In this month’s commentary, we continue to discuss the implications of President Biden’s announcement on the re-scheduling of cannabis with post Oct 6th transactions and agreements announced between Couche Tard (ADT) & Green Thumb Industries (GTI); Canopy Growth (WEED); as well as the entrance of Sean P Diddy Combs into the cannabis space. As capital markets remain challenging for growth companies, we discuss the termination of the acquisition by Verano (VRNO) of Goodness Growth (GDNS). As cannabis becomes more ingrained in more US states, we review analysis from the Kansas City Federal Reserve District on business activity, employment and tax revenue from the Fed’s 10th District.
We continue to maintain a weighting in the resilient healthcare sector to offset the effects of inflation and recessionary fears in the US. We discuss various macro factors that favour our allocation including demand on healthcare services both from elective surgeries as well as from a spike in flu season out-patient demand.
At time of writing, US mid-term results were not conclusive in terms of control of Congress. We will review these in more detail in next month’s commentary. Note for next month; the largest cannabis conference of the year is here once again- MJBIZ (Nov 16th) and we look forward to sharing details from this year’s edition in our next commentary.
October was a relatively positive month for North American equities as investors felt a FED pivot was in the works. That view brought investors back to equities with the SP 500 +8.1%. The month also witnessed follow-on implications of the early Oct announcement from President Biden with respect to re-scheduling cannabis in the Controlled Substances Act (CSA). First GTI and Couche Tard announced an exclusive partnership, then Canopy took another step to consolidate previously announced US cannabis investments. These announcements support our view that a de-risking around US cannabis is taking place, representing a great opportunity to invest. We also highlight what is taking place in the healthcare component of our portfolio with the effects of a significant kick-off to flu season. We are seeing strong demand for hospital visits and outpatient services and as a result we continue to see strength in our healthcare investments.
As we discussed in our last commentary, in early October, President Biden announced an expeditious review and re-scheduling of cannabis within the Controlled Substances Act. A few short weeks ago, we stated that this would begin to de-risk US Cannabis investing. Within a month, we have seen two large institutional/strategic investors decide that the risk of moving forward is greatly reduced and have come up with unique solutions to enter US cannabis markets more directly.
First, Green Thumb Industries (GTI) announced an exclusive distribution arrangement with Alimentation Couche Tard (ADT) through co-location with their Circle K convenience stores. GTI is a US multi-state cannabis operator (MSO) operating in 15 states with a total of 77 dispensaries, only 7 of which are in the state of Florida. ADT is the owner of Circle K, operating approximatively 6,500 convenience stores in the US and over 15,000 operating in 26 countries, Circle K has become one of the most widely recognized convenience store brands worldwide. There are over 600 Circle K stores in Florida.
The companies announced that there will be an initial rollout of 10 co-located cannabis stores adjacent to Circle K gas station locations starting in 2023. GTI will lease space from Circle K and offer registered medical patients a selection of branded cannabis products. Although Florida is a medical only market, it is the third largest cannabis market in the US, with 20 million residents and a $2 billion dollar run rate in medical cannabis sales.
When we look at ADT, a large $59 billion (Enterprise Value), TSX listed institutional name with a global footprint across 26 countries, it decided that based on the President’s announcement there was a willingness to move forward with a well-run, institutionally friendly operator. GTI is one of the more US institutionally friendly companies, has already filed S-1’s with the SEC and has filed its financial statements under US GAAP. In addition, the company is known for solid financials, strong execution and has operations in 15 states. ADT has engaged in cannabis before as a controlling investor of Fire & Flower (FAF), which coincidentally has its Hyfire software in select US dispensary locations. We believe this is another positive step to improving cannabis regulatory sentiment allowing more entities to enter and invest in the U.S. cannabis space.
To date, Florida has been dominated by the strong first mover advantage of Trulieve Cannabis (TRUL). With Circle K prime retail locations GTI can catapult itself into being one of the top names in the third largest cannabis market in the US. Currently, TRUL has 120 stores in FLA vs the closest competitor Verano Holdings (VRNO) at 61 while GTI currently operates 7 stores.
