Schwazze currently has the largest retail footprint in Colorado with 30 total stores. Last night in their quarterly earnings call the Interim CEO said that they will soon announce the closure of three stores in Colorado which would account for 10% of their retail footprint in the state. We believe this will be the beginning of a larger wave of retail closures that will reduce the number of stores in the state by between 10-20% within the next 18-months. Multi-Store Chains (MSCs) will be the main driver of closures by shuttering their under performing stores that no longer have any hope of turning back to profitability.
Why do we think this?
The Department of Revenue reported the following number for March Sales:
Sales | Medical | Recreational | State Total |
Mar-24 | $15,116,515 | $111,514,395 | $126,630,910 |
Mar-23 | $17,270,140 | $122,351,090 | $139,621,230 |
YoY Decline | -$2,153,625 | -$10,836,695 | -$12,990,320 |
YoY Percent | -12.47% | -8.86% | -9.30% |
March has been the month with the state’s highest revenue for the past two years, with July coming in as a close second place, reversing in 2021 to be the highest with March as a close second. This means troubling things for the Colorado market if March is the highest or second highest sales for 2024. If you take the average revenue per recreational license in March, you get average store sales of $163,991.76. Assuming an average Gross Profit of 40% of revenue, we do not believe current average revenues can sustain profitability in most major markets in the state due to the high costs of rent and labor.
We know that 4/20 this year was down over 19% YoY, even with the holiday being on a Saturday this year, so that tells us that April revenues will be down month-over-month and year-over-year. Further evidence to support this belief comes from the following state wholesale tax data for the month of April.
*We have extrapolated revenue data from the state tax reports, at the state excise tax of 15%, thereby calculating the dollar amount of total monthly transfers to both unaffiliated and affiliated parties.
Cultivation Wholesale Revenue | |||
Apr-24 | $26,938,859.20 | Apr-24 | $26,938,859.20 |
Mar-24 | $28,896,324.60 | Apr-23 | $31,292,591.00 |
MoM Decline | -$1,957,465.40 | YoY Decline | -$4,353,731.80 |
MoM Percent | -6.77% | YoY Percent | -13.91% |
This data suggests a MoM slowdown in the transfer of wholesale marijuana and that wholesale transfers are outpacing retail sales in YoY declines. So we can surmise that April sales figures will come in less than that of March, staying on historic trend. We can also infer that Cultivation will be severely impacted by continued outpacing of retail YoY declines if the trend continues throughout the summer months. We are predicting a period of steep over-supply in the market, unless there has been a drastic reduction of plant count over the past three months, which we currently find unsupported.
This sales data suggests that March will be one of, if not the, highest sales months in 2024 in Colorado. That is why we predict store closures over the next 18-months. This will be compounded if the national economy enters a downturn.
Covenant Default. What is it?
A Covenant Default happens when a person or a company fails to fulfill a covenant under the loan agreement. Every loan will have different Covenants that the borrower must maintain, failure to do so will put them into a Covenant Default and may result the loan being called or a forced restructuring of the borrower’s company.
You may ask yourself why I am writing about this topic.
I’m introducing Covenant Defaults because I have been watching Schwazze inch closer to breaching one of their main Covenants on their largest loan. It is important to note that Schwazze, like many small and micro-cap companies, has debt coming due starting in January of 2025, with maturities stretching over the next three or so years. So this means that Schwazze, and many small and micro-cap companies, have to figure out a way to payoff, refinance, or restructure their debt. This would have been an easier feat even just two years ago, but now with interest rates at current levels it will be hard to make refinancing affordable for many struggling small-caps.
With that being said, Schwazze has a Covenant in its largest loan that it must maintain a balance of $10,000,000 in bank accounts at the end of each quarter, or it would be in Covenant Default on a $95M loan. I noticed over the past few quarters that their cash reserves have been dwindling quarter-over-quarter, and have been trying to figure out just how they will restructure in the event of a Default which may be actualized based on the following cash and cash equivalent balances:
Ending Balances | 31-Dec-23 | 31-Mar-24 | |||
Cash and Cash equivalents | $19,248,932.00 | $13,151,317.00 | Change QoQ | -$6,097,615.00 | -31.68% |
The decline QoQ would be an alarming change under normal circumstances, but now being only ~$3M from Covenant Default and less than a year away from debt maturities we have a company in dire distress. Couple these facts with a continuously declining Colorado market, and increased pressure in the New Mexico market, we think the possibility of Schwazze breaching Covenants and being in Default is high, and the likelihood that they only close three stores is low.
Thank you for reading,
Disclaimer:
This is not investment advice. We do not have, nor make any opinion on the potential performance of the stock of the aforementioned company. We hold no position in the aforementioned stock, nor plan on taking any position. This analysis is provided as a comment on an industry, not an opinion on an individual company or security.
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