Ninepoint Alternative Health Fund

Executive Summary

In this month’s report, we detail the Q2/21 financial results for the US multi-state operators (MSO’s) that are key holdings in the Fund. We discuss the implications of significant M&A taking place in the US cannabis industry. We believe that there is the potential for significant growth for investor portfolios in 2H/21 based on the operational strength of the US MSO’s, their growth state by state while equity values remain muted. We also look at regulatory changes in the US investment business as Merrill Lynch and other firms have adjusted their policies with respect to trading/custody of US Cannabis names. This has significant positive implications for the liquidity of the US industry. We also discuss the significant changes for vaccination as the US FDA fully approved Pfizer’s coronavirus vaccine and continues to consider approval of its booster shot.

Introduction

The Ninepoint Alternative Health Fund is over four and a half years old and continues to outperform its benchmark and other related indexes that investors use to compare our performance. In this month’s commentary, we illustrate how the performance in the Fund is aided by our diversified approach, investing in many aspects of health and wellness as well as healthcare that are all benefiting from the re-opening trade as the US economy continues to re-open. Companies in the portfolio that performed well in the period include Abbot Labs (ABT) +4.46%, AMN Healthcare (AMN) +12.42% Innovative Industrial Properties (IIPR) +14.38 and Pfizer PFE +7.62%. In addition to the benefits of our healthcare focus, there are exciting opportunities taking place in the US cannabis space with significant M&A announcements that took place this month involving Terrascend (TER), Planet 13 (PLTH), Green Thumb Industries (GTI) and AYR Wellness (AYR).

We note that since Feb 10 peaks in cannabis names, the MSO ETFs are down ~45%* while the Canadian LP ETFs are down ~53%*. The Ninepoint Alternative Health Fund, Series F with its diversified approach and active management is off 24%, offering significantly less downside volatility. From our perspective investor exuberance in the cannabis space anticipated significant short-term US federal regulatory change, something that we have always stated would be more gradual. (*Indexes used are HMMJ and HMUS).

This has created a compelling investment opportunity as this short-sighted sell-off has occurred despite continued strong financial results as well as NY, VA and CT all passing adult use legislation. In addition, NJ starting its adult use program potentially in Q4 representing significant market growth for the MSOs operating in the state. This is after a very strong early trajectory from AZ adult use sales, all taking place while company fundamentals across the US continue to improve. We continue to remain very bullish on the US cannabis space.

In this month’s report we detail the Q2/21 financial results for the US multi-state operators (MSO’s) that are key holdings in the Fund. We believe that there is significant growth for investor portfolios in 2H/21 based on the operational strength of the US MSO’s, their growth state by state while equity values are compelling.

At a time when public market equity values are not responding to the strong fundamentals seen in the Q2 financial results of the leading MSO’s, the companies are using their balance sheets to add operations in key markets. Simply put, there are times to invest in under followed, underappreciated sectors and this is one of those times.

While the Fund focuses in the cannabis sector, the Fund offers a diversified approach to the re-opening trade that is taking place in the healthcare sector. As lockdowns and work from home ends, people are leaving their homes and resuming more normal daily routines. An area that the Fund offers exposure to includes elective surgeries, medical device replacements as well as the growth in healthcare staffing. Companies such as AMN and JNJ, all provide investors with the upside that is taking place in the healthcare sector as resumption of patient visits and needed medical services are required. Last year and throughout the pandemic elective surgeries and hospital visits were cancelled. We see pent-up demand for medical services that is driving 2021 financial results. This represents a breakout opportunity.

Regulatory

US Federal Cannabis Laws

The timing of US federal cannabis legislation and the exact areas that legislation will cover remain unclear, as there is not yet adequate support for any of the various cannabis reform packages that have been proposed. The positive take away is that there are many proposals and in our opinion, a large list of provisions to discuss, debate and reach consensus in Congress. What is also important is that the clock is ticking in terms of getting something done. Pressure is being exerted on the Democrats to fulfill an election promise that has wide voter support and if the US gets to the mid-term elections without any substantive changes with respect to cannabis legislation, it will reflect negatively on the Democrats. In the meantime, the status quo provides an opportunity to build a regulatory 'moat' that keeps Canadian operators, large CPG and pharmaceutical companies from entering the space, giving more time for MSO’s to open dispensaries in the best locations and establish brands thereby gaining traction with consumers.

We mentioned above that investing in the cannabis sector at this time is compelling given that equity markets remain muted for the sector, at a time when US multi state operators have executed business plans, continue to grow state by state while increasing sales and free cash flow with double digit growth in many cases. As a result, we have very valuable companies trading at a fraction of the multiples of other industries that don’t have the growth prospects or cash flow strength, yet they trade at much higher multiples.

