A Comparative Look at Valuation

• Cannabis stocks have advanced sharply since August 29th when the U.S. Department of Health and Human Services announced its recommendation to remove cannabis from a Schedule 1 narcotic to Schedule III. The precise timing of the Drug Enforcement Agency ruling (approve/disapprove) is unknown but likely sometime before the 2024 election.
• Tier 1 cannabis operators are trading at 3.0x ’24 EV/Sales with a 5 year CAGR of 11%. Looking broadly at the alcohol, tobacco and pharma sectors, cannabis stocks are trading in-line but with a more attractive growth profile.
• The valuation of a business operating in an emerging industry that is federally illegal presents numerous challenges and complexities, which for Cannabis, is brought on by:
  • • • The dichotomy between state and federal laws
      • A higher degree of operational risk associated with limited banking services
      • An excessive tax burden (IRS Code Section 280E) and other costs of prohibition
      • Timing of legalization/implementation of new state markets
      • A robust illicit market

• Valuation metrics usually considered in assessing early -stage businesses include EV/Sales and EV/EBITDA. Some cannabis companies report in conformity with GAAP while others have elected IFRS (International Financial Reporting Standards) making an “apples to apples” comparison less meaningful. Furthermore, consensus estimates are “Adjusted EBITDA” and the definition varies widely among operators – the differences among these standards impacts EBITDA . EV/Sales is arguably a more meaningful metric because revenue recognition is consistent.
• Revenue forecasts are with limited visibility with regards to the legalization and implementation of new state markets and the impact of law enforcement on disrupting illicit market sales. 5-year consensus estimates are provided for Tier 1 (more analyst coverage than Tiers 2 and 3) and may prove conservative given the limitations in forecasting.

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