In another positive response to President Biden’s announcement, Canopy Growth (WEED) a NASDAQ and TSX listed issuer, an institutionally followed group is attempting to be an early mover given the new guidance provided in President Biden’s announcement. Keep in mind that WEED’s largest shareholder/investor is Constellation Brands (STZ) listed on NYSE and through its controlling interests in WEED would create a holdco, Canopy USA, to hold majority interests via non participating shares in Acreage Holdings (ACRG) Wana Brands and Jetty. WEED will then create its own non-participating shares for STZ to abide by US federal law. The non-voting non-controlling structure that Canopy proposed in the proxy explained how it would allow three U.S. cannabis investments to leverage each other's IP and distribution networks before federal permissibility. In essence the structure is an elaborate attempt of a company attempting to avoid US 'plant-touching' regulations on a major US exchange.
The NASDAQ objects to its plan and in the proxy filing, WEED indicated that “Nasdaq has proposed that such consolidation is impermissible under Nasdaq’s general policies." As a result, if WEED wants to close on the transaction, it appears that WEED would need to de-listed from NASDAQ. There are reports suggesting that the TSX would allow the proposed structure with WEED becoming solely a TSX issuer. We do not believe that the transaction moves forward on this basis as the one advantage that Canadian cannabis companies have over US MSO’s is their senior listing on a major US exchange (NASDAQ or NYSE). If WEED moves to the TSX, even though the TSX is a well-regarded exchange, WEED would suffer significant capital outflows as it would lose its liquidity advantage while it continues to suffer significant quarterly cash flow losses relative to the leading US MSO’s that are generating strong Gross Margins and EBITDA margins and, in some case, significant positive cash flows.
Cresco & Columbia Care Divest Licenses and Assets to Sean P Diddy Combs
As part of the merger transaction that required divestitures to satisfy state licensing requirements, Cresco Labs (CL) and Columbia Care (CCHW) announced the signing of definitive agreements to divest licenses in New York, Illinois, and Massachusetts to a group led by Sean “Diddy” Combs. The divestiture of the three state licenses and related assets totals US$185 million; $110 million in cash and the balance in seller notes. The assets involved in the transaction include:
Combs has a history of success having built a portfolio of global brands across music, entertainment, spirits and fashion. It will be interesting to see how he is able to change or make an impact on the branded business in cannabis.
For CL and CCHW, there are still several other state licenses to divest prior to closing the transaction. Those licenses include Ohio’s vertically integrated operations, a processing facility in Maryland where recreational is scheduled to begin in 2023, and Florida license that is yet to be operational.
Verano Terminates Acquisition of Goodness Growth
VRNO announced that it has terminated its deal to acquire Goodness Growth (GDNS), originally announced on February 1st. VRNO has stated that GDNS has breached elements of the agreement and is legally able to terminate and as a result, VRNO is seeking $18 million in termination fees/expense reimbursements from GDNS. GDNS believes VRNO has no legal basis to terminate and is alleging that VRNO is actually in breach accusing VRNO attempting to avoid closing after GDNS refused to reduce the purchase price. GDNS has one of the ten coveted licenses in New York that allows it to build out large cultivation in addition to operate a maximum 4 dispensaries. In addition, GDNS has holds 1 of just 2 licensed operations in Minnesota. Given slower than anticipated regulatory implementation of the NY recreational market, there is a perception that VRNO may have developed cold feet.
Kansas City Fed Cannabis Impact
The Federal Reserve's 10th District (the Kansas City Fed) recently revealed a study on the impact of the cannabis industry in the states of the 10th District. That includes the states of CO, KS, NE, OK, WY and parts of MO/NM. The summary from the report is that the legal cannabis sector creates jobs, demand for real estate and increases needed state tax revenues. To quote the report "the industry has led to higher employment and stronger demand for commercial real estate. In addition, tax revenues have increased.” The report acknowledges however that without access to banking services the industry’s growth risks being starved of growth capital. The key change required is the passage of SAFE (Secure and Fair Enforcement Act) by the US Senate.
As we continue to focus our cannabis investing in the US market, it is important to further detail some of the weakness taking place in the Canadian cannabis industry. We continue to see weakening trends in Canada. There are over 3,200 stores across Canada with HiFyre estimated sell through rates decelerating, with October sell through of $373 million, a 5% YoY increase. Its important to see the slow-down as the first half of 2022, sales growth was 20% YoY. Clearly inflationary headwinds and increased pricing pressures are having an impact.
