Resumed Life Sciences Coverage: US Multi-State Operators

Undervalued on Fundamentals, Stuck on Regulations

The ATB Take:
We are resuming coverage of the US MSOs with a new macro thesis. We believe the sector is undervalued on fundamentals, but near-term catalysts that could broadly reset market expectations are regulation-related, with no visibility on timing. The market is loaded with negative sentiment on failed regulatory reform, neglecting the industry’s growth runway and margin potential. In 2023, we expect pricing headwinds to continue, but we expect margins to stabilize as MSOs cut costs and focus on cash flows. We believe near-term top-line growth will be moderate as markets mature and consolidate, and as new states marginally add to sales. In a starved-for-capital, lower-growth environment with evolving state regulations, investors should focus on names with near-term cash flow generating ability, diversified footprints, and balance sheets with lower leverage ratios and no near-term debt maturities. 


Undervalued On Fundamentals
MSOs are trading at an avg. 2023e EV/EBITDA multiple of ~6x, a 45% discount to our sector valuation of ~11x. We believe this discount is due to the market being overly negative on margins and growth. Despite price pressures, we think the industry average adj. EBITDA margin will stabilize at 23% in 2023 (supported by cost cutting) and over the longer term will re-approximate that of Alcohol at 30%. On growth, assuming a CAGR of 8%, it would take approximately 18 years for legal sales to reach $103bn, which is the size of the already-existing US cannabis market, including illicit sales. Our sector valuation uses a 2028 exit EV/EBITDA multiple of 10x, for implied LT growth of 8.0%, which compares to a market-implied exit multiple of 7.0x, for LT growth of 5.9%. 

Potential Impact of Regulatory Catalysts
We estimate (i) a potential revision of 280E could improve cash flow conversion and add 1.6x to our target 2023e EV/EBITDA multiple, (ii) up-listing and investor base broadening could lower cost of capital and add 1.2x to our target multiple, and (iii) federal legalization of cannabis could elicit a step-up in growth expectations and add 9.8x to our target multiple. Our bull case implies a 2023e EV/EBITDA multiple of 23.5x, a 298% expansion from current levels. 

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