For those of you who have been following me for a moment, you will know that I got back into the swing of cannabis in late summer just last year. I originally started covering cannabis stocks in late 2018 when cannabis was very young and just starting out up in Canada. I am a San Franciscan and had seen the change in attitudes towards cannabis. Personally, I do not consume the products; this, despite my birthday being 4/20. Unfortunately, in early 2019 while traveling through South And Central America I contracted a virus that took me down for some 15 months. I am a master coffee roaster and trod through these regions in search of unique and interesting coffees that I have partnered up with a roaster here in California to produce for me (You can try my coffees if you like). When I got back to investing and analyzing, one of the very first stocks I looked at was General Cannabis. I analyzed them back in November of last year. I thought it was time to look at them again.
I had left California for Colorado for a number of reasons. Colorado, of course, is the epicenter of cannabis change. After Colorado switched to adult-use legalization, the dominos fell. It should be noted that Washington State also legalized recreational cannabis however, they lack the notoriety that Colorado garnered.
Within the state of Colorado is General Cannabis. They are a budding cannabis company with three main cores of business. They are:
I wanted to break down the respective divisions of the company to show what they were and how their interconnectivity will likely produce increased earnings. For now, here is a look at the chart on General Cannabis $CANN:
Note: When you look this chart up make certain you are not looking at Heritage Cannabis up in Canada; they share the same symbol.
Next Big Crop
The first arm of the company is Next Big Crop. This is the consulting arm of General Cannabis. Basically, the services they offer are to help companies get started in the industry. They consult on how to go through the entire process.
I’m not a big fan of consulting firms simply because they are difficult and expensive to scale. Nonetheless, there are revenues to be had as the entire country looks set to switch to cannabis legal for adult use. So, perhaps Next Big Crop can add to the topline. But, the interconnectivity of General Cannabis lends itself to this being an advantage.
Should the new firms that Next Big Crop will be consulting for need any new financing, General Cannabis has another division that does financing.
GC Capital is a lender and investment banker in the cannabis industry. Right now, banking is not legal in the United States for cannabis companies. However, the House of Representatives just passed its version of the SAFE Banking act and that is now in committee for the Senate. I am doubtful that the passage of this bill will negatively affect GC Capital since allowing banking will allow for more readily available transmission of funds. That remains to be seen for now.
In the meantime, since you have two arms of the company looking for avenues to assist new companies, this could be beneficial.
This is the arm of the company that I like the most with the most potential. SevenFive was purchased via a stock purchase back in May of last year. They are a grow facility that produces some 3,000 pounds of cannabis annually. The cannabis is oversubscribed every grow season. At ~$1,500.00 per pound in wholesale terms, that’s about $4M – $4.5M annual revenue. Given their base of revenue prior to the purchase, this pushes the company’s revenue upwards by double.
Also, General Cannabis purchased a dispensary in Pueblo, Colorado and that is coming online which will add both EBITDA and net earnings to the bottom lines.
Overall, General Cannabis is increasing its revenue base and this looks quite promising. Let’s break down their financials to see where this could take the company and $CANN.
Revenue & Gross Margins
Revenues are starting to appreciate as this chart shows:
The problem with this revenue increase is that it is not exactly organic. While Next Big Crop and GC Capital may have added to the revenue picture, the increases here are more driven by the two recent acquisitions. Revenue growth that is increasing is good. But, what about the assets that are in place with GC Capital and Next Big Crop? As I mentioned, it is difficult to grow and expand consulting firms. But, the financing arm could be potentially lucrative.
Still, the acquisition of SevenFive Farm may be the driver for General Cannabis. If they have a product portfolio that sells out on a regular basis then this opportunity needs to be cultivated and pushed further. Colorado is a mature cannabis market but, there are other markets opening throughout the country that could be a potential opportunity for expansion.
SevenFive Farm could add a solid $1M per quarter onto existing revenues. And, the addition of the dispensary, a potential selling place for premium label products derived from SevenFive, will add EBITDA profits and net earnings. The premium products could add needed gross margin increases.
Gross margins should increase with the inclusion of the dispensary’s revenues and margins into the financial data. For now, it is falling well below norms:
When I first looked at General Cannabis, with the recent print of 37.5% in gross margins, it seemed likely that there would be an upward trend. The latest quarter was a miss on that.
Dispensaries tend to have consistent gross margins; they do not deal with too much variability. A store knows how much foot traffic it is going to see from past experience. So, labor costs can be kept in check. At the same time, all of the products they purchase are the end products. Therefore, there is consistency in pricing from that versus what a grow facility may see in the way of variability.
It will take some time, but the full inclusion of the dispensary and the grow facility will very likely increase gross margins.
