Outperforming Cannabis Stocks Without Federal Legislation: These Top MSO Picks Will Surprise You

As mentioned last week, we feel federal cannabis legislation is unlikely to come this year with a more realistic timeframe for legislation being next Summer or Fall when Democrats have a better sense of where they will stand coming out of the mid-term elections. An optimistic outlook will likely lead to more wide-sweeping legislation while a pessimistic view will prompt a push for moderate gains like a stand-alone SAFE Act. As such, the opening of US cannabis stocks to greater institutional investment that is expected to come with legislation and boost valuations across cannabis has to wait. Despite the lack of looming catalyst, we remain bullish even in the short term on cannabis stocks on positive market fundamentals (including populous state markets coming online for rec in ’22 and company execution). In particular, we favor underappreciated operators which have a chance build out sustained leadership positions within core markets. We are confident that execution by these companies will translate to outperforming stock returns and valuation upside even if the broader market stays flat or continues on a downward trend in the short term.

Additionally, consolidation will drive returns in the coming months. As we have previously stated, we believe all but the largest cannabis companies are in play for takeout in the near term and predict that outperforming stocks will include those that make the biggest splash as acquirers and companies that are acquired.

With this note, we highlight our top picks amongst the biggest MSOs and smaller operators that are best positioned for outperforming stock returns through execution on growth initiatives and takeout. We also identify five unfollowed names in the space that can offer outsized returns on greater awareness and continued execution.

Top MSOs: Ascend Wellness Holdings Inc AAWH, Ayr Wellness Inc (OTC: AYRWF), Jushi Holdings Inc (OTC: JUSHF) and Terrascend Corp TRSSF.

Valuation multiples reflect a premium for the largest MSOs by market cap and the companies with the broadest exposure by geographic footprint. We believe the premium is misguided as it comes at the expense of projected revenue growth and margin expansion and in some cases meaningful competitive advantages within specific markets. Bigger is not necessarily better particularly in the short term.

With this in mind, our top MSO picks for the remainder of this year and early 2022 are Ascend, AYR, Jushi and Terrascend. Of the twelve largest MSOs, these four have the highest projected revenue growth for next year and are four of the top five MSOs in terms of ’21-’22 EBITDA margin expansion. For each, the outperforming growth in ’22 comes despite the fact that some key assets will not ramp until at least 2023. For Terrascend projections also do not include contributions from the outstanding GAGE acquisition. We forecast GAGE revenues to be $310M next year and adjusted EBITDA to be more than $100M. Despite anticipated outperformance, the four trade at discounted valuations relative to other large MSOs (average of 8.4x vs. 12.1x).

Beyond projected growth and margin expansion, we favor these companies because each has to-date taken a more conservative approach to state expansion focusing on execution within core markets and the build out of defensible long-term leadership positions in specific states. The same cannot be said for some other top MSOs and ultimately, we believe the conservative approach will translate to outperforming results as markets ramp following recent legislation. Additionally, we believe each is positioned to make large-scale acquisitions in the near term which will meaningfully contribute to results and catalyze investors. As we have previously stated, we believe large-scale transactions and particularly public to public consolidation will become more common in the near-term. Ascend, AYR, Jushi and Terrascend have all been successful in making large scale acquisitions that will contribute to near term results

and we believe each is well-positioned to do so again in the coming months.

Of the four, we believe AYR and Terrascend are likely to make the biggest investments beyond existing markets in the near term. Ascend and Jushi are more likely to focus to invest in existing markets.

AYR has been on an expansion run for the last year but is still likely to seek out New York exposure and additional East Coast and Midwest assets. Additionally, entering a market like California or Colorado in the near term to complement its Arizona and Nevada exposure could be viewed favorably as a more mature market like these coupled with existing assets would give AYR one of the biggest TAMs in the space. Regarding potential California M&A, the overlapping relationships between AYR and Glasshouse could make for a logical M&A partnership.

Meanwhile, Terrascend stated in connection with the GAGE (OTC: GAEGF) transaction announcement that additional meaningful expansion news was coming and we believe Terrascend needs additional expansion to excite investors. Of the largest MSOs, other than Planet 13, Terrascend has the smallest geographic footprint in terms of state exposure. For Terrascend, we expect New York could to be a focus as well as Massachusetts or Maryland on the east coast to solidify the company’s footprint in the region. Expansion into additional mid-west states to compliment the Michigan exposure following the GAGE deal would also be a logical focus for Terrascend.

AYR Remains Top MSO Pick

AYR remains our top pick amongst large MSOs based on the company’s history of proven execution in the challenging markets of Massachusetts and Nevada, our positive view of on-going expansion initiatives (AYR has expanded through acquisition into six additional states) and a discounted valuation. Regarding state expansion, we believe AYR should be given greater credit for having completed acquisitions this year (only Illinois remains outstanding) and particularly the quick closing and integration of Liberty Health. The Liberty Florida operations have already been meaningful contributions to AYR results this year. The closing of transactions in our view is another example of AYR’s strong execution capabilities.

