Chart: Cannabis Is More Capital-Intensive Than Tobacco, Alcohol, Pharmaceuticals - Does It Pay Off?

The Viridian Chart of the Week on 8/27/23 demonstrated that cannabis is more capital-intensive than tobacco, alcohol, pharmaceuticals, or general consumer products. Cannabis measured 1.67x capital/sales. The industry has managed to reduce capital intensity slightly since then, and the group now measures 1.54x capital/sales.

The high capital intensity has severe implications for internally fundable growth. If, on average, it takes $1.54 of extra capital to get $1 of additional sales, with 30% EBITDA margins and high 280e taxes, it is clear that growth requires external financing. S3 will help but not eliminate this issue.

This week’s chart explores the differences between major MSOs in capital intensity and the implications for EBITDA margins and EBITDA/ Capital employed.

The green bars on the chart show each company’s March 2024 Capital employed (book equity+ book debt-cash) divided by its projected next twelve-month sales. Note the significant discrepancy between the least capital-intensive competitor, Jushi JUSHF vs. the most capital-intensive AYR Wellness AYRWF. Jushi has only $.80 of capital for each dollar of sales, whereas AYR has $2.33 of capital for each dollar of sales.

The orange line shows each company’s projected 2024 EBITDA. Higher capital intensity tends to correlate with higher EBITDA margins. This effect is probably due to margin increases achievable from vertical integration, but secondarily, it is due to the cost savings of greater process automation.  

There are several outliers in this distribution. Jushi has better-projected margins than its low capital intensity would predict. Perhaps Jushi will have to spend more to achieve the revenues and EBITDA that analysts are projecting. AYR is another anomaly in that its 25% projected EBITDA multiple is lower than the dotted regression line suggests. AYR has invested significant amounts in Ohio and Florida in anticipation of adult rec roll-outs, potentially understating returns on capital.

The purple line on the chart shows EBITDA/Capital Employed, which is unlevered pretax return on capital. The downward trend in the data suggests that while greater capital intensity enables higher EBITDA multiples, it may not pay off with regard to return on investment. Jushi, with the second-lowest projected 2024 EBITDA margin, has the highest EBITDA/ Capital of the group.

In the long run, interstate commerce will mitigate the issue of capital intensity inhibiting internally fundable growth. The ability to centralize operations with regional grow centers and consolidate other operating functions will reduce the capital intensity of the industry and foster better capital returns. IC is still years away, however, and in the meantime, investors should be watchful of the capital intensity of the companies they invest in to make sure the growth opportunities justify the capital outlays.

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.