Finding Opportunities in a Cannabis Market Meltdown
Featuring Shayne Laidlaw
Published on: October 1st, 2019 • Duration: 15 minutesShayne Laidlaw, cannabis sector head at Hedgeye, makes his Real Vision debut to discuss the outlook for cannabis legalization and to provide an update on the SAFE Banking Act. In this interview with Jake Merl, Laidlaw notes the growing concerns regarding recent vaping issues, drills down on his short-term bearish thesis for Canada, and highlights his favorite long and short ideas in the space. Filmed on September 30, 2019.
JAKE MERL: Welcome to Trade Ideas. I'm your host, Jake Merl. Today, we're joined by Shayne Laidlaw, cannabis sector head at Hedgeye. Shayne, it's great to have you on the show for your very first Real Vision interview..
SHAYNE LAIDLAW: Thank you so much for having me. It's a very exciting time.
JAKE MERL: We'd love to get your thoughts about what's going on in the cannabis market right now. We actually just had Todd Harrison of CB1 on the show just last week. However, since Todd's interview, we've gotten some more news regarding the SAFE Banking Act, which is the bill that will potentially allow cannabis companies access to capital markets and the banking system. Can you please break down what's happened over the past week, why it's so important and what investors should expect in the weeks and months to come?
SHAYNE LAIDLAW: Yeah, it's been another wild week in cannabis. I think, as you said, the SAFE Banking Act vote within the house, that was probably the most pivotal point in the cannabis industry over the last few months from a regular tori change on the margin to the positive. All those widely speculated that we get through at least the house given it's dominated by Democrats. I think the overall strength of the vote, 76% of the vote going for a yes is very significant as the bill now moves to the Senate. Within that, you also had strong representation from Republicans as well, which speaks very well to what could happen in the Senate, which is Republican dominated, as you know.
Now looking at the Senate, you have Mitch McConnell, who has Kentucky as His representative state, and there's obviously a big focus on hemp there. He has a strong focus on moving regulatory items through the Senate and into legalization as work on this bill specifically. Then Mike Crapo, the chairman of the Senate Finance Committee, is also going to be a pivotal portion to watch as this bill moves forward.
JAKE MERL: This is a great milestone for the sector. However, marijuana is still illegal at the federal level, it's only decriminalized, legalized or medically legalized in certain states. Given that fact, what's your outlook for the legalization process?
SHAYNE LAIDLAW: Yes, I think it has a lot to do with who's in the big seat in Washington from a presidential perspective. If we continue to see Republican dominance throughout both Congress and in the White House, I would say that something more like the state's act is more likely something that allows it in writing the states to regulate how they want to regulate their cannabis laws, whether it be completely illegal, medical only or adult use. If we have regime change, and it goes on the Democratic side of things, I think a full on legalization, or a decriminalization of the substance is more likely.
JAKE MERL: Right now, there's a lot of negative publicity regarding the space with the vaping issues. How do you see that impacting the long term legalization process?
SHAYNE LAIDLAW: Yeah. The vaping has been a bit of a mess over last couple weeks. Even I was at home, just before this interview getting ready this morning and the Today show was on and whether it's day or night, they're always talking about vaping. It's been an increasing trend over the last couple weeks.
Obviously, it gets them clicks but it furthers the problem from a stock perspective and from a public markets perspective for these cannabis stocks. I think if you look at what states like Massachusetts are doing, banning vape sales, whether nicotine or marijuana from the illegal channels completely until January 25th, 2020, just taking a step back is really causing a lot of near term noise.
I think this harkens back to the times of alcohol prohibition. Thinking about people, they didn't just stopped drinking, they went back into the illegal market, which are very dangerous from that respect. I think regulators really have to get their head on straight here and think about what really is the problem and that's black market vape pens and moving more towards legalization and regulation is the most important thing to do, not shutting off access to a legal product.
JAKE MERL: As legalization unfolds, are you looking at any particular states that will experience the most growth, which states are you most excited about?
