha knows both of your names and the work that you’ve done.
Looking at the cannabis industry right now, what’s the feeling that each of you have having been a leading participant in the cannabis analysis over the past few years? How are you looking at it these days and how are you feeling about it in general?
AB: I’ll let you go first, Julian.
JL: Oh, sure. I mean, so just general thoughts on Investing Cannabis. I think for sure, especially for myself who joined this Investing Cannabis starting around the 2020, 2021 time, just right around the peak. I think, there’s definitely a set of errors, some from myself, and some on the behalf of management.
The personal investing errors would definitely be underestimating how quickly growth will decelerate following the pandemic. And this wasn’t necessarily just related to cannabis. This happened also in e-commerce, or any of the other businesses that saw a big boom following the pandemic.
And I also definitely overestimated how much synergies could be extracted from M&A, in hindsight, it turned out that M&A just did not really lead to a lot of reduced operating expenses. And, of course, as I think every investor, they’d be definitely underestimated the level of price compressions and just how, how vicious that price compression has been.
But I think, those factors did not have to lead to where cannabis stocks are trading today. I think that arguably, a bigger, well, just, and also a very significant driver of the underperformance has been self-inflicted from the management teams, very specifically related to how much debt they have taken on over the last couple of years to fund M&A.
I think I have previously mentioned on a podcast with Rena that I was of the view that these names should be using stock. They should be issuing stock to be funding the M&A just because it did not quite make sense to be issuing debt at the high interest rates with 280E taxes and so forth, but, I mean, obviously, no one is listening to me then.
So all of these names have issued a ton of debt. And so they’re left in the uncomfortable position where they haven’t realized the growth, or the margins they expected, but they’re left with all this debt. And a lot of these names, their debt is maybe multiples of their market cap. Of course, the better names. The names that have done better are the names to have less debt. But, yeah, so debt remains a very important driver of risk even today.
AB: Yeah. Good points, Julian. And I would say for me, I think I’ve been a little bit on top of this. Rena, our last two interviews have been kind of a bummer, right, and my outlook has been muted. And a year ago, I was so optimistic because I looked at how much cannabis prices have fallen. And as the rest of 2022 played out, I kind of learned a lesson.
The problem there, as Julian pointed out to, there are some problems with the cannabis industry, and they should have been doing equity instead of debt. But the real problem is we have the same investors. It’s a pool of investors that’s mainly retail and all entirely tired of cannabis looking for new buyers. Where are they?
And I’ve been under the assumption that they’re just around the corner, but I don’t know where the corner is, or when it will happen. And what they’re waiting for is either Nasdaq listing for American cannabis operators, or more importantly, I think the end of 280E. And I think until then, we’re kind of stuck in a rough spot.
RS: What do you think about speaking to management’s inability to always have the proper vision and sometimes the proper implementation? What do you think of some, like Jason Wild of TerrAscend (OTCQX:TSNDF), him pushing to list on the TSX. Thoughts on maybe broadly speaking, what management is trying to navigate and change?
AB: Yeah. I’ll go first. I’ll say that on the TSX thing, it is a small step in the right direction. But at the end of the day, it really doesn’t matter. What matters is the ability to trade on a major U.S. exchange. I don’t have anything against Canada. I’m very grateful to Canada for what it did for my career. And I like almost every Canadian I meet, but I will say that the country is small and nobody cares about trading in Canada.
I say nobody. Few people care about it. And I used to manage $0.5 billion of equity money with some others. And before that, I was managing $10 billion of fixed income with some other professionals. And in neither place, did we ever buy foreign securities, foreign listed securities? Never. And I’m not saying that’s 100%, but there are very few people professionally that will cross the line. Sometimes they’re not allowed to. Otherwise, they just – they got enough.
JL: Regarding the TSX listing, I’m actually of the view that, okay, I mean, obviously, Jason Wild has been a wonderful investor and spokesperson for cannabis. But in regards to the specific event, I’m not as enthusiastic. I wasn’t of the view that adding another listing on the TSX was the issue facing cannabis stocks.