In a recent filing, the Canada Revenue Agency stated that the number of cannabis licensed entities that are failing to pay their federal excise taxes on time continues to increase, illustrating a sign of cash weakness for many operators. CRA officials stated that as of September 30th, the mid point of the federal government’s fiscal year, there were over 170 entities that had unpaid taxes representing approx. $100 million Canadian. Troubling for investors should be the growth in unpaid taxes with a doubling since last year where the amount stood at $52 million for the same period. There are several reasons that account for the financial challenges faced by Canadian cannabis operators. These include price compression due to over-crowding of dispensaries in many metro areas; the number of licensees continues to grow despite market weakness. Once again, we stay well underweight the Canadian names.
We continue to use a weighting in the resilient healthcare sector to offset the effects of inflation and recessionary fears across many other consumer sectors. Healthcare is not interest rate sensitive and demand for medical consumers is affected by different market forces. In the current environment, the number of insured Americans is significantly higher than in the last recession of 2008, which makes healthcare consumption and demand dynamics more resilient in coming quarters.
We continue to see pent up demand for elective surgeries that were delayed or cancelled in 2020-21. We are also seeing growth in outpatient treatments and demand related to urgent care with the first flu season in 3 years, illustrating early cases of various respiratory illnesses.
Green Thumb Industries (GTI) was the first US MSO (multi state operator) to release Q3/22 results and the company surprised to the upside with revenues and cash flow ahead of expectations despite the inflationary headwinds affecting the North American economy. Revenue was $261 million, up 3% or $7 million QoQ, and 12% YoY. Importantly, inflationary impacts on production costs were less than anticipated with gross profit of $131.2 or 50.2% gross margin vs 55.4% in Q2, benefited from a full quarter contribution out of New Jersey adult-use sales, and growth in the Illinois market. Adjusted EBITDA grew 7% QoQ to $84 million or 32% of revenue. Further showing the strength of continued execution, cash flow from operations was $48 million after tax payments of $31 million. Q3 represented the 9th consecutive quarter of positive GAAP net income, with $10 million or $0.04 per share. GTI continues to state that it is ready for a US listing, being the first MSO to file an S-1 registration statement with the SEC however it is also investigating creative legal structures to list on the TSX as has been promoted by WEED.
Top ten holding Johnson & Johnson (JNJ) reported Q3-22 results that showed stability with a beat on revenue and EPS estimates. Revenues reached $23.8 billion exceeding estimates of $23.4 billion based on growth in its pharma and medtech divisions. Encouragingly for investors, JNJ is maintaining full-year guidance for sales and adjusted EPS respectively. Pharmaceutical sales grew 9.2%, driven by DARZALEX (treating adults with multiple myeloma), TREMFYA and STELARA (both treat adults with psoriatic arthritis). JNJ Janssen COVID-19 Vaccine worldwide sales were $489 million in Q3-22 exceeding estimates of $158 million. MedTech sales grew 8.1%, driven primarily by electrophysiology products (tests related to heart arrhythmia), contact lenses and orthopedics and wound closure products. Post-quarter end (JNJ) announced the acquisition of Abiomed (ABMD) for ~$17B. ABMD manufactures the Impella miniature heart pump, and through the acquisition, JNJ will strengthen its MedTech business as ABMD has achieved exclusive FDA approval for patients with severe coronary artery disease. Another key for JNJ is that cardiovascular technology is one of the fastest growing segments within the MedTech space and will assist JNJ with its mid to long term growth.
UnitedHealth Group (UNH) announced strong results again aided by a higher proportion of insured Americans, with Medicare reimbursement that is higher over the last decade. Revenues exceeded $80 billion growing 12% YoY and earnings from operations of $7.5 billion.
Growth in the third quarter was driven by continued expansion in value-based care initiatives at Optum Health. The company increased its full year 2022 net earnings outlook to $20.85 to $21.05 per share and adjusted net earnings to $21.85 to $22.05 per share.
Another beat over analyst estimates came in from Pfizer (PFE) with Q3-22 sales and EPS beats primarily due to COVID-19 vaccine revenues that were underappreciated in estimates. PFE reported Q3-22 revenues of $22.6 billion versus consensus $21.07 billion. 3Q22 adjusted diluted EPS of $1.78 reflects 40% growth YoY., adjusted diluted EPS grew 44%. The company raised its revenue guidance for Comirnaty by $2 billion and reaffirmed revenue guidance for Paxlovid of ~$22 billion and overall raised its full-year 2022 adjusted diluted EPS guidance to $6.40-$6.50.
