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Medmen’s (MMNFF) Net Operating Losses Piling Up as it Attempts to Scale

support@smarteranalyst.com (Ben Mahaney)

MedMen (MMNFF) is one of those plays in the cannabis sector that attracts a lot of overall positive attention, yet there are a number of things to consider over its viability as a long-term growth story, as a growing number of analysts and pundits suggest.

Many think MedMen is the most recognized brand in the U.S., giving the impression it has the strongest potential to succeed in the U.S. and Canadian markets going forward.

I think it's far too premature to draw that conclusion, as there are a large number of retail competitors in the U.S. that have the potential to grow meaningful revenue and market share in the years ahead.

Earnings and potential

In its latest earnings period MedMen generated $36.6 million in revenue, slightly beating by 0.1 million, up 155.1 percent year-over-year. GAAP earnings per share in the third quarter finished at -$0.20, missing by $0.09.

For the quarter the company had a huge net operating loss of $53.3 million, and for the nine-month period ended with the quarter, losses accumulated to $178.4 million.

Even though it has grown revenue nicely, the cost and losses associated with that growth has resulted in the company losing over 15 percent of its value. Since mid-June it has started to rebound some, closing at $2.73 as I write. Significantly down from its 52-week high of $7.57.

Based primarily on its perceived leading brand recognition in the U.S., the company projects annual sales to jump to $1 billion over the next several years. That would make it the largest pot retailer in the U.S. as measured by revenue.

The downside to that is if it struggles to find ways to dramatically cut costs as it scales.

Some of Wall Street believe opening new retail stores in major markets like Arizona, Florida and Nevada will result in the company achieving profitability within a couple of years. That's overly optimistic from my point of view.

It's going to have to scale enormously in order to make up for the growing costs of opening and operating new stores. A two-year period doesn't leave a lot of room for cutting those costs based upon scaling revenue alone. It'll help, but if it continues to expand at a rapid pace, I don't see the company cutting costs and being efficient enough to become profitable in that time period.

The only thing I see that could change that over the next couple of years would be if it successfully sells more of its own brands, which command a gross margin of 80 percent, against the 55 percent average gross margin it gets from selling third-party cannabis.

That other thing to consider is many of its competitors may aggressively pursue growth, but at a more cost-efficient pace, where they become more desirable holdings than MedMen. That would mean less interest from the market and the loss of momentum in its share price.

Current and future operations

According to its investor presentation in May, the company had 35 stores that were operational, and was licensed for 86 retail stores across twelve states, including pending acquisitions. By the end of 2019 it expects to have 50 stores open for business.

In the largest cannabis market in the world - California, it generated $24.9 million in revenue during the last quarter, accounting for 7 percent market share in the state. Another positive is it boosted its gross margin in California from 51 percent to 57 percent.

Adding market share in California along with its increasing gross margins, combined with selling more of its own products, should over time, bring about the profitability the company is seeking, if it doesn't burn through its cash.

As for the announced partnership with Cronos Group in Canada, I'm not as convinced this is going to add much to the company's performance, if the deal is consummated. Something is better than nothing I guess, but that market has some big players with a lot of deals in place with retailers. I don't think it will be able to rely on its branding strength in Canada as it has been able to in the U.S.

Conclusion

Based upon its aggressive "land grab" for an increasing number of retail outlets, MedMen is likely to eventually catch a decent bid. That said, I don't think it's a company that is going to form a higher bottom anytime soon.

Consequently, I think it's going to be a good stock to trade, but not one I would hold onto for a long period of time.

For those that really believe in the growth narrative surrounding MedMen, it would be best to add to positions on the dips, as it's going to be difficult for those that buy near the ceiling and then experience the inevitable big pullbacks that will continually be part of owning MedMen.

I don't have any problem believing MedMen can grow revenue via acquisitions, but I don think it's going to struggle to obtain the profitability it guides for in the time frame asserted by management. That will eventually put a lot of downward pressure on the stock when that is realized.

The positive is the company has laid out a clear and visible path to growth and profitability. The question is whether it can deliver on those promises in the relatively short period of time it has guided for. If not, investors will have to be patient if they took a position at a high price point. This is why trading rather than buying and holding at this time is the best play at this time.

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