I think it’s more related to the fundamentals, again, the debt and also just custody. Having the stocks listed on the TSX doesn’t really change the custody issue. I mean, there’s plenty of stocks listed OTC that could be custodied. So, it’s more of just the federal criminality of cannabis.
What I would have been hoping for these management teams to be doing, which they haven’t, although TerrAscend ironically has been in terms of debt, is that, I was hoping they would be — being more aggressive in terms of resolving their debt, even resorting to issuing equity to pay down debt. And I realize how painful it sounds to be issuing equity after it’s fallen this much to pay down debt.
But at the same time, when you have something like a Trulieve (OTCQX:TCNNF), let’s talk about Trulieve, right? Trulieve is trading around 4x adjusted EBITDA. That valuation is pretty low, but at the same time, because of how much debt and interest expenses they have, they’re not really generating any cash flow, especially if you don’t include the stock-based compensation. They’re not generating real earnings for shareholders.
But again, 4x adjusted EBITDA. At the same time, if they were simply to issue the stock and pay down debt, that valuation 4x adjusted EBITDA does not get diluted, obviously the equity valuations in terms of price-to-sales or price-to-earnings will get diluted.
But would they? Because of 280E taxes, when you’re paying down these debt, you’re actually creating — these are, like, double 20% yields, free cash flow yields on the debt after accounting for 280E taxes. I’m of the view that if these names had substantially less debt for generating real cash flow, even no matter how pessimistic you’re on cannabis, they would not be trading at 4x EBITDA. Right now, the valuations here is not a custody issue, it’s a debt issue.
AB: I agree. Julian, people are scared of the debt. And I happen to think that they’re right to be scared, unfortunately. I hate to be the guy who rains on everyone’s parade because there are some cannabis stocks that are here right now, right here, I like. But the biggest are not the best. And let’s just pick on Curaleaf (OTCPK:CURLF), for instance, that is the biggest and not the best, in my opinion.
And I wrote a piece on Seeking Alpha when I got lucky. It was at $4 when I wrote it, and that was the peak. And I said, sell the rally. That’s very unlike me to tell the public to sell. And although a lot of my pieces are – they’re usually more like don’t buy it yet, but I said sell.
And my target on that is based on a pretty high multiple that Julian just said 4 for Trulieve, which is correct. I was using 7 for Trulieve for my year-end target. And I’ve lowered it to 6. And my target is now 2.20 for year-end, and the stock is pushing $3 right now, south of 3. And so what is wrong with Curaleaf? I think a lot. They have negative tangible book value in excess of $700 million negative. That’s number one. Number two, they have a ton of debt. Number three, they’re not generating positive cash flow.
And I think there really is too much debt. And I think what Julian says could work if they’ve just, even at the low price got rid of the debt, turn it into equity, it’s so cheap that maybe people would buy it. But I’m going to step back and say wait, though, until 280E goes away, or you can trade on the Nasdaq because the stock would be more valuable. And I don’t think either of those things are going to happen right away. I’m on the lookout, but I don’t think that they’re going to happen immediately.
JL: Yeah. And I think that, related to that, I think that management teams have – that’s the reason why they haven’t been issuing equity is that they seem to be hoping for some SAFE banking induced rally or some miracle, some Hail Mary to happen, like, legalization or something, so that their equity will go up, and then obviously issuing equity at that point will be less expensive.
But I think at this point, we need to come to face the reality that our politicians, they don’t really seem to want to remove 280E taxes, or decriminalize cannabis, or whatever, at least not that quickly. So, I think that the issue is that the longer they wait, every single year is another year where they’re having to basically issue more debt to pay for their capital expenditures and interest expenses.