In the chart above, notice that US cannabis companies trade at 11X 2022 EBITDA while Canadian cannabis trades at 105X EBITDA, yet they are excluded from the largest cannabis market in the world and generally do not have any EBITDA to speak of. Also interesting is the trading metric of the work from home stocks, with companies like Zoom recently selling off as their guidance is weakening with people going back to work.

Pfizer announced FDA Approval of its COVID 19 vaccine

The U.S. Food and Drug Administration (FDA) approved Pfizer Inc’s (PFE) COVID-19 vaccine, the first vaccine to receive full FDA approval. They will now be marketed as Comirnaty (koe-mir’-na-tee), for the prevention of COVID-19 disease in individuals 16 years of age and older. This is meaningful as FDA approval is expected to set off more vaccine mandates by employers and organisations across the US to ensure the population gets vaccinated and reduces the risk of contracting coronavirus. Full approval also reduces the concerns with respect to safety of vaccines as we have seen since the approval announcement, the rate of vaccination is rising once again in the US. The difference between the previous Emergency Use Authorization (EUA) and full FDA approval is that EUA was established to facilitate the availability and use of medical countermeasures, including vaccines, during public health emergencies, such as the current COVID-19 pandemic. To achieve full approval, the FDA requires six months of follow-up data with FDA inspectors visiting the plants where the vaccines were made in addition to reviewing each step of the production process for extra assurance that the shots are made under safe, sterile conditions.

Because vaccines are typically given to otherwise healthy individuals, they are generally subject to more regulatory scrutiny than other medical products, including prescription drugs. Full approval means the Pfizer vaccine now carries the FDA's strongest endorsement of safety and effectiveness. The vaccine continues to be available in the US under emergency use authorization (EUA), including for individuals 12 through 15 years of age and for the administration of a third dose in certain immunocompromised individuals. The vaccine had initially been given emergency use authorisation. Its two jabs, three weeks apart, are now fully approved for those aged 16 and older. Booster shots for some groups are also expected to be approved by the FDA in the coming weeks.

US Brokerage Industry Compliance Changes with Marijuana Related Businesses

Merrill Lynch Wealth Management with approx. $1.5 trillion in AUM, a division of Bank of America (BAC) has announced changes in the way its brokerage clients that have interests in cannabis companies can transact with Advisors. The company’s executives announced the “Project Thunder” initiative, a campaign aimed at addressing frustrations and different pain points endured by the brokerage’s advisors. One of the key changes is increased flexibility on accepting retail clients’ investments in plant-touching US companies, dubbed marijuana-related businesses (MRB). Onboarding clients with MRB’s and investments has remained a sticking point at many brokerage firms due to variances in state laws and the lack of clarity at the federal level according to compliance consulting firm Guidehouse. Merrill (BAC)’s strategy is not a complete fix, but it should serve to increase investor access to cannabis companies and represents a significant contrast from past years’ trends of banks and custodians unable to hold MRB securities. Media reports suggest the change was triggered by client demand, and recent increases in departure of advisors above the traditional attrition rate seen at Merrill over the last decade. It's important to note that BAC’s overall advisor count, including bank-based Edge advisors in addition to the Merrill Lynch sales force totals 19,358 advisors, almost double the entire number of IIROC advisors in all firms across Canada.

Company Announcements

This reporting period was filled with meaningful M&A announcements involving the US cannabis market. We note various transactions where well capitalized, fundamentally strong US MSO’s are selecting the markets they wish to expand into, buying smaller, less well capitalized companies at reduced valuation metrics.

Terrascend (TER) announced an agreement to acquire GAGE Growth Corp. (GAGE) in an all-share transaction valued at $545m, an ~18% premium to previous day’s closing price as at Aug 31^st. Recall that GAGE went public in April and has never hit its IPO opening price or valuation. Based on consensus estimates, the deal value implies a 2021 sales multiple of 3.44 times and a 2022 sales multiple of 1.44 times. In our opinion, the valuation is fairly low given the assets and revenue that GAGE is generating. The transaction allows TER to enter the third largest US state cannabis market, a state that is one of the most fragmented and competitive in the country. GAGE is Michigan's largest operator with 10 dispensary locations and 2 cultivation facilities in the state.

Making the deal more valuable for TER is an announcement that GAGE made after its Q2 results, announced an expansion of their Cookies relationship. Essentially in addition to the 2 MI Cookies stores, they will be able to launch 8 Cookies "Store in a Stores" in MI. In NJ, TER also has its 3 Apothecarium locations in NJ that will be exclusive Cookies "Store in a Store". This expansion of the Cookies relationship has the potential to meaningfully drive EBITDA growth. For TER upon completion of the transaction, the combined business will have operations in 5 states and Canada, including 7 cultivation and processing facilities and 23 operating dispensaries serving both medical and adult-use cannabis markets in the U.S. and Canada.

