Many cannabis businesses are struggling to stay afloat, and it’s not because people aren’t interested in the industry.
Due to the federal status of cannabis, businesses in the cannabis space are subject to different regulations than traditional businesses in the United States. One of the key factors responsible for the current state of affairs is Section 280E in the tax codes.
Green Wave Advisors has released a new report explaining the impact of the federal prohibition on cannabis businesses. Since many multistate operators (MSO)’s have gone public, the companies are including financial disclosures explaining the influence of 280E.
This tax code prevents those “trafficking” federally illegal substances from claiming business-related deductions on their taxes, and unfortunately at this time that includes cannabis, even if the business is operating legally at the state level.
However, businesses are able to deduct the Cost of Goods associated with operating their business on their taxes. This is not an easy thing to prove, however, and can be costly to do so. This is not the only workaround 280E, but the others present similar challenges.
Green Wave Advisors limited its scope to those businesses with a market cap of greater than $500M with the exception of MedMen Holdings Inc. (OTC: MMNFF). The report found that only three businesses it vetted turned a profit at the end of 2018’s fiscal year.
Cresco Labs (OTC: CRLBF), Green Thumb Industries Inc. (OTC: GTBIF), and Trulieve Cannabis Corp. (OTC: TCNNF) were found to be those that were profitable, with tax provisions of $4.4M, $8.6M, and $28.8M respectively and income losses of $7.5M, $28.6M, and $71.7M. The three companies paid tax rates of 59%, 30%, and 40%.
The remaining companies operated at a net loss in FYE 2018 and quantified a rough estimate of potential tax credits if Section 280E were not in place.
Acreage Holdings (ACRG.U), Columbia Care (CCHWF), CuraLeaf (CURLF), Harvest Health & Recreation (HRVSF), and MedMen showed an estimated NOL tax credit loss of $13M, $8.3M, $11.8M, $14.7M, and $55.3M respectively.
“While regulatory uncertainty continues to loom, current valuations may provide an attractive risk/reward profile for investors with an undefined time horizon, able to “sit” patiently until federal laws are modified,” said Matt Karnes, the founder of Green Wave. “When the added costs of prohibition are no longer necessary, businesses will be better
able to generate meaningful free cash flows, become less dependent upon outside sources of capital
and ultimately garner higher valuations, in our view.”
For the first nine months of 2019, the story is painted a bit differently as all mentioned MSOs incurred losses with the exception of Trulieve which has earned a profit due to an unrealized gain which was associated with the change in fair value of its biological assets. If Trulieve did not have this gain, it would also be in the red.
As displayed, Section 280E is causing a fair amount of issues for cannabis companies. Other roadblocks for these companies include the limited access to traditional banking as well as the illicit market continuing to thrive.
Green Wave Advisors believe that these problems will continue as long as restrictions are imposed and/or recreational cannabis use is legalized.
Karnes added, “We believe losses in some markets will continue until restrictions are further eased and/or recreational use is legalized. A good example is New York State, and in particular, Manhattan, in which medical marijuana licenses are highly coveted. With limitations on allowable form factors (among other challenges) and high operating costs, these storefronts are likely losing money but the silver lining remains in the conversion to recreational use.”