So time is not their friend when they have this much debt, whereas and again, they don’t really have to remove all of their debt. But if they were to even remove just enough debt so that, they’re generating some more cash flow and that cash flow could be used to, at least, cover their capital expenditures and pay down more debt.
Then you start getting to a positive loop where time does become your friend. And that, I think, in my view, kind of differentiates some of the names like Green Thumb Industries (OTCQX:GTBIF), which are profitable on a GAAP basis and have cash flow to pay for capital expenditures, pay down debt versus unfortunately, a name like Trulieve, which, again, I highly respect their management team, their stock is extremely cheap.
But the reality is, every year that passes by, the valuation position gets a bit worse just because they’re probably going to have more and more debt as the years go on.
AB: Yeah. So I wanted to add. On Curaleaf, I was saying what’s wrong with it, and I’ve left off one thing, their current ratio. And the current ratio, I think most of your listeners probably know this, but just to repeat what it is. It’s the current assets divided by the current liabilities. So a high number is good, a low number is bad. And for Curaleaf, that number is I’m just looking up 0.9x.
So in other words, they have more liabilities than assets that are due within a year. And this captures, by the way, a big thing that my tangible book value barely captures, and that is the income tax payable. And I don’t even throw that income tax payable into net debt, but I think maybe I should because it’s real, and it’s a big burden. And, Curaleaf owes a lot in taxes. $210 million, to be precise.
And GTI, which I don’t think it’s time yet to buy GTI, by the way, but GTI shines compared to that. And I wrote a piece this weekend for my subscribers, and I said, GTI is a good replacement for Curaleaf. I don’t own it in my model portfolios, but I know some people like the big MSOs (multi-state operators), like (MSOS).
And the reason is, it trades at 3x tangible book, not — it has a tangible book value of $551 million, which is way more than the minus $700 million and change at Curaleaf. And it has less net debt, and its current ratio is 1.9x because they only have $10 million of income tax owed. GTI only owes $10 million in income taxes that haven’t been paid. And for Curaleaf, it’s more than $200 million.
And this is a big problem. If you look across the entire industry, not the Planet 13 (OTCQX:PLNHF) that I like, they don’t have that problem, but all of them owe a lot in taxes. And it’s worse at some places than others. But I would just say back to Julian’s point about, pushing the debt out. That’s what some companies are doing.
Ayr (OTCQX:AYRWF), for example, that has way too much debt, and it’s been killing perceptions about them. And they’ve been kind of extending it, but I don’t think it does the trick, unfortunately. I think as long as they have debt, people are going to worry. I like Hydrofarm. They have a lot of debt. It’s not due until 2028, but people don’t care. It’s got too much debt. 2028 is a long time, especially in cannabis land.
RS: Do you feel that it’s a misstep to put off paying taxes as a strategy?
AB: I haven’t really gotten into that, but I understand what you’re saying and where you’re coming from. And I’ve heard some people talk about, like, Verano (OTCQX:VRNOF) owes a lot in taxes. And I think they talk about how smart that is. It’s a good source of money when it’s so expensive to borrow. So I don’t want to say it’s stupid because I don’t think it’s necessarily stupid, but for investors, it’s dangerous to not take it into account.
JL: Yeah. I think that, historically, deferring taxes has carried a pretty low interest rate. I mean, all things being equal, it’s not the worst idea to use the deferred taxes as a source of capital, especially for these capital-constrained businesses.
However, I think where maybe the issues were is where they were deferring taxes and using that extra capital to fund M&A, or fund some CapEx that didn’t pay out, whereas maybe if, for example, they had used deferred taxes in order to pay down debt, just kind of change the interest rate from the debt, the high, the double-digit debt to maybe to single digit taxes, that might have worked out a bit better.
AB: Yeah.
RS: One of the things that I wanted to ask, and we’ve definitely talked about this on the Cannabis Investing Podcast before is this notion, and it gets more convoluted probably every year, most definitely. This notion of timelines and in the investing timelines that investors have in the industry and how important it is to navigate where your investment is if you’re not trading these stocks.