AYR is forecasted to be the biggest revenue grower amongst large MSOs next year with revenues projected to more than double Y/Y as the company integrates in acquired assets and continues to scale operations in expansion markets and Massachusetts and Nevada. Even amidst its wide-spread buildout of assets, AYR continues to project as one of the most profitable operators with adjusted EBITDA margins of nearly 40% (vs. MSO average of 36%).

Never-the-less AYR remains the cheapest large MSO on the basis of EV/EBITDA (6.1x 2022 estimates) and is valued at a discount to even the broader peer group (7.9x). In our view, AYR’s persistent valuation discount stems from poor timing on transaction closings (deals began to close this winter when cannabis stocks began to pull back) and pessimism over the company’s ability to meet ’22 targets. We remain confident that targets are achievable and expect company updates in connection with Q3/21 and Q4/21 earnings reporting will validate this opinion and provide a catalyst for the stock.

Valuing AYR at a multiple in line with even that of the broader peer group offers roughly 30% upside from current levels.

 

Continue to favor Smaller Operators, of those Cansortium and Goodness Growth are Top Picks

The top ten US cannabis companies by market cap trade at a roughly 35% premium to the remaining smaller operators in the space based on projected 2022 EV/EBITDA multiple. In general, we continue to favor smaller operators in US cannabis noting that the valuation discount exists in spite of outperforming anticipated growth and neglects the likelihood for takeout at premium multiples for many in the near term. Furthermore, as we have previously stated, access to capital, the legacy justification for a valuation premium for larger operators, is no longer a factor given the greater availability of capital in US cannabis over the past year and particularly in the form of non-dilutive financings. Capital is more expensive for smaller operators but no longer prohibitively so and we expect capital to become even cheaper as more real estate and debt lenders focus on the space.

Amongst smaller operators, we favor companies that have sufficient capital or access to capital to fund near term growth initiatives and are positioned to outperform both in terms of top line growth and profitability with core operations in the near term. We also consider companies with uniquely positioned assets in markets that could be favored by MSOs for acquisition.

Amongst our covered names, companies which fit this criteria and thus warrant greater investor consideration include: Cansortium CNTMF, Goodness Growth Holdings GDNSF, Lowell Farms LOWLF, Schwazze SHWZ, and TILT TLLTF. Of these, in the near term we particularly favor Cansortium and Goodness Growth Holdings.

Cansortium (Buy Rated: $1.50 Price Target)

Cansortium quietly is a leading operator in Florida and is scaling operations in the state with plans to have twenty-seven dispensaries open by year-end and a cultivation capacity capable of supporting more than $200M in annual sales by early 2022.

Beyond Florida, Cansortium has two open medical dispensaries in Pennsylvania (and plans to open a third), a production operation in Michigan and owns one of the three existing medical licenses in Texas. We forecast revenues to nearly double next year ($75M to $142M) and for adjusted EBITDA margins (~45%) to exceed that of even many top MSOs primarily on solid execution in Florida. Beyond 2022, we expect Pennsylvania to become a more meaningful contributor as sales in the state ramp and for the company’s Texas business to eventually present a huge growth opportunity noting that Cansortium will have to make a meaningful investment to buildout assets.

Beyond operations, we believe Cansortium is a sought-after takeout candidate for its Florida exposure (the only operator in the state of significant scale that has not been acquired by a leading MSO) and expect interest to be enhanced as the company completes its on-going cultivation expansion project and as initiatives to get a recreational law on next year’s ballot gain traction.

We believe a recreational ballot initiative is likely to pass in Florida next year particularly after so many new residents moved to the state from northern and western states during COVID. Meanwhile, Cansortium’s position in Michigan, Pennsylvania and Texas offer attractive growth opportunities for any acquiring company. In particular, Cansortium’s Pennsylvania dispensaries and its Texas license could quickly become valuable if/when regulators expand the markets in these populous states.

Cansortium continues to trade at a discounted valuation to the broader peer group (4.0x ’22 EV/EBITDA vs. 7.9x) mainly as a result of a lack of investor awareness. We expect an acquisition would price Cansortium at a premium valuation but note that even putting the valuation in line with the peer group would provide roughly 120% upside for the stock from current levels.

Goodness Growth (Buy Rated: $4 Price Target)

Goodness historically has been a sleepy medical only operator formerly known as Vireo Health. This changed with the passage of favorable legislation this year in Arizona, Minnesota, New Mexico and New York (four of the company’s core markets) and in connection with an on-going build-out of assets in each of these states (and Maryland). In our view, Goodness now has one of the most exciting growth opportunities in cannabis. Management has guided to 2022 revenues of $140M to $180M and adjusted EBITDA between $35M and $55M. Guidance compares with our estimates of $67M and $2.5M respectively for this year and frankly we believe these targets could prove to be conservative particularly if the company can gain meaningful traction in Arizona and Maryland following the buildout of assets this year.

