Value Hive Podcast

Aaron Edelheit: Dumpster Diving in Cannabis

Fri Feb 09 2024

cannabis industryinvestment strategiescultivation companiesrisksfuture potentialbeverage industry

Description

This episode explores the challenges and opportunities in the cannabis industry, focusing on investment strategies, successful cultivation companies, risks, and future potential. It also discusses the potential growth in the beverage industry and provides insights into specific companies.

Insights

Investing in Cannabis

Despite challenges faced in 2022, the cannabis sector still presents a massive opportunity for investors willing to do deep dive research and balance personal beliefs with responsible risk management.

Successful Cultivation Companies

Glasshouse Brands and Grown Rogue are two companies that have shown impressive cultivation gross margins and competitive advantages in the cannabis industry.

Reassessing Investment Strategy

The speaker admits their previous bullish view on the cannabis industry was wrong and now focuses on companies that excel in one specific area and demonstrate operational excellence.

Challenges in the Cannabis Industry

Many companies struggle with high production costs and lack of profitability, but Grown Rogue aims to find success by positioning itself as a craft producer with moderate volumes and high margins.

Investment Strategies and Industry Outlook

The cannabis industry has experienced significant fluctuations in stock prices, but the speaker believes in its long-term potential and focuses on companies with sustainable competitive advantages.

Risks and Future Potential

Investing in the cannabis industry is extremely risky and unpredictable, but there are opportunities for growth, especially in the beverage industry.

Chapters

Introduction
Cannabis as a Replacement Product
Reassessing Investment Strategy
Successful Cultivation Companies
Grown Rogue's Success and Expansion
Grown Rogue's Strategy and Industry Challenges
Investment Strategies and Industry Outlook
Risks and Future Potential
Opportunities in the Beverage Industry

Summary

Transcript

Introduction

00:01 - 08:45

The Macarops Value High podcast aims to make high risk-adjusted returns and offers differentiated research, theory, education resources, and a slack community.
MIT Investment Management Company (Matico) invests with emerging managers and created emergingmanagers.org for stock pickers.
Aaron Edelheit is an expert in the cannabis industry and has stayed invested despite challenging times.
Cannabis stocks trade on secondary or tertiary Canadian exchanges and liquidity can be low.
Lack of regulatory movement and drying up liquidity affected the cannabis sector in 2022.
Many funds shut down and investors left the industry during that time.
Aaron Edelheit believes in the massive opportunity in cannabis as a replacement product.

Cannabis as a Replacement Product

08:15 - 17:13

Cannabis is seen as a great replacement for other substances people consume, as it has fewer side effects and is less toxic.
Legalizing cannabis leads to positive societal outcomes, such as a decrease in drug driving and workplace accidents.
Claims linking cannabis to psychosis and teenage use are not supported by clear data.
The lack of institutional investors in the cannabis sector presents a significant opportunity for those willing to do deep dive research.
Despite the challenges faced in 2022, the speaker's cannabis fund had a successful year with a 70% increase.
Investing in the cannabis sector requires balancing personal beliefs with responsible risk management and objective research.
Initial investments based on market demand did not yield expected growth, leading to a reassessment of investment tactics.
Multi-state operators (MSOs) are companies that own multiple cannabis businesses and are considered important players in the industry.

Reassessing Investment Strategy

16:49 - 25:57

The speaker admits that their previous bullish view on the cannabis industry was wrong.
They believed in the value of vertical integration, size, and cash flows of multi-state operators (MSOs).
However, they realized that older markets were becoming more competitive and prices were dropping while new markets were opening up.
Many MSOs were built on a limited license model, which became problematic when prices dropped.
The complexity of operating in different states with varying regulations was underestimated.
The speaker shifted their focus to companies that excel in one specific area and demonstrate operational excellence.
Growing cannabis at scale is more challenging than previously thought, and there is a shortage of consistent, low-cost, high-quality cannabis.
Economies of scale only work if there is a competitive or cost advantage, not just a limited license.
The speaker now allocates capital to cultivators and brands that show promise through research and due diligence.

Successful Cultivation Companies

25:28 - 34:02

Many companies in the cannabis industry do not disclose their unit-level economics, making it difficult for investors to understand the true costs and profitability.
Glasshouse Brands is a company that focuses on growing good quality cannabis at scale and at a lower cost than its competitors. They have a state-of-the-art greenhouse in Santa Barbara with ideal weather conditions.
Growing cannabis is challenging due to its susceptibility to mold, pests, disease, and temperature fluctuations. It requires perfect conditions for optimal growth.
Glasshouse Brands has shown impressive cultivation gross margins despite the decline in California cannabis prices. They have a cost competitive advantage over other greenhouse producers.
Grown Rogue is another small company that stands out in the cannabis industry. They are the number one cultivator and flower brand in Oregon, which is a highly competitive market with low pricing.
Grown Rogue achieved free cash flow positivity with their $800 indoor flower, which is unique among other companies.