What would you say to investors at the end of August 2023, knowing what we know now and not knowing what we don’t know, how, a, how important is it to pay attention to the federal legalization headlines?
I will say my opinion on that briefly. I feel like at this point, nobody knows what the hell they’re talking about. I think everybody’s proven that in terms of predicting things. I don’t know whether or not the new election coming is going to provide some very positive sentiment for the industry.
I could see it going both ways, but I definitely wouldn’t put your money betting on anything. And I would say that it doesn’t make good use of our time as investors in the cannabis industry to predict when that is going to happen. I would say we have to navigate what’s in front of us.
Having said that, a) do you agree with that sentiment? And, b) how would you advise investors to look at their timelines and what would you advise them based on their timelines to be looking at? I know that you’ve mentioned a few stocks to be looking at in general. Based on timeline specifically, is there something to keep in mind unique to that?
AB: I’ll go first. So I think you’re a 100% on that people don’t know what they’re talking about. They’ll say things like, oh, Safe Banking is coming, and I’ll say, who cares? Safe Banking doesn’t do anything really for the big public companies. It’s good, and I’m all for it, but who’s it help? The consumer and minority small businesses.
And so I would start off by saying, if you’re investing in cannabis, you have to remember it’s a big universe. It’s not just the big American operators. And so, I think I do a pretty good job of covering both ancillaries and Canadian LPs. There are other sectors. I just don’t care about right now. There’s certain biotech companies and there’s CBD companies. So I don’t mean to say that’s the whole thing, but I’m finding a lot of very good values in deeply discounted debt-free cash-rich Canadian LPs.
And then on the ancillary side, I think, they don’t pay 280E tax. And some of them don’t have that much debt. I know I mentioned Hydrofarm (HYFM) has a lot of debt, but you can look at companies that have little or no debt. And so that’s the first thing I would say.
So if you were to say, yeah, but I’m talking about American cannabis operators, what do you think there? And I would just say, I wrote for the New Cannabis Ventures Newsletter yesterday. It’s very important to start looking at price to tangible book value. And I know that’s a term that not that many investors even care about. And if you’re a growth investor like most cannabis stock investors are, you may not even know that because it’s really for growth investing.
It’s not really a good term. For deep value investing, it is. But I think that, as Julian pointed to, the debt outstanding is a big problem. And if you’re thinking about who’s going to make it to the finish line, people with huge negative tangible book values and lots of debt do quickly or in trouble compared to those with lower amounts of debt, high tangible book value in a long time. And so, I think that that’s what investors need to start looking at.
JL: I think, in terms of my views about predicting legalization, I think unless you’re making predictions about it taking a long time, it’s probably a hard thing to do for your portfolio.
I think that it – it’s, I mean, it would have been great to say a couple of years ago, but, I mean, better late than never, it’s probably better to position your portfolio, so that it could do well even if or especially if legalization takes a long time. The way these balance sheets are looking at a lot of these MSOs as I’ve said earlier, time is not your friend.
The more time goes on, the more mortgages get pressured. And I mean, really, these names are having – they’re going to have to basically either issue debt or equity just to sustain current operations, pay down interest. Whereas it’s I mean, yeah, I get that. It might be a little, quote sexier, to be buying these MSOs. But I am still of the view that the cannabis REITs, especially names like (NYSE:IIPR) or my top pick, NewLake Capital Partners (OTCQX:NLCP) are arguably the best way to invest right now. Just take, for example, NewLake Capital Partners. It’s not going to have the same debt issues as the MSOs.
In fact, NewLake Capital Partners has about $40 million of net cash, which if you are familiar with net lease REITs at all, you will know that that’s pretty insane. Typically, when you look at a name like Realty Income (O), Realty Income has debt-to-EBITDA in the 5.5x range, or maybe 5x range. In other words, if they’re generating $500 million in EBITDA, they have like $2.5 billion in debt just sample numbers, and they have an A minus credit rating.
