Why Has Liberty Health Sciences Stock Bucked the Marijuana Downtrend?

There has been a lot of chatter recently about Liberty Health Sciences and for good cause. The stock is up almost 80% since the beginning of October while the majority of the marijuana industry continues to flounder (HMMJ Index down 20% over that period).

We wanted to try and understand this standout performance.

LHS Stock Price

 

In this piece we highlight three possible reasons why LHS stock has been outperforming marijuana peers:

  • Solid positioning in the Florida market
  • Sound business fundamentals
  • Potential take-out target

For unfamiliar investors, Liberty Health Sciences is a US-based marijuana company focused exclusively on the Florida market. While LHS was technically an MSO throughout 2020 Q2, the company sold the majority of its stake in Ohio based JVs at the end of their August quarter.

This sends a clear signal of do-or-die in Florida. While the Florida market is known to be expanding rapidly, so is competition. We wanted to start by looking at the company’s performance to date and how they’ve positioned themselves in the most second-most populous state.

Are Rising Tides Just Lifting All Ships?

Similar to all the meaningful players in the Florida market, LHS has benefited from a rapidly expanding market in terms of both patient count and sales. According to data as of Nov. 29, patient growth has shown no signs of slowing down.

However, as mentioned above the competition is heating up. The number of open dispensaries is increasing at a faster rate than the number of patients. This means competition will be intense and most dispensaries will continually serve a lower and lower share of the total patients.

Florida Patient Count to Dispensary Ratio

Source: Florida OMMU

To thrive in the Florida market, companies will need to select effective dispensary locations and scale their store count efficiently. The simplest way to measure a company’s success is by looking at the total share of sales relative to their share of dispensaries.

Looking only at sales per store can allow the growing Florida market to falsely bolster performance. In such a competitive environment, successful companies will capture an outsized portion of sales relative to the size of their operations. A ratio greater than one indicates a company’s stores generate a greater share of sales relative to peers.

It’s also important to tie the analysis back to the total market share. If a company only has one store that does very well, it will look very efficient, however, there will be little revenue and subsequent profit to distribute to shareholders.

The following graphs show the relative market share and overall dispensary efficiency for both medical marijuana (extracts) and smokable product (flower) sales for the week of Nov. 29.

Florida Cannabis Company Market Share and Store Efficiency for Extract Sales

Source: Florida OMMU

Florida Cannabis Company Market Share and Store Efficiency for Flower Sales

Source: Florida OMMU

As expected, Trulieve captures an outsized portion of the total market (largest circle) and operates the most efficient dispensaries (highest ratio) for both extracts and flower.

Looking at Liberty Health Sciences, it’s clear they are not a dominant player in the extracts space. Excluding Trulieve from the group, they are still 30% below the group average in terms of store efficiency. They also sit 6th in market share with 4.6%.

Looking at flower sales, the picture improves. LHS’ dispensaries are the second-most efficient at generating sales of flowers. Excluding Trulieve from the group, they are 140% above the group average while sitting second in market share with 15.8%.

Clearly, investors are valuing LHS based on the potential of the flower market. This segment is largely underserved to date and has seen weekly sales grow over 85% since July 19. With companies reporting steady pricing (for now) amid increasing competition, this is a solid position for LHS.

Although LHS saw a slight drop in total weekly flower sales near the end of October, the numbers have since recovered. Given the importance of this business segment, investors should watch for signs they are faltering.

Until that time, given LHS’ healthy balance sheet and solid fundamentals (see below), investors can be happy with their solid position in the Florida marijuana market.

Healthy Fundamentals

Adding to Liberty Health Sciences’ solid position in the Florida market is its sound fundamentals and impressive growth.

They reported 2020 Q2 earnings (quarter-end Aug. 31) at the end of October and managed to grow revenues 93% to $10.6 million while gross margin improved to 47% from 40%. Clearly, increasing scale has benefited their margins — a good sign for investors.

At the same time, LHS managed to decrease operating expenses, even after removing negative operating expenses from consideration (royalty, share-based compensation). However, most impressive is their flat sales and marketing expenses while generating substantial revenue growth.

The company generated positive cash flow from both operations and investing, however, after removing non-cash expenses, operating income was -$0.6 million. Given their growth rate and their cash balance (~$24 million), LHS shouldn’t have any issues reaching profitability if they choose to stop investing heavily in growth.

Cresco Labs Take-Out Target?

Finally, is the potential for an accretive acquisition.

Last week Cresco Labs announced they are canceling their acquisition of Florida-focused VidaCann. In short, it appears the deal, largely all-cash and valuing VidaCann at $120 million, was too steep a price for Cresco to enter the Florida market given current market conditions.

Given Liberty Health Science’s solid position in Florida, its healthy operations, and modest cash balance, they appear to be an excellent target.

With equity markets largely dried up for marijuana companies, any successful deals will likely be limited to stock. Within the same release, Cresco also announced the sale and leaseback of two cultivation and processing facilities for ~$38 million, freeing up $158 million in cash for the company.

Now, given Cresco Labs’ substantial footprint across the U.S., it would be shocking for them to avoid entering the second-largest U.S. market. This means they will likely look for other opportunities.

With Florida law requiring fully-vertical operations, at this time, entering organically would require too much time and capital. This leaves acquisition as their best bet, and they now have the cash to invest in growth.

Given Liberty Health Science’s solid position in Florida, its healthy operations, and modest cash balance, they appear to be an excellent target. While LHS currently trades at a market cap of ~$230 million, it’s a target that is within reach for Cresco Labs.

From the chatter on Twitter, it also appears to be what most investors think is likely. The anticipation of a deal may be another reason the stock price has been rebounding.

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The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Capital 10X hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.

Evan Veryard
Evan Veryard has a Bachelor's of Chemical Engineering from McGill University and a MaSc. of Chemical Engineering from RMC. He has over 6 years of research experience focusing on industrial materials. Address: 682 Indian Road, Toronto, Ontario, M6P 2C9. Phone: 416-721-8257.
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