Why I'm Back In Ayr Wellness, For Now...

Ayr Wellness is a multi-state operator (MSO) in the US cannabis markets. They operate in eight states, covering an addressable population of over 85 million people. Ayr has 71 open dispensaries, with over 90 expected by year-end 2022. Ayr also has a large cultivation footprint, with 557k square feet online currently, and 1.2 million expected by the end of the year.

Where possible, they are vertically integrated, meaning they pair the retail stores with cultivation and manufacturing facilities. This tends to enhance margins and gives them greater control of the supply chain.

Ayr offers a deep brand portfolio, with KYND flower, Origyn extracts, STIX prerolls and a very popular beverage called Levia infused seltzer. Based on enterprise value, they are the eighth-largest US cannabis company.

Ayr has been in our portfolio in the past. We exited the position in late January to focus on a couple of undervalued larger MSOs. This worked out well from a timing perspective, as Ayr is down -70% since we sold it. This is one of the primary reasons we are outperforming the MSOS ETF by over 7% year-to-date.

The objective of this article is to assess the current prospects for Ayr, revisit the valuation, and discuss a catalyst on the horizon that may change the trajectory, sentiment, and stock price.

What Happened?

Ayr has had its ups and downs, but when you look over longer time horizons it has been highly correlated to the MSOS ETF. This is common among the largest US cannabis stocks, they zig and zag, but end up having high correlations. The chart below shows the one-year return from April 10th 2021 to April 10th 2022. Over the full period, MSOS was down -52% and Ayr was down -59%.

Recently, the correlation has broken and Ayr has sold-off sharply. The primary reason Ayr has dropped is that they were not approved for adult-use sales at the April 11th New Jersey CRC meeting. Eight operators were up for a vote, and Ayr was the only one not approved. The other seven operators began sales on April 21st. Since the no vote, Ayr has underperformed MSOS by 32% in less than one month.

Ascend, one of the approved NJ operators that is similar in size to Ayr, is down just 10% over the period, illustrating a 51% difference between an approved and not approved New Jersey MSO.

Since New Jersey opened, the approved operators have outperformed the broader industry. As maturing markets sales have slowed, investors are thirsty for new growth, especially in the cannabis-investing sweet spot: limited-license markets moving from medical to adult-use sales.

New Jersey has 9,200,000 residents and currently there are twelve adult-use stores open. And, this doesn’t account for people coming in from nearby New York and Pennsylvania. On opening day alone, over 12,000 people spent almost $2 million on cannabis.

Due to not being approved, Ayr has sold off sharply and the valuations have become more compelling.

Growth and Valuation

For quantitative analysis, I started by researching the compound annual growth rates of sales for a basket of similar-sized MSOs. Over the four-year period, Ayr's sales are growing at a 79% rate, which is 32% faster than the peer-group average.

Sales Estimates (in millions)

I also studied two different valuation metrics to complement the sales-growth analysis. Based on enterprise value to sales, the peer group is at an already low 1.7x 2023 sales. Ayr trades at a 54% discount to the group average for 2023, making them the cheapest based on EV/Sales.

Enterprise Value/Sales

The second valuation metric I chose is enterprise value divided by adjusted EBITDA. Again, they are the cheapest of the group, trading at just 2.4x 2023 adjusted EBITDA.

Enterprise Value/Adjusted EBITDA

Ayr has the fastest-growing sales, and is the cheapest according to two valuation metrics. This is compelling, but sometimes it takes a catalyst to reverse sentiment and renew interest in a stock. Thankfully, one is on the horizon.

Potential Catalyst

While there has not been any public explanation for the no vote at the April 11th meeting, the three Ayr stores in New Jersey have a large number of medical patients. One of the primary concerns of the New Jersey CRC is making certain there is enough product for existing medical patients. They did not want to open adult-use sales and have it cannibalize the medical system. It’s possible the CRC wanted to give Ayr another six weeks to either harvest more supply, or workout wholesale agreements to ensure capacity.

In an interview with CEO Jonathan Sandelman on New Cannabis Ventures, he stated that they had always used May 24th as the approval date for their financial models. This interview took place after they were not approved on April 11th, so I don’t know if this is genuine, or adjusting the story to fit a new narrative. But, it does seem possible that Ayr knew they would not be ready for the April 11th and were always shooting for May 24th.

If Ayr is approved on May 24th, three stores may move from medical-only to adult use and revenue will quickly jump. Top New Jersey locations are capable of doing $50 million/year in revenue. Plus, they have cultivation that is going from 24,000 square feet currently up to 100,000 by year end.

Along with the change in revenue, sentiment and investor flows may flip. Since not getting approved, there’s been consistent selling pressure. This has let off recently, and we have have seen more constructive price action on above-average volume days. This is often a promising sign.

What If I'm Wrong?

I don’t know that Ayr will be approved on the May 24th, but I think it’s a good enough probability that it’s worth a bet. However, I would strongly encourage you to either set a stop loss about 5% below the price prior to the meeting on May 24th, or be sitting in front of your screen and watching the New Jersey CRC meeting on Zoom. If Ayr is not approved, I will quickly exit. This would show some type of incompetence and they will be punished for missing the revenue and not executing.

To be more conservative, please consider waiting for the New Jersey CRC meeting on May 24th and Q1 earnings on May 26th. These two events will provide much more data on Ayr's near-term outlook. You may miss the first part of the move, but you should still be able to capture most of the longer-term upside.

Cool Idea, But I Hate Cannabis Stocks

When I write a bullish piece, I’m well aware most of the readers have been burned by cannabis stocks and may have limited appetite for long ideas. So, if you are on board with Ayr's fast growth rate, low valuation, and the potential catalyst, go long the stock and short the MSOS ETF. This way it’s a relative value trade.

If cannabis stocks get hammered, the MSOS short will pay off and you can still harvest the alpha from the potential Ayr outperformance. If my thesis is correct, you have the opportunity to make money, even if cannabis stocks go down.

Conclusion

Ayr is one of the top US cannabis companies. They have diversified operations, an expanding footprint, and are poised to grow as key East Coast markets open. Recently, the stock has detached from peers based on not being included in the first round of approvals in New Jersey.

If they receive approval at the May 24th New Jersey CRC meeting, the stock is poised to outperform peers. Bullish cannabis investors can establish a long position. Those that like the idea, but are cautious about cannabis can get long Ayr and hedge with the MSOS ETF.

Finally, this is a speculative, more trade-oriented idea. Please only follow this advice if you are an aggressive investor and are prepared to quickly exit if Ayr is not approved on May 24th. Otherwise, please consider waiting for the results of the New Jersey CRC meeting, and even earnings on May 26th. Having both data points will make Ayr's near-term future much clearer.

Disclosure: As of 05/18/22 Ayr Wellness is a member of the Green Giants portfolio. I was not compensated to write this report.

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