Relative to revenues, total operating costs are too high:
For now, the foundation of this business is not efficient. It is effectively a service company offering consulting and financing options to the cannabis industry. Yet, relative to what General Cannabis is bringing in, they are spending too much to run the company. I would be very interested to see how the inclusion of the dispensary and grow facility.
The thing is, if the dispensary and the grow facility do improve the bottom line, I would still want to see the financing and consulting portion of the business carry its own weight. This is the organic growth from the revenue picture I mentioned earlier. I would not want to see the two new inclusions carrying the weight of these other two endeavors.
EBITDA, Earnings Before Interest, Tax, Depreciation, and Amortization, is steadily increasing, but still have a way to go:
You can see the effects of the drop in gross margins on EBITDA. Had General Cannabis been able to maintain the near 40% in gross margins on the increasing revenues, versus the near 20%, the EBITDA story would be quite different. It is this subtle change in one metric that has a ripple effect all the way down.
Net income took a hit from decreasing metrics as well as costs associated with acquiring additions:
If you were to average the past two quarters, they flatline at -$1.9M per quarter. But, by averaging, you take away the momentum from the previous quarters’ great turn towards profitability. Still, the addition of costs associated with acquiring the dispensary and the grow facility may pale in comparison to what they lost.
Is General Cannabis a Good Buy?
The purchase of SevenFive Farm and the dispensary show that General Cannabis is switching gears entirely. Whereas before they were service-related in the financial sector and business development, now they are direct to consumer with cannabis products. This is not necessarily a bad thing at all. But, I would have wanted to see the original core business carry its own.
In theory, financial services should do very well with cannabis. The one thing that cannabis lacks is a viable financial services segment simply because of the illegality of cannabis in the United States on the federal level. But, that looks set to change. So, perhaps there are future opportunities for GC Capital and Next Big Wave. In the meantime, I would like to see improved metrics from these two divisions. Otherwise, they may weigh down the success of the newly vertical arm of the enterprise.
The inclusion of a grow facility and a dispensary are paving the way for a whole new direction. They now have a farm that is oversubscribed with sales of their products. I say: Expand. If it’s working, then have the ability to really push forward and build something.
Then, they also have the dispensary which is stated to be adding to EBITDA and net profitability immediately. Given the inclusion of a grow facility with the dispensary, General Cannabis now has the ability to create its own premium brands. Given that SevenFive is always oversubscribed, it tells me they have a product that is both high quality and potentially underpriced.
General Cannabis Base Case Scenario
General Cannabis is currently trading at $0.85 per share. What could it be worth?
From a revenue perspective, I am expecting about $4M total from the SevenFive Farm as well as an additional $2M from the dispensary; a total of about $6M annual. Also, General Cannabis was producing ~$7.5M annually from GC and Next. The new total for revenue will likely be approximately $13.5M – $14M.
Margins are going to be tough to predict since there is a lack of consistency. But, with the dispensary, I would expect about 60% gross on the $2M, an additional 55% on the $4M, and then, well probably about 50% on the remaining $7.5M. That, of course, is being quite generous since they have yet to hit those metrics consistently, if at all. This would give the combined firm some $7.15M on ~$14M in revenue.
Then, total operating expenses are largely consistent at $2M quarterly from the core business. But, the total operating expenses from the other two additions may be more difficult to predict and so I will work with metrics I see consistently.
First, with the dispensary, from the MD&A we know that the dispensary is both EBITDA profitable and net earnings profitable. Likely, total operating expenses are coming in about 35% of revenue, so ~$600k. Then, for SevenFive, since they are oversubscribed, very likely their pricing is such that they have raised prices to cover necessary costs to most extents. This will likely come in at 35% of total revenue; $1.4M.
This means total operating expenses are going to hit at approximately $4M total. Given the $7.15M in gross profits, this leaves $3.15M in operating profits.
An EBTIDA rate of about 10% of revenue will leave approximately $1.5M in total net earnings.
There are 62M shares outstanding. This would mean an EPS of ~$0.0215.
Future Earnings Multiple
What is a viable future earnings multiple for General Cannabis? Hmmm… on the one hand, they are a financial services company that has some growth but lacks profitability. On the other hand, they are a cannabis producer and direct-to-consumer dispensary. These multiples tend to be significantly higher.
Time to bust out on the 9th-grade algebra that we were told we would never actually use in the real world.
For the $8M I will apply a 35x future valuation and for the remaining I will apply an 80x future valuation giving an average of 55x future multiple. But, that could easily rise if the SevenFive Farm starts to increase revenues rapidly. With that, I think the stock could be trading at $1.34 per share.
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