SHAYNE LAIDLAW: The most states that are already written in stone here from a legalization perspective, and that's Illinois, Michigan. A couple of our top ideas at Hedgeye are Cresco Labs and Green Thumb who have the top two of three stakes in the state of Illinois. You have Cresco Labs who has three Canopy license and they'll have access to 10 stores and you have Green Thumb who has two Canopy license and will have access to 10 stores as well. They're going to be able to really execute on the growth in that market come Jan 1, 2020 when adult sales are legalized there.
Then from new news perspective, you look at states such as Arizona, northeastern states are starting to band together and start to think about legalization with New Jersey, New York and Connecticut. Then eventually Rhode Island is just sitting in between. They're going to have to do something so that pocket on the East Coast is a very critical moving point. Then Arizona is one of those West Coast states that I looked at to legalize, at least vote on it this upcoming year with legalized sales starting in 21.
JAKE MERL: It's interesting, you mentioned both Green Thumb and Cresco Labs, because those are two stocks that Todd Harrison actually recommended as well. You're in good company there. Can you please break down those two stocks a little bit more, review their fundamentals and why investors should be bullish on them?
SHAYNE LAIDLAW: Yeah, Todd's a great guy. I think we're well aligned on many of the calls out there. I may be a little bit more bearish on Canada in general but speaking to the US, we're generally aligned from that respect. I'll take Cresco Labs first. I think anytime we looked at any company within the cannabis space from the time this is about one year ago today, it's always been management team first. We really were vetting all these management teams to really avoid the CannTrusts of the industry, the Nama State technologies of the industry, which are some of the first CEOs we met in the space. You get the idea there might be a little bit of extracurriculars going on at these companies.
With these two companies, specifically, note, first and foremost, we're very confident in the management teams. We really like the trajectory of where they're taking their businesses. They're both building parallel path businesses, one being wholesale to dominate becoming the next General Mills of the industry, although with better margins than General Mills has now. Then the other path being the retail component. I think longer term, there's an opportunity for these companies to split because they're going to trade at very different multiples, and different margin profiles for both a retail and a wholesale business. For now, they work very well as a cohesive unit, and driving that forward.
It's management team, it's brand and it's execution at retail, both when the doors are open and opening the actual doors, because that's one of the biggest problems in this industry is right now is the management teams are putting out these egregious expectations on what they think they can do, but really following what people actually do and actually open and actually grow is one of the most important things in this industry.
JAKE MERL: In terms of the actual stock price, how high do you see shares actually go? What's your valuation target?
SHAYNE LAIDLAW: The stocks are down. Cresco, I think it's down in the last six months. You have Green Thumb down 40%, 45% in that range. It's been a very volatile space. Since the beginning and since I've put these names on, I've always held fast to the fact that these names can easily double, if not triple, because I'm very confident in their ability to execute on the growth in this industry. Because you can deal with this near term volatility, but it's the winner, it's the people that are executing on the best states and putting the best plan forward that are going to win longer term.
If they continue to ride on their line that they're on now and have the best house of brands and have the best retail concepts, I'm fully comfortable saying that these are going to be the winners longer term in the US. Trying to put a number on it today, with this volatility, I think would be a little ill-advised but saying that these are going to be the winners in a market that's growing from 10 billion in legalized sales to 50 plus over the next decade, I think those stocks are going to have a pretty good run.
JAKE MERL: Given the volatility we've seen recently, what would you say is the biggest risk to your bullish thesis for these two stocks?
SHAYNE LAIDLAW: Near term, it's this continued vaping crisis. I think we're not at the end of this, I rode the wave of AAA with Howard Penny, who's been on the show before, on the short side and back onto the long side. Just when you think it's done, there's going to be another thing that comes up. We really need to get past this patchwork of legalization that's really affecting the growth of this industry, and move more towards that regulated environment. Get cannabis off the schedule one drugs, we can start doing more serious studies on the substance. That's what we need to move forward. I think we're still going to have continued volatility over the next year or so.
JAKE MERL: Shayne, I'd actually like to back up a bit and hit on a point you mentioned earlier, you said you were bearish on Canadian cannabis companies. Can you explain that a little more, please?