NewLake Capital has a net cash position, all right? So they don’t – that I can’t stress that enough that at the same time, they’re not subject to 280E taxes. They’re generating around 80% or higher free cash flow margins. That’s the actual margin – that’s GAAP margins to shareholders, and they’re able to pay, use that to fund a 12% dividend yield.
And so, look, if in any situation where these MSOs survive. Forget thrive, they just survive, don’t go bankrupt. They’re still running a business. Shareholders do a capital. They’re getting this huge dividend yield, it should keep growing because these lease escalators grow around 2.7% every year.
And growth could accelerate once the valuations picked up for the stock, they’re able to issue stock and acquire more properties. But the idea is that the downside risk here is just in – it just like day and night compared to the MSOs, while still offering exposure to that upside. In fact, in my opinion, greater upside potential than the MSOs over the long-term.
RS: How would you articulate the downside risk? Because it would seem to me, I mean, and we’ve talked about NLCP and IIPR a bit on the show before on the Cannabis Investing Podcast. Are you worried about the tenants? Are you worried about the tenants’ ability to survive, let alone thrive? And what else — how else would you articulate the downside risk there?
JL: Of course, if it turns out, that selling cannabis legally in the United States turns out to be an unsustainable business model, then at some point, all of the tenants of NewLake Capital stop paying rent, they all go bust, however that looks. And at which point, that’s not too great for shareholders of NewLake Capital.
But again, remember, they have no debt. They have $39 million, or $40 million in net cash. Just think about the worst-case scenarios, right? I guess, worst-case scenario, they just kind of have to sell off all their properties, you can go and get some recovery for these properties.
Again, there’s – this is a net cash position. This doesn’t become a zero, far from it, right? Basically, the only way you get to this apocalyptic scenario where they have to sell off all their properties is if you have the names like, Curaleaf, Trulieve, Columbia Care (OTCQX:CCHWF), Green Thumb, these names have to go bust before NewLake Capital reaches that position where they have to sell off their properties and probably – sell out some discount and return the capital to shareholders.
That downside sounds pretty good to me. Obviously, it wouldn’t be ideal if everyone goes bust, but whereas the MSOs, there are scenarios where they go to zero just if legalization takes too long or if they never pay down debt. With NewLake Capital, it’s just not there.
AB: Yeah. I don’t cover NewLake Capital on my focus list of 26 names, but I looked at it while you were talking. And in the past, I’ve been laughed at because I warn investors, it’s OTC. It’s not New York Stock Exchange or Nasdaq. And they’re like, “Oh, what’s that matter?” And I don’t know that it matters that much except for the size of the investor base.
But I will say positively, what you pointed out is correct. They have a lot of cash and no debt or limited debt. They have a lot more cash. But I think more importantly for Rena, is it’s trading below tangible book value. So it’s already factoring in that they won’t be able to get if they have to liquidate their assets. They won’t be able to get full value, it’s already factored in.
JL: Yeah, it’s just kind of curious. I think the fact that (OTCQX:NLCP) trades at this 12% yield. And again, I need to be clear that not all cannabis REITs, I don’t like all cannabis REITs. But that’s why I’m specifically talking about NewLake Capital REIT properties, but I – the fact that the landlord is trading at these valuations, basically 7x real estate earnings. It illustrates just how pessimistic things are in the cannabis sector.
The way I view that is, the pessimism is not necessarily defined by how cheap the MSOs get. It’s defined by how much the valuations overall are from reality. Just talking about, again, I’m not trying to hate on Curaleaf somewhat. I know we’ve talked a lot about Curaleaf.
But like the fact that Curaleaf is trading at around 9x EBITDA, whereas Green Thumb is trading at 6x EBITDA. That indicates how weird the sector is, given that Green Thumb has less debt it’s profitable on a GAAP basis. Just the fact that valuations almost seem to not make sense. That is an indication of how pessimistic things are.