Planet 13 (PLTH) has agreed to purchase the Florida license from Harvest Health and Recreation (HARV) to operate as a Medical Marijuana Treatment Center issued by the Florida Department of Health for US$55 million in cash. Under Florida state law, Licensed Medical Marijuana Treatment Centers are vertically integrated and the only businesses in Florida authorized to dispense medical marijuana to qualified patients and caregivers. The MMTC’s are authorized to cultivate, process, transport and dispense medical marijuana. License holders are not subject to restrictions on the number of dispensaries that may be opened or on the number or size of cultivation and processing facilities they may operate.

This is a significant opportunity for PLTH as it gets the company into a new state market, one that is among the largest medical markets in the US. From its original focus in NV with its Super Store on the Las Vegas strip, PLTH now operates in 4 states including NV, CA, IL and now FL. Each of these states could be home to a Super Store given the unique tourism and population bases within each state.

Green Thumb Industries (GTI) announced that it has acquired GreenStar Herbals, a Massachusetts licensee that operates two adult-use retail locations in the state. With GTIs acquisition of Liberty Compassion earlier this year, GTI now has the maximum number of dispensaries allowed in MA along with cultivation/manufacturing operations to support its branded wholesale business in MA. With this acquisition in MA, GTI increases its national presence to 64 open retail locations, with licenses for 114 retail locations.

Ayr Wellness (AYR) announced the acquisition of Natural Medicine LLC, which operates three retail dispensaries in Pennsylvania. The stores are located in Bloomsburg, State College near Penn State University, and Selinsgrove, operating under the ‘Natures Medicine’ banner. All stores will be rebranded to Ayr Wellness subsequent to close. Terms of the proposed deal include upfront consideration of US$80M (US$35M in cash, US$20M stock and US$25M in sellers notes) as well as the potential for an additional US$40M in earnouts based on 2021 EBITDA targets. Management anticipates the deal to close in Q4/21. This transaction strengthens Ayr's presence in PA, one of the largest U.S. medical markets, adding to its six current licenses.

The desire to be in the US cannabis market has also led to significant interest from Canadian licensed producers. In August, Tilray (TLRY) announced the acquisition of 68% of the convertible notes outstanding in MedMen (MMEN) from its holder, Gotham Green Partners. The notes when converted represent a 21% equity interest in MMEN. For that 21% stake, TLRY is paying $120 million, Implying MMEN equity value of $560M and an EV $720M or 5.5x sales for MMEN that has negative EBITDA. Note the 5.5 times sales multiple paid for MMEN vs the 3.4 times multiple that TER paid for GAGE, keeping in mind the relationship with COOKIES and the growth of revenue in MI.

Timing of the TLRY conversion would only take place after federal legalization. As part of the transaction, a group connected to TLRY invested $100 million in a PIPE (private investment public entity) to assist with capital expenditures necessary to re-build and grow MMEN. It must be emphasized that the desire to be in the US cannabis industry has led to TLRY being involved in a fairly weakened US MSO, as the company has already gone through financial restructurings and re-financing proceedings over the last 18 months. MMEN has also had to sell its NY license, an important state market that is about to open to adult use.

Village Farms International (VFF) announced that it has acquired privately held, Colorado-based CBD-platform Balanced Health Botanicals in a transaction valued at US$75M, US$30M paid in cash, net of all debt of Balanced Health, and 4.7M shares of VFF, based on the VWAP for the 10 days ending the day prior to the Closing Date. Balanced Health Botanicals operates a growing brand in the hemp-derived CBD market in the United States. For VFF, it obtains an immediate entry into the US CBD market in a consumer products category, as well as the broader consumer packaged goods (CPG) wellness arena. The acquisition is expected to generate annual revenue of more than US$30M and an adjusted EBITDA margin of in excess of 15%. The company also maintains distribution to over 5,500 retail locations in the US. We see that the acquisition complements VFF’s strategy of being well positioned in advance of any regulatory change keeping in mind that VFF already operates 5.5m sq.ft. of cultivation in Texas greenhouses, assets likely geared towards the cannabis market when federal legalization occurs.

Fire & Flower (FAF) announced its entry into the California market through “Fire & Flower US Holdings opening its first branded store in Palm Springs, CA, through its strategic licensing partners. FAF announced its initial entry into the U.S. cannabis market in February 2021 when it signed a licensing agreement with American Acres to license its Fire & Flower branded store and HiFyre operating system providing its technology platform for dispensaries in California, Arizona and Nevada. Through this licensing arrangement, American Acres is expanding Fire & Flower's retail footprint in the U.S.

