This guest op-ed was submitted by Anthony Coniglio, CEO & President of NewLake Capital Partners
The past 12 to 18 months have been trying for the cannabis industry. Operators had to contend with a myriad of issues, including price compression, inflation, and lack of access to capital. Due to the federal prohibition of cannabis in the US, many cannabis businesses also had difficulty accessing banking and financial services. Additionally, high taxes on cannabis products, such as state and local taxes, as well as onerous federal taxation under 280E, made it challenging for some to remain competitive and profitable, especially when competing against the illicit market.
About a year ago, the Biden Administration requested that the Department of Health and Human Services (HHS) reconsider how cannabis is scheduled under federal law. Then, in early September, HHS signaled it recommended to the Drug Enforcement Administration (DEA) that cannabis be rescheduled. While the exact details of the recommendation haven’t been released, there are multiple reports that the agency is suggesting moving cannabis from a Schedule I substance to a Schedule III of the Controlled Substances Act (CSA) – the same category as Tylenol with codeine.
While ultimately, the scheduling of cannabis under the CSA is primarily the responsibility of the DEA in consultation with the Food and Drug Administration (FDA) and other relevant agencies, this marks a historic first for a major federal agency to issue a recommendation on how cannabis is classified. After facing some serious headwinds, these tailwinds are welcomed news for the cannabis industry.
RELATED: When will federal marijuana legalization happen?
The current cannabis investment landscape
The news from HHS is also reigniting excitement in the investment community because eliminating 280E would finally help level the playing for cannabis businesses. If cannabis were to be rescheduled from a Schedule I to a III under CSA, it would effectively eliminate one of the biggest hindrances to profitability for cannabis businesses – Section 280E of the US Internal Revenue Code (26 U.S.C. § 280E).
This tax provision specifically applies to businesses engaged in the trafficking of controlled substances, as defined by federal law – and today, cannabis falls in that bucket. However, if 280E were to be eliminated, entrepreneurs in the sector would be able to take most business deductions and credits that are normally available to other types of businesses.
Despite the positive implications of the HHS announcement, as investors, we continue to focus on the fundamentals and adjust for potential benefits down the road. For those looking to step into the sector, we think it is critically important to do the homework and some good old-fashioned underwriting because there may be distress and dilution before the benefits of rescheduling appear.
Evaluating a company involves an assessment of many factors, but one of the most important is the financial health of the business. In this regard, a company’s financial statements are critical to the assessment. Looking at the financials and the footnotes, you can learn a lot about a company. This is particularly important in the cannabis industry.
RELATED: Eight major impacts cannabis rescheduling may have on publicly traded companies
Those interested in investing in a cannabis company should conduct thorough research and due diligence to make informed investment decisions. Here are some key factors and considerations for investors to look for when evaluating the financial health of a cannabis company:
The Opportunity: Assess the size and growth potential of the cannabis market in the company’s target regions. Look at market trends, consumer demographics, and demand projections. Evaluate the company’s business model, including its strategy for cultivation, production, and distribution. Consider whether it operates in the medical or adult-use cannabis market and where it is in its maturity cycle.
Financial Analysis: Review the company’s financial statements, including revenue, expenses, profitability, and cash flow. Pay attention to balance sheet strength and debt levels, including potential unpaid federal taxes. In particular, look at the company’s ability to meet current and long-term liabilities, as well as the maturity of its outstanding debt. If there is a meaningful shortfall in current assets to current liabilities or significant near-term maturities, the company may experience distress or need to raise capital, diluting shareholders. Do not ignore the footnotes, there is usually a wealth of information there.
Competitive Position: Analyze the company’s competitive position within the industry. Who are its competitors, and what sets the company apart? Look at market share and branding efforts. Assess the experience and track record of the company’s management team. Strong leadership is crucial for navigating the challenges of the cannabis industry. In particular, look at the management team’s ability to raise capital. This industry requires significant capital and management’s ability to raise capital is critical to long term success.
The Reach: For cannabis cultivation and production companies, assess their production capacity and efficiency. Scalability is important as demand grows. Understand the company’s distribution strategy. How do they reach consumers? Distribution partnerships and retail relationships can be significant. In many instances being vertically integrated (retail and wholesale) is very helpful to absorb price compression and manage cash flow. Consider the company’s brand and reputation. Positive consumer perceptions and brand recognition can be valuable assets.
Valuation & Vision: Evaluate the company’s valuation relative to its financial performance and industry peers. Assess whether the stock is overvalued or undervalued. In addition to the company’s long-term vision and growth strategy, look at your balance sheet analysis and see if the balance sheet risks are appropriately priced into the valuation.
Corporate Governance: Review the company’s corporate governance practices, including board structure and transparency. For public companies, review the Proxy Statement to understand the individuals, their expertise and independence. Some investors may also consider the company’s commitment to social responsibility, sustainability, and community engagement.
This article was submitted by a guest contributor to GreenState. The statements within do not necessarily reflect the opinions of GreenState, Hearst, or its constituents. The author is solely responsible for the content.