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We cannot be certain what will happen with SAFE this year, however, by all accounts, there is a better chance that the legislation will pass before year-end than ever before. As previously stated, we are confident that at least a 2-3x immediate upside for US cannabis stocks is warranted on passage and the ensuing institutional investment. We expect those gains would be just the beginning and importantly, beyond legislation uncertainty, we see limited risk of further downside in valuations for the space in the near term, even if Q3 earnings reporting next month proves disappointing as it may on inflation driven reduced consumer spending and wholesale pricing pressure in key markets. With potential gains and limited downside risk in mind, it is a good time to invest in the space in case legislation is happening.
With passage, we expect the stocks of the largest MSOs will outperform as new institutional investors initially seek out more known commodities and bigger market caps. Within that group, we believe investments in Ascend (OTCQX:AAWH) and AYR (OTCQX:AYRWF) offer the greatest potential for upside. Ascend and AYR are the cheapest large MSOs with ’23E EV/EBITDA valuation discounts relative to larger peers of nearly 60% and more than 70%, respectively. The discounted valuations come despite each, in our view, being as well or better positioned for near and long-term success as any operator in all of US cannabis following meaningful fundamental progress in recent months. Furthermore, we believe each is positioned to lead future consolidation of the industry whether SAFE occurs or not. We maintain strong Buy ratings for each and feel that Ascend and AYR should be considered for new investment or as a trade out of existing holdings particularly in larger, more expensive MSO stocks with less attractive growth profiles.
Meanwhile, before potential broader gains on SAFE passage later this year, a near-term trend we are watching is a looming increase in M&A. The perception of further progress on SAFE before year-end could drive enhanced M&A activity with large MSOs jockeying to best position themselves to attract institutional investors with scale and the broadest geographic presence. Increased M&A activity or even the perception thereof should drive outperforming stock returns for smaller- and medium-sized operators for the remainder of this year. Viable takeout candidates amongst names we follow closely which could provide immediately beneficial assets to a larger MSO include: 4Front (OTCQX:FFNTF), Body and Mind (OTCQB:BMMJ), C21 (OTCQX:CXXIF), CLS Holdings (OTCPK:CLIHF), Cansortium (OTCQX:CNTMF), Greenrose (OTC:GNRS), Lowell Farms (OTCQX:LOWLF), Marimed (OTCQX:MRMD), Planet 13 (OTCQX:PLNHF), Schwazze (OTCQX:SHWZ), and Vext (OTCQX:VEXTF) Significant Progress in Recent Months Enhances Investment Opportunity for Ascend and AYR.
Ascend and AYR made significant progress this Spring to enhance future growth opportunities and eliminate key factors that historically dragged on stock returns. Neither has gotten credit and each stock has underperformed the market despite progress.
Both Ascend and AYR became early rec license recipients in New Jersey and are now poised to become long term winners in the state on initial mover benefits. In New Jersey, both Ascend and AYR are positioned to benefit from strong retail demand and inflated wholesale prices as vertically integrated players with growing cultivation capacity. In our view, only TerrAscend (OTCQX:TRSSF) is better positioned in the state. In the near term, we expect each to benefit from strong New Jersey contributions (inclusive of meaningful revenues and high margins) with Q3 results, which will offset any weakness elsewhere in their businesses on reduced consumer spending on inflation and wholesale pricing weakness.
Meanwhile, following the MedMen (OTCQB:MMNFF) settlement this winter, Ascend is set to become one of the just ten future vertically integrated operators in New York, and in April, the company quietly completed an acquisition to enter Pennsylvania, the company’s sixth state. We expect further expansion in Pennsylvania to come through M&A and investment.
For AYR, in addition to New Jersey, the company opened two Greater Boston dispensaries this month, including a Back Bay location, which along with Ascend’s store near Fanuel Hall, is set to be the top dispensary in the state.
Anticipate M&A Uptick on Legislation Hope
In order to attract the greatest amount of institutional investment and distinguish themselves from peers, we expect some large MSOs will seek out the addition of plug-and-play assets in the form of existing operators and look to acquire well-positioned single-state and concentrated multi-state operators. Enhanced M&A activity, or the perception thereof is likely to drive outperforming stock returns for small and medium-sized US cannabis companies in the coming months.
This type of jockeying was the genesis of Cresco’s (OTCQX:CRLBF) interest in Columbia Care this winter and that was before a finite catalyst in the form of institutional investment through legislation was provided. Smaller companies, even the well-positioned ones trade at a steep discount to larger MSOs, so cost should not be prohibitive if the acquired entity can bring greater initial interest from institutional investors. We believe that the possibility of upcoming financing access and enhanced valuations in the near term on SAFE’s passage are likely to make even a premium price required to complete a transaction (whether in the form of cash or equity) palatable. For sellers meanwhile, an understanding that large MSOs will disproportionately benefit from initial gains for the space if legislation occurs will likely drive acceptance of sales. If cannot beat them, might as well join them.
In our view, the grouping of most likely takeout candidates in US cannabis that could provide a large MSO with a valuable asset to market includes: 4Front, Body and Mind, C21, CLS Holdings, Cansortium, Greenrose, Lowell Farms, Marimed, Planet 13, Schwazze and Vext.
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