Financials

During August, US MSO’s released Q2 financial results that beat analyst expectations. Despite the significant growth and fundamental strength that has been achieved, these companies sometimes go unrecognized outside the cannabis industry. This quarter is one year after the unprecedented Q2-20 reporting period when the assumption was that pantry loading was the reason for significant growth in quarter. We provide notes on Q2 results from leading MSO’s that illustrate substantial YoY growth even over those stellar pantries loaded results of a year ago, illustrating the strong fundamental growth within the US cannabis space.

Curaleaf Inc. (CURA) announced revenue increases of 166% YoY and 20% over the prior quarter with revenues of $312.2 million in Q2, well above the consensus of $308 million. Q2 CURA storewide (retail) sales reached $222 million from its chain of 108 stores across 23 states, up 18% QoQ, representing 71% of revenues, while wholesale distribution revenues were up 24% QoQ reaching $89 million. The company reported adjusted EBITDA of $84.4 million. The results were significant in light of the re-opening and resumption of what some analysts expected as normal consumer spending. Even as consumers resumed spending on travel, dinner, nights out and other discretionary categories, cannabis consumption demand continues to remain resilient. For CURA, we see continued growth with its operations benefiting from adult use changes taking place in NJ (Q4/21 to Q1/22) as well as upcoming adult use market opening in NY (Q4/22-Q1/23). In addition, growing presence in strong medical markets such as PA and FLA contributing significantly to CURA operations in upcoming quarters.

Columbia Care (CCHW) announced record quarterly revenue of $109.7 million, an increase of 232% YoY, an increase of 19% QoQ. Also noteworthy was its operational cash flow strength generating record adj. EBITDA of $16.4 Million, an increase of $21.1 Million YoY, 58% QoQ. The company also reaffirmed 2021 guidance with revenue forecasts of $500-$530 million and adj. EBITDA of approx. $100 million. What is also important is that there is continued growth ahead for CCHW, with its top 5 markets continuing to contribute positively to cash flow, including CA, CO, MA, OH and PA. With NJ, NY & VA transitioning to adult-use sales over the next 6 to 18 months, we believe these east coast markets will effectively complement CCHW's west coast footprint (AZ, CA, CO), which continues to see solid growth.

Cresco Labs (CL) reported strong results with revenues of $210 million, up 17.7% QoQ, well above consensus of $196 million. The CL retail network had sales of $101.3 million from 33 stores, up 22.3% QoQ while wholesale revenues were $108.7 million was up 13.7% QoQ. Again, most important in the financial results is that the company continues to see growth as they maintained their 2021 guidance with an annualized run-rate of $1 billion in sales and adj. EBITDA run-rate margin of at least 30% by the end of 2021. Key markets for growth for CL include FL where they closed the Bluma wellness transaction in April, OH where management sees significant medical revenue growth this year while the state will likely have an adult use cannabis ballot initiative during the mid-term elections. This growth coupled with its strong position in IL where the number of dispensaries is scheduled to grow considerably while not adding any cultivation licenses will lead to significant demand for wholesale distribution.

Green Thumb Industries (GTI) continues to execute on its priorities for growth and profitability announcing its Q2 results, its 10th consecutive earnings beat. Revenues reached $222 million up 14% QoQ beating consensus of $207.5 million, up 85% year-over-year. GTI’s retail sales grew 15% in the quarter while wholesale revenue was up 13%. Adj. EBITDA was $79 million, up 11% QoQ, beating consensus of $74.7 million. Bottom line adj. earnings per share (EPS) was $0.14, up 150% QoQ, vs consensus of $0.08, the company delivering its fourth consecutive quarter of positive net income. The company continues to operate efficiently in 13 states with a total of 62 retail locations, and our belief is that growth in the second half will be strong as operations in state markets OH, PA, NJ and FL are aided by production expansions. In addition, with NJ and CT adult use sales contributing in Q122 with NY, VA and RI adding more adult use driven momentum in 2023 and beyond.

Harvest Health & Recreation (HARV) continues to generate strong results with is primary markets of AZ and PA as Q2 results brought in revenue of $102.5 million, an increase of 84% YoY, up 15% from the first quarter of 2021. Adjusted EBITDA in the second quarter was $28 million, compared to $26.9 million in the first quarter again generating stronger cash flows from core markets AZ, PA, FL and MD demonstrating strong organic growth trends. With HARV continuing to operate effectively, it sets up well to become part of TRUL as state regulators approve the acquisition (Q1/22) creating the largest and most profitable cannabis company in the US.

