Description

We believe the legwork some of the cannabis multi-state operators (MSOs) have put into being early movers in the limited license cannabis markets in the U.S will pay off significantly over time.  We believe that now is finally a good time to put money to work in this sector.  Ascend Wellness (AAWH) is one of those companies that is set up to be a multi-bagger over the next few years.

Why pull the trigger on Cannabis companies now?

Not because of some Federal legalization catalyst.  This is the weakest reason to buy these stocks.  Will it help?  Sure.  Probably depending on the structure of legalization.  But to base investing in these companies solely on this reason is dumb.  For all intent and purposes, cannabis companies have legitimate bank accounts (that they pay extra for).  Consumers being able to use credit cards would probably be a 10-15% lift to industry-wide sales.  Valuations would go up as more capital would be “allowed” to invest.  In our view, the most economic value added aspect of federal reform would be the elimination of 280E.

Reason #1:  Valuation on Current Earnings.  The companies in the cannabis space have been overvalued on current earnings for the past few years, but given the pull back now they are getting reasonable to cheap on current earnings.  The Tier 1 and Tier 2 group ($400 million mkt cap and up) is trading at about 7-8X 2022 EBITDA, while some names in particular have gotten particularly cheap such as AAWH at just 5.2X this year.  In 2019/early 2020, there was a rush of public companies with flawed business models raising huge amounts of capital under the leadership of questionable management (e.g. Medmen).  That certainly wasn’t the right time to invest.  The cannabis names were valued at 15-20X EBITDA (if they even had EBITDA) during this time period.  Today, you are not paying for that big ramp in growth at the mid-single digit earnings multiples.

Reason #2: Financial Markets are eliminating competitors.  The publicly traded MSOs have strong balance sheets and are competing for the most part on smaller operators who have limited access to institutional capital.  Starting a cannabis business can be capital intensive and legally challenging and expensive depending on what state you are operating.  Funding for cannabis is thin to begin with, but with the private capital markets drying up for smaller operators it makes the larger MSO’s in even a stronger position.  

Reason #3: Cannabis has elements of being recession resistant:  Historically the alcohol industry is generally regarded as a recession resistant industry.  While recreationally legal cannabis is a new industry and we have not seen consumption trends in recession, we have seen that consumption was strong during the Covid period during 2020.  On the other hand, our analysis does show that cannabis spending can be negatively impacted by higher gasoline prices and lower disposable income.  If there were significant layoffs in a recession and more people were  at home, you could see a lift from consumers using cannabis while unemployed.

The Market’s AAWH Serve are Attractive - 

Not all markets are the same, not even close

Cannabis markets can vary widely from state to state.  It is VERY important to see what markets the MSO serves to determine earnings power.  Identical assets and operational expertise will yield very different results depending on what state you are in.  

The following table lists AAWH’s markets and their characteristics and our simplified subjective current impressions of each market.  Our grades of these markets can change with the stroke of a regulatory pen or a vote opening a market from medical to include recreational

Compared to a few other states where MSO’s operate

AAWH’s footprint was chosen to be in states where issued licenses are limited with some states having much more restrictions than others.  The fewer the licenses issued, the better.  The lower the local and state taxes, the better.   The larger the upfront cost to start a cannabis business, the better.

The larger the population, the better. 

Management

Some of the most important attributes for management at cannabis companies at this point in time are: 

1) Strict financial discipline, focus on return on capital

2) Be flexible and be able to operate in changing regulatory environments.

We think CEO Abner Kurtin has both these characteristics.  While not an experienced participant in the cannabis industry, he comes from a financial investment background which is essential to being a survivor in this thinly capitalized industry. 

Financial Model

The company will fund its capex on new cultivation facilities from a combination of sale leasebacks and capex.  There are no new acquisitions modeled in this model and capex will be used to fill out its existing footprint.  The company should have adequate cash on hand and through credit to fulfill these expansion projects.

Valuation

181 Shares Outstanding

Market Cap  $425 million

Cash $144 million

Debt  $234 million

Net Debt $90 million

Enterprise Value  $515 Million

EV/ 2022 EBITDA  5.2X

EV/2023 EBITDA   3.0X

The larger (billion plus) MSO’s trade at 7-8X this year, and consumer goods and beverage companies trade at 8-12X EBITDA.  

We believe that AAWH should trade at 8X next year’s EBITDA or roughly $9-10/share  or 4X from here.

Risks

Global Recession

Changing of regulatory environment (for the worse)

Over budget on capital projects

New competitive entrants.

Catalysts

Execution of existing business plan.

Catalyst

Execution of business plan

Merger/Acquisition

Taken private