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Monitor Cannabis Credit Quality with the Viridian Chart of the Week

Monitor Cannabis Credit Quality with the Viridian Chart of the Week

In the current capital-starved environment of 2023, monitoring the credit quality of portfolio companies has become crucial. Credit analysis has even taken the spotlight over equity analysis. The Viridian Credit Tracker Model provides a multidimensional approach to credit quality assessment, utilizing 11 market and financial variables to quantify four main credit factors: Liquidity, Leverage, Profitability, and Size. We believe that understanding these factors is essential when evaluating a company’s overall credit quality.

However, having a single indicator of credit quality can often be advantageous as a portfolio monitoring tool. The best single number that investors can calculate, in our opinion, is Total Liabilities/Market Cap. This ratio has a rich history in credit distress prediction, with variations of it being used in models like the Z-score and analysis of junk bond credits. It is also the most highly weighted leverage indicator in the Viridian Credit Tracker model.

On the Viridian Chart of the Week, the blue line represents Total Liabilities/Market Cap as of 10/13/23. The bars indicate improvement or deterioration, with positive green bars representing reduction in the ratio and negative red bars showing increases. Several companies, such as C21, Unrivaled, Glass House, TerrAscend, and AYR, show moderate improvement, while others like MariMed, Trulieve, and Cannabist show moderate deterioration. Schwazze, Red White & Bloom, and Acreage display more significant deterioration.

Compared to other commonly used credit ratios like Debt/EBITDA or EBITDA/interest, the Total Liabilities/Market Cap ratio offers several advantages:

  • It’s a dynamic ratio that fluctuates daily, capturing the immediate impact of stock-related news on credit quality.

  • It incorporates the market’s view of a company’s equity value, which traditional financial statement measures alone cannot capture.

  • It takes into account critical factors specific to the cannabis sector, such as lease liabilities, taxes, and deferred acquisition liabilities.

  • It is easy to calculate, interpret, and outperforms traditional financial statement measures in distress prediction.

However, the ratio does have downsides:

  • It does not directly measure liquidity or account for a company’s size. For example, American Green is not considered a better credit than Cresco Labs, despite having better Total Liabilities/Market Cap ratio. The Viridian Credit model accurately ranks companies based on these additional factors.

To effectively utilize the Total Liabilities/Market Cap ratio:

  • We recommend creating a spreadsheet to automatically download and calculate the ratio on a weekly basis.

  • Investors should intensify their review process for credits with a ratio higher than 4x and consider special mention for anything over 6x.

  • Monitor the weekly changes and pay attention to consistent directional movement. While overall market movements can impact the ratio, consistent movement against the market should be investigated.

  • Remember that no single statistic replaces thorough quantitative and qualitative analysis, but the Total Liabilities/Market Cap ratio is a valuable addition to every debt and equity investor’s toolkit and monitoring system.

The Viridian Capital Chart of the Week provides essential insights into investment, valuation, and M&A trends derived from the Viridian Cannabis Deal Tracker. The Deal Tracker is a proprietary information service that monitors capital raise and M&A activity in the legal cannabis, CBD, and psychedelics industries. It tracks and analyzes over 2,500 capital raises and 1,000 M&A transactions, amounting to over $50 billion in aggregate value since its inception in 2015.

Please note that the preceding article is from one of our valued external contributors and does not represent the opinion of Benzinga. It has not been edited and aims to provide independent insights.