Yeah, again, with the case of NewLake Capital, I think it’s being – it’s like a baby thrown out with the bathwater. I think that investors, they don’t want to look at the MSOs overall. Like the generalist is not looking at the cannabis sector just because they can’t, or they just see the stocks going down. They don’t want to.
And I think ironically, investors in the cannabis sector, they seem just so laser focused on the MSOs specifically just kind of wanted to keep hurting themselves. They don’t – they’re not even expanding their horizons to look at names that are super profitable with no debt.
AB: Yeah.
RS: Alan, I’m curious. Speaking of no debt and you were talking about the Canadian LPs that you like, you’ve been on the Cannabis Investing Podcast talking about Organigram (OGI) and you’ve written out about some Canadian stocks, as you mentioned recently. Is that the number one reason there? And do you want to expand a little bit on what you like about them?
AB: So, I don’t think that Canada is booming, and I think it’s great that it was the first G7 nation to go legal. They kind of screwed it up. Mainly, the screw ups were besides the taxation rate, which was a screw up. Having the provinces be the middleman is a big problem.
But I think that there are some companies that have proven themselves that as tough as Canada is they can fall slower, grow faster, whatever the case. And I think that more importantly, for investors, they are federally legal and they’re trading – these companies are trading debt-free companies, Organigram and Cronos Group (CRON) are trading way below tangible book value. They’re rich on cash and they have almost no debt, or no debt.
And then Village Farms (VFF) has a little bit of debt. But I just wrote about that recently, and I think they’re doing very well in their Canadian business. Unfortunately, investors have to decide what’s their lettuce business worth? What’s their CBD business worth? And I say just go with zero. It’s still worth what it’s more than what it’s trading at.
JL: And I guess this relates to the discussion on Curaleaf, maybe something positive you could finally say about Curaleaf. Regarding the Canadian stock, there was a rumor in the last three months about Curaleaf specifically potentially acquiring Cronos. That was a really interesting idea, just given it seems random.
But if you frame it from the perspective of balance sheet, it was actually quite impressive and quite interesting, because Cronos has, last time I checked, just under $1 billion of net cash. Obviously, they’re kind of burning cash pretty quickly because they’re not close to profitability. But the idea there is, like, you got this Canadian operator who’s not quite like all the rest.
You got the likes of Tilray (TLRY), Canopy (CGC), Aurora Cannabis (ACB), all of these names are very highly levered. But Cronos here has almost $1 billion of net cash. The idea that Curaleaf could maybe acquire them, ideally with the all stock, not even no cash involved in that transaction, maybe shut down the Canadian operations and just bring that cash to the balance sheet.
That would have been very interesting. That would have, probably almost fully addressed all of Curaleaf’s balance sheet issues. But again, no deal has been announced, but I think my view of Curaleaf would improve.
AB: Julian, I like your analysis usually, I have to take 180 degree difference. I think that was BS and how would that happen? Are the people that run Cronos that stupid? I don’t think so. And why would they take the expensive stock of Curaleaf? They’re not that stupid. Trust me.
JL: Oh, I mean, I’m not speaking to the likelihood of the transaction. And again, there hasn’t been any news since the rumors happened. But I’m just speaking, like, if it were to happen, that would probably favorably influence my view of Curaleaf just because historically, they’ve kind of been a, growth-at-any-cost kind of operator. But yeah, I mean, if they’re able to address their balance sheet issues, that would be a positive, I think.
AB: Yeah. Well, they got Germany, though. Go Curaleaf in Germany.
RS: I’m curious we talked about the small pool of investors. And Alan, you question whether or not it makes a difference if a company is on a major exchange. I saw a news today, or late last week, or this week about Agrify (AGFY) receiving notification about being delisted from Nasdaq. Do either of you have thoughts on the company’s aside from IIPR, like InterCure (INCR), like Agrify, any of the companies that do trade on a major exchange?
