Title: The Illusion of a Thriving Cannabis Industry: Only a Handful of Companies Meet Institutional Standards
The cannabis industry has seen a significant rebound in the past year, with some stocks increasing by as much as 104%. However, despite this growth, the investable universe remains limited to just a few dozen companies. In fact, when it comes to institutional investors, only a handful of operators meet the minimum threshold of $100 million in adjusted EBITDA.
According to a recent report, the seven companies that clear this bar are all American, and they account for the majority of the total US public cannabis market capitalization. These companies are Trulieve, Green Thumb Industries, Curaleaf, Verano, Cresco Labs, Ascend Wellness, and Vireo Growth.
The reason for this limited pool of investable companies is due to the structural challenges facing the cannabis industry. For one, the sector is plagued by a lack of scale and liquidity, making it difficult for institutional investors to take meaningful positions. Additionally, the industry’s financials are often distorted by accounting conventions and unpaid taxes, making it difficult to determine which companies are truly profitable.
Adjusted EBITDA, a common metric used to measure a company’s profitability, is particularly misleading in the cannabis industry. This is because companies are forced to pay federal income taxes on gross profit, rather than net income, due to Section 280E of the federal tax code. This eats into cash flow and can make it difficult for companies to generate actual cash.
Furthermore, the industry’s reliance on sale-leaseback structures and other financing methods can also distort financials. These structures can hit cash flow but are often added back into EBITDA, making it difficult for investors to determine a company’s true cash generation.
As a result, several companies that appear healthy on EBITDA may actually be struggling to generate cash. For example, Ascend Wellness reported $13 million in operating cash flow over the last twelve months, but applying a standard methodology to adjust for deferred 280E taxes, the company’s cash flow flips to negative $43 million.
The industry’s reliance on accounting conventions and unpaid taxes has created a gap between reported profitability and actual cash generation. This gap is likely to continue until the industry consolidates or the largest names grow into something closer to consumer-staples scale.
In the meantime, the seven companies that clear the $100 million threshold are likely to continue to dominate the market, while smaller operators face a harder road to growth and survival.
