Cannabis Chart Of The Week: Which Margins Should Investors Focus On?

Viridian’s Chart of the Week focuses on the strengths and weaknesses of different margins as a measure of profitability and credit quality.

The green line in the graph shows consensus estimates of 2025 net margins; the red line shows 2025 cash flow from operations margins, while the blue line shows consensus estimates of 2025 EBITDA Margins. The chart is arranged to show companies with the highest projected Cash Flow margins on the left.

Note that in every case, the net margin is lower than the cash flow from operations margin, which, in turn, is lower than the EBITDA margin. Why are these measures so different, and which should be paid most attention to? The obvious, although frustrating, answer is that it depends on the use.

Net margins are rarely discussed in cannabis, and a quick look at the graph shows why. Nine of the seventeen companies have negative net income estimates for 2025. The chief culprit is, of course, 280e taxes, and several of these companies are also overleveraged with relatively expensive debt dragging down net income. The main advantage is the matching principle of accounting. When a company buys inventory, it is not counted as an expense since it has not yet sold the product. Similarly fixed assets are expensed over time in keeping with their useful life. One significant disadvantage of Net income, however, is that management choices can manipulate it. A company that changes inventory accounting methods or fixed useful life estimates for fixed assets will change its net income. Similarly, management has a wide range of choices on how to accrue expenses, all of which impact net income.

Operating Cash Flow Margins have one huge benefit – they are the most difficult to manipulate. Most changes in accounting policies leave cash flow unchanged. Operating cash flow is where analysts should focus on determining debt capacity and ability to fund operations internally. Weaknesses included the fact that if one stretches payables or purchases insufficient income, both will temporarily at least increase operating cash flow.

EBITDA is one of the best measures of the overall earnings power for all stakeholders. EBITDA multiples are often used to value companies using comparable company values. However, one must be aware of the implicit assumptions being made. One is that the companies being compared have similar tax structures. This is obviously invalid when comparing U.S. Cannabis companies to Canadian LPs or other CPG sectors. All other things being equal, U.S. MSOs should carry lower EBITDA multiples since more of it must go to taxes. Another implicit assumption is that the comparison groups all have similar CAPEX requirements. If they don’t, then EBITDA distorts a critical aspect of discounted cash flow valuation. Still, if investors are mindful of the implicit assumptions, EBITDA can be a helpful valuation tool, although its use in credit analysis is more mixed.

Investors can be creatures of habit, reaching for the same tools for every use. Each of the multiples discussed should be calculated and weighed to form consistent and accurate valuation and credit judgments. Investors need to be aware of the assumptions they are making with too much emphasis on one of these measures.

The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.

The Viridian Cannabis Deal Tracker provides the market intelligence that cannabis companies, investors, and acquirers utilize to make informed decisions regarding capital allocation and M&A strategy. The Deal Tracker is a proprietary information service that monitors capital raise and M&A activity in the legal cannabis, CBD, and psychedelics industries. Each week the Tracker aggregates and analyzes all closed deals and segments each according to key metrics:

• Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors - from Cultivation to Brands to Software)

• Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A) Status of the company announcing the transaction (Public vs. Private)

• Principals to the Transaction (Issuer/Investor/Lender/Acquirer) Key deal terms (Pricing and Valuation)

• Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)

• Deals by Location of Issuer/Buyer/Seller (To Track the Flow of Capital and M&A Deals by State and Country)

• Credit Ratings (Leverage and Liquidity Ratios)

Since its inception in 2015, the Viridian Cannabis Deal Tracker has tracked and analyzed more than 2,500 capital raises and 1,000 M&A transactions totaling over $50 billion in aggregate value.

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.