AB: So I think that investors are kind of overly worried about reverse splits, but a reverse split will take care of this. And I think the problem is if you argue about that, then they’ll just say, yeah, but they already did a reverse split and then it went down again. See, see, but they’re mixing up the reality of bad companies with still bad valuations.
And so, I don’t really cover Agrify, but I don’t make a big deal out of it. And Organigram just did a reverse split, so it could keep on the Nasdaq, and people were making that argument with me. I’m going to buy it when it goes down. It’s up now.
RS: And what would you say, how do you reassure shareholders or prospective shareholders about that?
AB: Well, first of all, I say, who knows? Because zero is the floor, unfortunately, for any stock. The market’s inefficient. Why are people paying so much for Curaleaf against GTI? It makes no sense. It’s not that they’re stupid. It’s that they’re inefficient.
And I think that’s really the thing that I try to convey to anybody that listens to me, just because you’re smart and you have it figured out, it doesn’t mean you’ll be instantly right.
JL: Yeah. I think when stocks are trading on the major exchanges, there definitely is some curious things going on there. I think that, especially, I mean, if you just look at (IIPR) versus NewLake Capital (OTCQX:NLCP), both very similar names doing net leases with the cannabis operators. But whereas NewLake Capital has been focusing on the limited license states, and they have no debt.
Again, IIPR also has very little debt. They have $400 million of debt, which is around one-times debt-to-EBITDA. But they’ve been a little more aggressive in terms of acquisitions over the past couple of years. So they have a lot of assets, maybe in California, or a lot of those unlimited licensed states. But even so they’re trading at a significant premium to NewLake Capital, largely probably because of their Nasdaq listing.
But I think beyond that, I think it’s very interesting that I see a lot of investors favoring a name like AFC Gamma (AFCG), which is listed on the Nasdaq, even though I’m of the view that just the way AFC Gamma is structured, it’s a lot more risky than a NewLake Capital.
Just remember, AFC Gamma is owning the mortgages backing these properties, but they’re not necessarily owning the properties themselves. Just that distinction allows them to be listed on the exchanges, but that means they’re not as safe, because they don’t already own the properties.
In the worst case, when someone defaults on their property, AFC Gamma is just going to get ownership of the property, whereas in the case of NewLake Capital, because it’s an operating lease, if the tenant defaults on the lease, NewLake Capital can sue the company for damages of that lease.
That’s an important distinction even though NewLake Capital is trading arguably cheaper than AFC Gamma. I mean, I realize AFC Gamma has a higher dividend yield, but that’s just mainly because of a more aggressive payout ratio. And I’ll also note that AFC Gamma is externally managed. I analyzed with some subscribers….
AB: …with some history on that name, too.
JL: Yes. I won’t go into that history of their past BDCs and stuff. But at the very least, the way it’s structured right now, there the management is – the current CEO, I mean, the executives team, if you were to just look at how much stock they own of AFC Gamma, it might look like they’re aligned with shareholders just because they’re pretty sizable shareholders.
But you have to do some digging whenever there’s these externally managed structures. It turns out that same executive team they own most nearly a 100% of the external manager. And that external manager is compensated directly based on the growth of assets of AFC Gamma, not assets per share.
So, they’re really incentivized to grow at any cost just to grow that AU, so they can earn more management fees. And normally, the market is pretty smart about these things. They understand with mortgage REITs or these externally managed REITs that they deserve to trade at a pretty big discount to the other internally managed REITs.
But in this case, I think because AFC Gamma is traded on the major exchanges versus NewLake Capital trading over the counter, you got this weird discrepancy where in spite of the clear higher risk in terms of the business model as well and also the risk of the management alignment, AFC Gamma is still trading where it is versus NewLake Capital
AB: Yeah.
RS: Alan, any specific thoughts there?
