Verano is now my favorite large telecom operator (upgrade) (OTCMKTS:VRNOF)

I last wrote about Verano (OTCQX:VRNOF) on July 26, when I upgraded my recommendation from sell to neutral. Since then, the company reported a weaker-than-expected second quarter. The price fell on the financial update and then plummeted on the news that the DEA has scheduled a hearing for its rescheduling recommendation.

I'm upping the buy recommendation on the stock with this article that looks at the chart, the second quarter and changing outlook, and the valuation. Readers of this article will understand why I like Verano now. I added a few this week to my Beat the Global Cannabis Stock Index that I share with 420 Investor subscribers.

The Verano standings are battered but solid

I want to start with the 3-year chart as it shows what was a very long-term bottom formation that took place in early 2023:

The trading range, which included a The all-time low near $2.50 in August 2023, just before the rumor emerged that the Department of Health and Human Services had requested that the DEA consider rescheduling cannabis, was around $2.50-3.50, and it is back in that range.

The one-year chart reveals a slightly different perspective:

First, the recent lows are above the late October low of $3.00. Second, there is a gap above $3.82. I see support at $3.00 and resistance between $3.75 and $4.25. The stock closed 2023 at $4.48.

Summer has fallen behind its peers in 2024:

Curaleaf (OTCPK:CURLF), which I upgraded from Strong Sell to Sell last week, is down further, but Verano is well below the 2.6% average.

I think the important dates to keep in mind are 8/29/23, the day before the news of the possible rescheduling broke, and 4/30/24, when the market peaked on the news that the DEA was officially recommending rescheduling.

Since August 29, Verano is up 24.1%, but it is well below three of its peers and above only Curaleaf. The average Tier 1 MSO has gained 54.3%.

Since the April peak, Verano has fallen more than all others except Curaleaf. The average decline has been 42.9%.

The second quarter was tough for Verano

In my article last month, I warned that the outlook for Verano has been deteriorating. I shared a preview with 420 Investor subscribers ahead of the August 7 report saying that analysts expected revenue to be $226 million and adjusted EBITDA to decline to $67 million. The company reported second-quarter revenue of $222.4 million, up just 0.5% sequentially but down 5% from a year ago. Adjusted EBITDA beat expectations at $70.6 million but was 1% lower than a year ago.

In the second quarter, retail sales revenue fell 12% from a year ago, while wholesale sales revenue grew 7%. Operating income improved from the first quarter, but fell 10% from a year ago. Operating cash flow of $8 million decreased sequentially.

The current ratio at the end of the second quarter was just 0.99X, indicating that current liabilities are slightly higher than current assets. Net debt increased slightly to $266 million during the quarter. This net debt does not include income tax payable and deferred tax, which amount to $426 million. Tangible book value was reported at -$50.7 million.

Updated outlook for Summer is solid

Prior to the fourth-quarter report, analysts were expecting 2024 revenue to grow 2% to $921 million, according to AlphaSense. They were projecting adjusted EBITDA of $277 million. The company did not provide any guidance in its press release sharing second-quarter financial results due to pending acquisitions in Arizona and Virginia, which ended up closing in late August. Despite the additional revenue, analysts have lowered their forecasts. They now expect 2024 revenue to decline 3% to $908 million. Adjusted EBITDA is projected to fall 8% to $282 million.

For 2025, analysts were projecting revenue of $1.027 billion with adjusted EBITDA of $328 million, a margin of 31.9%. They now project revenue to grow 9% to $986 million, with adjusted EBITDA growing 9% to $308 million, a margin of 31.2%, which is close to the 31% level I had used in that July article.

Despite the M&A, which I believe made sense for both the buyer, Verano, and the seller, projected estimates for 2025 are lower today than before the quarter was reported. The decision Florida voters make in November when they vote on legalizing adult-use marijuana will certainly impact the 2025 projections.

Summer is cheap compared to its peers

Compared to the other four Tier 1 MSOs, Verano trades at the lowest enterprise value relative to projected 2025 adjusted EBITDA, tied with Trulieve (OTCQX:TCNNF):

Even Curaleaf, which I don't like at the current price relative to its peers, is cheap compared to where cannabis stocks should be trading in my opinion. Verano has a much better balance sheet than Curaleaf, but it's not flawless. Green Thumb Industries (OTCQX:GTBIF) has positive tangible book value and very little net debt.

In the article I shared here in July, I looked at my year-end target price of $6.49 based on 8x enterprise value and my projected 2025 adjusted EBITDA, which is below consensus. If I update that for the lower consensus and the adjusted share count and equity position, I get $6.19. This level, which is below the April 30 close, would represent a potential gain of 87.5% from the $3.30 close on August 30.

My year-end target may be too aggressive, as investors may not see the valuation upside until the 280E is removed, which is not likely to happen in 2024. That said, the valuation could rise much higher in 2025. Verano is the only Tier 1 name I have in my model portfolio that is aiming to outperform the global cannabis stock index, and I expect it can do very well in 2025.

Conclusion

While I still fear that analysts’ margins for Verano are too high, this is not a problem for it in the short term. The company’s next financial update will be in early November. I added it to my model portfolio this week at $3.24, which represents a 27.7% drop from its price at the end of 2023. Even so, this price is 28.1% above its all-time low set just over a year ago.

I continue to hope that the DEA will be successful in its attempt to reclassify cannabis from Schedule 1 to Schedule 3. This will eliminate 280E taxes, which will help the cash flow and net income of Verano and all cannabis operators in the United States.

The chart looks constructive and the valuation seems very cheap relative to its peers. Verano is not my favorite cannabis stock by any stretch, as my position in my model portfolio is only 3.1%, which is below its weight in the global cannabis stock index of 3.3%. I currently own 42.9% of MSO.

While I am optimistic about the investment potential of MSOs, there are risks. A rescheduling may not occur and these companies generally have low or negative tangible book values ​​and substantial debt. I believe the ancillary companies, which represent 33.9% of my model portfolio, will benefit from the removal of 280E as their clients' financial strengths improve. These stocks trade on the NASDAQ and some are trading below tangible book valuation or at relatively low multiples to projected adjusted EBITDA. I have reduced my exposure to Canadian LPs to 22.9% in two stocks. In this case, there is no benefit from rescheduling, but the stock looks cheap.

For investors looking to cash in on cannabis, I think MSOs are very timely. The removal of 280E, if it happens, could be a catalyst. It is still unclear whether Trump would be elected president and would support it, and this is the main risk to rescheduling. For those who want to make a bet and stick to the bigger names, I think Verano is the best Tier 1 right now. I prefer some of the Tier 2 names and a few other smaller ones.

Editor's Note: This article discusses one or more securities that are not listed on a major U.S. exchange. Please be aware of the risks associated with these securities.