Abbott Labs (ABT) Q3 revenues reached $10.4 billion while diluted EPS was $0.81. A key driver for ABT was its medical device division, with sales growth of 11.3% in the third quarter, led by strong double-digit growth in electrophysiology and diabetes care. ABT electrophysiology improves the diagnosis and treatments of some of the most common heart rhythm disorders while its diabetes care division is focussed on its FreeStyle Libre® continuous glucose monitoring system that helps reduce acute diabetes-related events. Encouraging for future quarterly results, ABT raised its full-year 2022 projected adjusted diluted earnings per share guidance from $5.17 to $5.23
Since inception of the option writing program in September 2018, the Fund has generated significant income from options premium of approximately $4.47 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.
Cross asset volatility, collectively, currencies, fixed income, high yield, and treasuries continue to misbehave. We believe the current bout of weakness, sour sentiment, and historic spike in rates are part of full cycle investing and should be monitored. While anxious in the near term, periods of extreme volatility often set up attractive entry points for high conviction plays that suffer from short-term drawdowns as intermarket correlations peak. History of bear markets is there are observable deterioration across various macro economic variables before we achieve a bottom. The bottoming of the market is a process and not a point. We also need to see lower levels of trending volatility and accelerating volume signalling to us a healthier investing environment. For market direction to change, we will need to see a macro trend reversal, usually driven by a catalyst event like a drastic change in Federal Reserve rhetoric that causes the market to reposition for a different policy regime and which brings renewed enthusiasm and capital into risk assets. Yield curves flatten and inverts while headed into a recession and then steepens while in a recession. For now, overall market risk is to the downside leading us to favor more resilient subsectors such as healthcare. Patience remains our core allocation. Every spike in equity volatility (VIX) and the related spikes in volatility of volatility (VVIX) has been an opportunity to monitor correlations within health care/cannabis.
Our current interpretation of cross asset volatility indicators and daily trading volume metrics indicate to us, for the time being, we will be selective traders of our preferred option trades, especially on decelerating volume and deteriorating fundamentals. We need to see lower levels of trending volatility and accelerating volume signalling to us a healthier investing environment. Volatility spikes are trending and as such we have been quite selective on our trades, tilted more towards large cap, lower beta health care to execute on, for now. During the month we used our options strategy to assist in rebalancing the portfolio in favor of names we prefer while generating approximately $69,000 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. Examples of such trades include Pfizer (PFE), AstraZeneca PLC (AZN), and Johnson & Johnson (JNJ). 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 AstraZeneca PLC (AZN), Abbott Laboratories (ABT), UnitedHealth Group Inc. (UNH), Merck & Co Inc. (MRK), Perrigo Company PLC (PRGO) and Tilray Brands Inc. (TLRY).
The Ninepoint Alternative Health Fund, launched in March of 2017 is Canada’s first actively managed mutual fund with a focus on the cannabis sector and remains open to new investors, available for purchase daily.
Charles Taerk & Douglas Waterson
The Portfolio Team
Faircourt Asset Management
Sub-Advisor to the Ninepoint Alternative Health Fund
|TR CAN/US HEALTH CARE BLENDED INDEX||4.1%||-36.6%||4.7%||-23.1%||-39.1%||-17.6%||-7.2%||-7.1%|
|FUND||TR CAN/US HEALTH CARE BLENDED INDEX|
1 All returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at October 31, 2022. The index is 70% Thomson Reuters Canada Health Care Total Return Index and 30% Thomson Reuters United States Healthcare Total Return Index and is computed by Ninepoint Partners LP based on publicly available index information.
The Fund is generally exposed to the following risks. See the prospectus of the Fund for a description of these risks: Cannabis sector risk; Concentration risk; Currency risk; Cybersecurity risk; Derivatives risk; Exchange traded fund risk; Foreign investment risk; Inflation risk; Market risk; Regulatory risk; Securities lending, repurchase and reverse repurchase transactions risk; Series risk; Specific issuer risk; Sub-adviser risk; Tax risk.
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