SHAYNE LAIDLAW: Yes. Being long Cronos and saying I'm bearish on Canada is a tough seat to sit in. I think longer term, there is going to be a bifurcation between the companies. There's been two ways of running business. It's an asset light model, where you focus on making strategic partnerships both domestically and globally, domestic being in the Canadian market, and that's Cronos is doing. The other method is building out million square foot greenhouse facilities expecting that you're going to grow the highest quality flower at the cheapest price in the worst region to grow cannabis.
We can put Aphria in that bucket, and then Cronos in the asset light bucket. Longer term looking at Canada, if you think about the growth coming out of the October 17th, 2018 launch of just flower and oil, you haven't really seen that aggressive growth that you would expect and that a lot of that dovetails off the fact that it's not a complete legalized market, there's still no derivative products. That's a very important segment of the industry from a consumer perspective.
JAKE MERL: By derivative products, you mean like vaping and oils?
SHAYNE LAIDLAW: Vaping, topical oils. You have the oils already but then you have edibles as well, and beverages will be coming down the pike as well. Without that, it's really not a legalized industry from a consumer's perspective. Now, once we get the launch here and governments put out that it's going to be December 2019. I think it's all but been accepted that it's slipping into 1Q20, but how far it slips into 1Q20. If it's potentially 2Q20, that's going to be very bearish from a stock market perspective for the Canadian LP specifically.
Yes, that does hurt Cronos as well, but I think as you look at Cronos internationally and their footprint in Europe, through their Israel partnerships, and then down in Australia, it really provides them a good diversification of revenues globally, and not to mention their Lord Jones acquisition that will bring them into the CBD market within the US, which is very important for them and I think underappreciated for what it can do for 2020. Because if you look at what Charlotte's Web has done, they've done about $150, or will do about $150 million in sales this year. If Lord Jones can just crack half of that, or even get to that $100 million mark, it's really going to provide Cronos with a good leg up and some good cash flow for their business.
JAKE MERL: Shayne, specifically drilling down on Aphria, can you walk us through your short thesis a little more and why do you think it's a good short candidate?
SHAYNE LAIDLAW: Yeah, so this is a very-- I don't like to say macro driven short, but it's more of a play on the industry and how we think operators within the industry should look longer term instead of what they look like now. This is going to be one of the biggest huge capacity players up in Canada. They have massive amounts of capacity and they also have a management team that we dislike. Irwin Simon, previously was the CEO and founder of Hain Celestial within the US, it was very much a roll up story. Not a lot of organic growth, despite being involved in organic categories. It was constantly making acquisitions, both domestically and internationally.
Now, he's seen that same thing happened with Aphria and now, he's the interim CEO and chairman of that company. We think with one proponent being that they have way too much capacity and not a focus on either higher quality grow, or lowest price, and a management team that we don't think is going to be able to execute on the long term strategy and navigating through all the ups and downs of this industry, especially over the next two to three-year time period, we don't see them being able to be a winner in Canada longer term.
JAKE MERL: Is the stock worth zero dollars per share, or you're just bearish and you think it has more downside risk?
SHAYNE LAIDLAW: From a bankruptcy perspective, they have more time than others. There's smaller operators that I think could go down to bankruptcy come next summer. Although I'm not going to call a bankruptcy on Aphria now and I'm not going to put any names out there from bankruptcy perspective but in Canada, I've increasingly heard people call this an upcoming nuclear winter. People have used other terms too, but it's going to be very volatile for some of the smaller players that don't have the best price and don't have the highest quality flower. That's not going to be a good place to be.
For companies in Canada that were more positive on it's-- the Cronoses of the world that have north of a billion dollars in cash. Although we're still negative on Canopy who does have a similar cash pile as well. We think they're a little over spread both across product formats and internationally. That's why we just can't get comfortable alongside with Canopy.
JAKE MERL: Well, Shayne, it was awesome having you on the show. Thanks so much for coming on. We'll see how the volatility shakes out in the months to come.
SHAYNE LAIDLAW: Thanks so much. Looking forward to being back.