Grown Rogue's Success and Expansion

33:35 - 42:47

Grown Rogue is a cannabis company that focuses on small-scale cultivation and believes in providing high-quality cannabis at the lowest price.
They have achieved free cash flow positivity and have become a top five indoor flower brand in Michigan.
Grown Rogue recognizes the demand for new genetics and different experiences in the cannabis industry, which sets it apart from a commodity market.
Unlike larger companies like Glasshouse, Grown Rogue prefers smaller facilities to maintain flexibility and keep up with the latest genetics and trends.
They have successfully replicated their business model from Oregon to Michigan and are now expanding into New Jersey where prices are much higher.
Grown Rogue has some of the highest margins in cultivation in Oregon and Michigan, despite not being covered by any analysts.
The company aims to reach $50 to $100 million in EBITDA with about 60% translating into free cash flow.
Comparing companies based on manufacturing capacity or square footage may not be accurate as regulatory structures differ across states.
Interstate commerce for cannabis is currently prohibited, making it challenging to value cash flows from different states accurately.

Grown Rogue's Strategy and Industry Challenges

42:18 - 50:26

Many companies in the cannabis industry struggle with high production costs and lack of profitability.
Grown Rogue, a company positioning itself as a craft producer, aims to find a sweet spot in the market with moderate volumes and high margins.
The challenge for companies is to define their strategy and differentiate themselves from competitors.
Grown Rogue's ability to achieve 30-40% margins in competitive markets suggests potential success in less competitive markets.
Marketing and advertising investment is crucial for companies to stay top of mind for consumers.
Cultivation of cannabis is not as easy as some may think, requiring both art and science.
The capital needed to build cultivation facilities for cannabis is scarce, leading to limited competition.
Many large companies have invested billions of dollars in Canadian cannabis companies without significant returns.
Grown Rogue's CEO, Ob Strickler, has created an efficient and high-quality cultivation facility that would be difficult to replicate.
Rescheduling cannabis could potentially change the dynamics of the industry and attract more investors. However, current investors remain cautious due to past volatility.

Investment Strategies and Industry Outlook

49:58 - 58:44

Cannabis companies have experienced significant fluctuations in stock prices, with some going from $300 a share to $1.91.
The cannabis industry currently has very little capital available, and the main investors are survivors and debt lenders.
The rescheduling of cannabis and the potential influx of capital could change the industry dynamics and lead to lower prices.
The speaker believes in the long-term potential of cannabis and focuses on companies with sustainable competitive advantages.
West Coast cannabis companies may find it easier to expand when they enter new markets on the East Coast.
The speaker expects an interim ruling from the DEA by Q1 that could potentially schedule cannabis as a Class III substance.
The speaker does not hedge their long positions by shorting MSOS or any other cannabis company due to unpredictable price movements.
In 2022, the speaker shifted their investment strategy towards convertible debt and senior secured notes for better yields.
The speaker is grateful for supportive investors who understand the volatility and illiquidity of the cannabis market.

Risks and Future Potential

58:16 - 1:07:18

The speaker is grateful for their supportive investors who understand the risks associated with investing in illiquid assets.
They believe that investing in the cannabis industry is extremely risky and unpredictable.
The speaker does not want to short any companies in an industry they are bullish on.
Potential reasons for the cannabis industry facing challenges include regulatory reform not happening, no further states legalizing adult use, no movement on interstate commerce, and a challenging investment market with higher interest rates and limited capital availability.
The speaker has moved up the capital structure to mitigate risks and get paid while waiting for federal reform.
The speaker believes that President Biden's support for cannabis could be politically beneficial for him due to his age and desire to appear "with it."
Execution risk is always present when companies expand.
The interviewer appreciates the speaker's honesty about their mistakes and openness to discussing them publicly.
The speaker finds the cannabis industry fascinating and believes it is disruptive to American society.
Hemp beverages are gaining traction in Minnesota, with 15% of liquor store sales being hemp THC beverages. This market represents a significant opportunity compared to the size of the US alcohol market (estimated at $260 billion).
Low dose cannabis beverages are socially acceptable and have great potential as investments.

Opportunities in the Beverage Industry

1:06:50 - 1:10:30

Celsius, a beverage company, has seen significant growth in the last five years, with a 5000% increase in stock value.
A money manager speculated on the potential of Celsius expanding its market share beyond one state and suggested that there is great opportunity in the beverage industry.
The speaker emphasizes the importance of following curiosity, conducting due diligence and research, and being comfortable with risks such as illiquidity and regulatory changes.
The speaker believes that there is tremendous growth ahead in this industry for the next 20+ years.
The conversation suggests the possibility of discussing beverages again when there are IPOs or public companies related to beverages.
The podcast is expected to be helpful for those interested in capital cyclical industries or hunting for opportunities in undervalued spaces.
Information about Aaron's cannabis fund can be found at mindsetvalue.substack.com.