AB: No, I don’t really follow the REITs so closely. I guess I cover (REFI), too. And I think Julian knows REITs more than I do. But I will say, when it comes to the REITs, I think that – if you think about what they’re buying or lending to, it may not be usable.
And I think, we were talking about the trading to a big tangible book value discount for NLCP. But I think that investors seem to be worried about if they get these properties back, what are they going to do with them? It’s not like the markets are going so well that, oh, yeah, I’ll take it. Please give it to me. No, it’s not working like that right now.
And a lot of the states are having disarray. And I think that I don’t own any REITs now in my model portfolios. And I think I agree with Julian. They are cheap, especially the one he’s talking about, but I’m just not sure they’re going to bounce anytime soon. I do see them as less risk than certain MSOs. That’s for sure.
RS: Yeah. Well, first of all, thank you both very much for joining. I hope that this is the first conversation that we have because I think a lot of – there’s been so much excitement and then disappointment around the cannabis industry, both in investing and just at large. And I think politically, there’s a lot of fits and starts.
And I think there is a lot of change to be had. There are a lot of catalysts coming. Who knows when those catalysts may be arriving? We don’t know. But there are definitely some interesting things to pay attention to as investors. So I appreciate you bringing a lot of sober analysis to this industry and I’ll leave both of you with your final thoughts and words to investors.
AB: I’ll step up. So thank you for doing this interview, and I agree with you. Fits and starts in our industry, sometimes people love them way too much, like in early ‘21 and sometimes they hate them right now. And just because everybody hates them, it doesn’t mean they’re a buy. And I’ve been telling my subscribers, I said the reason you’re subscribing isn’t because I’m going to tell you how to make money today. Unfortunately, unless you’re willing to go short, I don’t say that to them.
But unfortunately, unless you’re willing to go short, it’s really hard to make money in cannabis stocks right now. But by staying on top of it and watching the market, I think that the time will come when those catalysts are more near-term, real-time. And wouldn’t it be great to be able to buy at a low price when nobody else wants to buy? That would be great if it were a great time.
RS: Yeah. Julian, before you answer, I’ll say I just read a comment today on a Seeking Alpha article, and the commenter said something to the effect of, that Seeking Alpha teaches you how to become a better investor. It’s not necessarily about spoon-feeding, although sometimes that is provided. And I think to your point, people that are interested in this industry to be following along the way as we are now before it breaks out again, I think there is a lot of insight and edification waiting.
Julian, your thoughts?
JL: Yeah. Again, I share Alan’s thoughts. I think maybe investors, they got to realize that the amount of near-term catalysts on their horizon are probably pretty slim. At this point, especially for the MSOs, I think the only catalysts in play are going to be any that address their cost of capital, but those may not happen anytime soon.
And even in the case of Green Thumb, there’s no guarantee that there’ll be any removal of 280E, or anything there. Like, even in the case of my NewLake Capital, my top pick that I like, like, in terms of catalyst for full upside, those tend to be very directly aligned with whether or not there’s an actual fundamental recovery in the cannabis sector. And again that’s not really under the control of the tenants, or the landlords.
I think that investors, it’s important to perhaps even though you might have a lot of losses in the sector, remember that cannabis is not the only sector you can invest in. Even right now after a big rally, there’s still a lot of compelling value that you could be finding in the broader markets within the S&P 500, or even within tech. There’s still a lot that I’m liking within tech. I think just to keep your horizons open.
RS: Yeah. Good advice. Good advice. So, Julian Lin runs the Cannabis Growth Investor. And I will just point out since he mentioned tech that he also runs an investing group called Best Of Breed Growth Stocks..
And Alan Brochstein, the legend runs 420 Investor. Both of those investing groups are on Seeking Alpha, and you can find a transcript of this conversation on Seeking Alpha as well. Thank you both, very much.
AB: Thank you, and it was great talking with you, Julian.
JL: Yes, same with you, Alan. Thanks, Rena, for having us.
RS: Absolutely.
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