Trulieve Cannabis (TRUL) operations continue to be among the leaders in the US cannabis space with Q2 results that surpass estimates. Revenues were $215 million, up 80% vs Q2/20 and up 10% QoQ. The company continues to maintain the highest gross margin of all cannabis companies globally with a GM was 67.2%, gross profit $144.5 million. There has been some reduction in GM with TRUL although it continues to maintain the highest margin by a significant degree across the industry. Adjusted EBITDA for TRUL was $94.9 million and the company generated a net income of $40.9 million. The company continues to lead in the large and lucrative FL market, while also operating well in select markets including PA, MA WV, CT. TRUL recently opening its 96^th store in the nation while maintaining leadership in Florida with its 85^th dispensary location in the state. Recently, the company was one of only 2 licensees granted for cultivation in the newly created Georgia medical market which will be incorporated well into TRUL operations given its strong operations in neighbouring FL. As mentioned earlier, its plans to acquire HARV, one of the largest cannabis acquisitions announced in the U.S. to date continue to progress well having already passed US Justice Department reviews in a minimal amount of time. We believe the TRUL/HARV transaction is transformative, adding 5 states to TRUL 7 state footprint, with significant growth to operations in AZ, PA, FL, MA, CT, WV. Once the deal closes, combined operations will include 140 dispensaries in 12 states.

Village Farms (VFF) reported Q2/21 revenue of $70.3 million vs consensus of $63.9 million for the period ending June 30, 2021, a big beat on top line revenue. Cannabis specific EBITDA reached $7.4 million well in excess of consensus while the company’s produce business pulled down overall EBITDA with a very low margin to $1.5 million. VFF has outperformed its Canadian LP peers, gaining market share in the Canadian adult use market with 20+% sequential growth for 4 consecutive quarters. This is being achieved at a time when most producers are cutting costs, reducing SKU’s and still not generating positive cash flow from their cannabis focused business. VFF is producing at full capacity in its Delta BC greenhouse while getting ready to double production organically and potentially entering the lucrative QC market, expanding its addressable market by 15-17% in a favourable flower-dominant environment. As this company continues to execute as one of the best and most profitable cannabis operations in Canada valuation remains at a ~40% discount to peers on EV/2022e. We continue to be selective in our approach to the Canadian market, owning those businesses that we view as low-cost operations, with products in demand, gaining market share with competitive prices.

Options Strategy

During August the Fund continued using its options strategy to enhance risk adjusted returns. With the above average volatility in the cannabis sector, we are able to generate option premium, while lowering the overall volatility of the Fund relative to its underlying benchmark. Since inception of the options writing program in September 2018, the Fund has generated significant income from options premium of approximately $3.92 million. We will continue to utilize our options program to look for attractive opportunities given the above average volatility in the sector as we strongly believe that option writing can continue to add incremental value going forward.

During the month we used our options strategy to assist in rebalancing the portfolio in favor of names we prefer while generating approximately $12,000 in options income. We continue to write covered calls on names we feel are range bound near term and from which we could receive above average premiums. With the recent correction in our sector and drop in volatility we chose to not write any covered calls this month. We also continue to write cash secured puts out of the money at strike prices that offered opportunities to increase our exposure, at more attractive prices, to names already in the Fund including Johnson & Johnson (JNJ) and PLBY Group Inc. (PLBY). PLBY is a company operating in a capital light model with four established business lines; sexual wellness, style and apparel, gaming and lifestyle and beauty and grooming for which we are excited to invest alongside. It has a  portfolio of global brands, which admittedly were mismanaged in the past, but would be extremely expensive to replicate. We believe the new management will drive operational change and future growth. A new management team is resetting the foundation of the company with the goal of making the brand more relevant with younger consumers of all genders and is making waves amongst influencers. The recent operational changes by management and transparency around growth excites us to strategically allocate increasing capital to PLBY. This is an underfollowed company and not yet a consensus position on Wall Street. We expect this to change as execution risk begins to drop with each quarter of financial results and growth announcements. In our opinion, this name represents a rare opportunity to build generational wealth.

The Ninepoint Alternative Health Fund, launched in March of 2017 is Canada’s first actively managed mutual fund with a focus in the cannabis sector and remains open to new investors, available for purchase daily. An ETF version of the fund is also now available for investors. Utilizing our actively managed approach we are able to generate industry leading risk adjusted returns.

Charles Taerk & Douglas Waterson
The Portfolio Team
Faircourt Asset Management
Sub-Advisor to the Ninepoint Alternative Health Fund