Rescheduling, Ohio, New York: MSOs 2024 Outlook.

The year 2023 was a challenging one for MSOs, with intensifying competition and sluggish growth. Despite strong consumer demand, price cuts in states such as FL, PA, and IL generally offset rising volumes. The dulled market sentiment was reflected in declining valuations, which persisted until the HHS recommended re-scheduling (the MSOS ETF is up over 25% since the low on August 28). Re-scheduling will likely be the primary industry catalyst in 2024e (which could happen by Q2/24e due to the election cycle), leading to a step up in multiples; we expect MSOs would take advantage of improved valuations to raise capital and reduce leverage if this occurs. At the state level, the adult-use ramp in OH and NY will likely drive industry sales growth, but price compression will remain a challenge across different markets. FL and PA may move towards adult-use, which could improve sentiment, but actual sales in those states may start only in 2025e. 

Increasing Our Market Size Forecast
Our increase is primarily driven by higher sales in MN, NY, and OH (our base-case considers status quo markets, and does not include a meaningful contribution from legalization in additional states). We have increased our 5year CAGR to 9.6% (from 7.4%) to 2028e sales of $45.1bn (from $41.8bn). In 2024e, we expect legal cannabis sales of $30.7bn, reflecting 7.8% growth on 2023e sales of $28.5bn. 

Undervalued on Fundamentals
Our sector valuation indicates MSOs should trade at an average 2024e EV/EBITDA multiple of 11.8x, relatively in-line with the blended average of Alcohol (11.0x), CPG (14.4x), and Tobacco (8.5x). Large-cap MSOs are trading at a 2024e EV/EBITDA multiple of 6.4x, showcasing that the sector remains undervalued. 

2024 Predictions
(1) Re-scheduling will happen by Q2/24e, and many MSOs will move fast to raise capital on the stock rally;
(2) Volumes will continue to increase, but prices and store unit economics will deteriorate;
(3) Avg. adj. EBITDA margins will marginally improve as MSOs continue to streamline operations and enhance cultivation/manufacturing efficiency;
(4) Revenue growth, especially for larger MSOs, will be hard to find; and
(5) Deleveraging will remain a key priority for MSOs (and concern for investors), and we could see asset divestitures accelerating if re-scheduling does not happen soon. 

Focus on Quality
We think the sector is undervalued on fundamentals, with significant upside from regulatory developments that are a matter of when, not if. In this context, investors should emphasize quality through scale, top-tier margins, FCF generation, and healthy balance sheets.