Beyond 2022, we expect continued strong growth as the New York recreational market scales (starting in 2H/22) and as Maryland eventually opens for rec. We are confident that execution on expansion initiatives will result in greater awareness for the company and drive enhanced returns for the stock which is currently priced at a discount to the broader peer group despite the positive outlook (5.2x vs. 7.0x). Giving Goodness’ a valuation multiple in line with that of the broader peer group would offer roughly 40% upside from current levels.

Beyond execution, we believe Goodness is a takeout candidate. As we have previously noted the company’s New York license is one of the most sought-after assets in cannabis and we believe that only Etain Health and Goodness of the ten license holders would even consider selling at this point. The remaining New York license holders are well-funded public MSOs and Pharmacann which last month filed for an anticipated IPO at well over $1B valuation, largely on the basis of its New York position. Along with New York, we believe the Goodness’ assets in other markets could present nice compliments to the portfolio of any MSO or SPAC which is looking for a meaningful growth opportunity and immediate contributions. Of Goodness’ core markets, only Arizona is meaningfully penetrated by larger operators.

Goodness has a history of being a solid M&A partner for MSOs. In 2020, Goodness sold off Pennsylvania assets to Jushi and Ohio assets to AYR. Both of these operators would be interested in Goodness’ remaining assets. If Goodness is to sell on the basis of New York assets, we believe the sale will most likely come after final regulations are approved and operators have a better sense on market timing and dynamics. We expect that to come later this year or very early in 2022.

We believe a full company acquisition is the only potential exit for Goodness at this point however we note that a sale on New York assets alone could offer significant value. In February Ascend acquired MedMen’s New York license for a valuation of roughly $90M ($73M for 84% stake) and that came prior to the passage of recreational legislation and more importantly the confirmation that existing license holders like Goodness would be grandfathered such beneficial long-term sustainable competitive advantages in the state. We expect any sale today would garner a significantly higher valuation. All told, we believe the 12.0x EV/EBITDA multiple Trulieve paid for Harvest relative to Goodness’ 2H/2022 run rate represents a minimum starting point for any acquisition of Goodness.

Un-followed operators

As we have previously stated, given the limited number of banks covering US cannabis from a sell-side research perspective there are still a large number of quality companies with real and sustainable businesses that lack or have limited research coverage and thus investor exposure. Many of these companies trade at a fraction of the valuations of more broadly covered companies even on the basis of historical results and in our view, the only reason is a lack of investor awareness

Even ahead of federal legislation, we believe that awareness is coming as new cannabis markets come online and as scaled results make it too hard for investors to ignore these operators. On greater awareness we expect outperforming returns for investors in these currently underfollowed names. Additionally, as with smaller covered companies, we believe consolidation is in play for these companies as well financed MSOs look to expand.

Body & Mind, CLS Holdings, Glass House, Next Green Wave and Vext are five unfollowed but profitable operators which appear poised for meaningful growth in the near term. As with top picks highlighted, we believe these companies can offer meaningful investment upside in the near term even without legislation.

• Body & Mind BAMM: Body & Mind is a multistate operator with vertically integrated operations in Arkansas, California, Nevada and Ohio. The company is profitable and generates cash to a sufficient level to support on-going operations. In the last two months, Body & Mind has announced multiple meaningful growth initiatives including closing on the remaining balance of its Ohio business which had been a joint venture and the entry into Illinois and Michigan. We believe each initiative will be a meaningful contributor to 2022 results and beyond. Despite the positive news, Body & Mind stock is down more than 20% since the end of August.

• CLS Holdings CLSH: CLS is a vertically integrated Nevada operator with a dispensary in Las Vegas and a leading wholesale business in the state under the City Trees brand. Through a joint venture, CLS will also operate in New Mexico which is expected to be a key growth market next year following the kickoff of recreational sales in the state in Q1.

CLS also recently announced a joint venture to manufacture pre-rolls at its Nevada production facility on behalf of a leading brand in the state. The joint venture will drive meaningful growth for the company’s wholesale business with CLS planning to produce ~200K pre-rolls per month under the agreement. Despite execution and the pre-roll announcement, CLS’s stock underperformed relative to the broader cannabis market in the last few weeks.

• Glass House GLSHF: Glass House went public last year as part of the Mercer Branded SPAC transaction. The company plans to quickly become the leading vertically integrated operator in the fragmented California market with plans to build out a 5.5M sq. foot greenhouse capable of producing more than 1.7M lbs. of biomass annually (to go along with its 500K sq. foot existing footprint) and have more than 20 dispensaries in the state (vs. four today) upon completion of its outstanding Element 7 acquisition.

Glass House completed the acquisition of its expanded cultivation footprint earlier this month and plans to have phase one of the buildout (1M sq. feet) completed next year. At current stock levels, we do not believe the company is being given sufficient credit for the meaningful growth opportunity ahead and expect as construction progresses and as management can provide target estimates, valuations will look increasingly attractive. Additionally, as we have previously referenced we believe Glass House could be a takeout candidate given the limited MSO presence in California to date and our view that MSOs will increasingly look to more mature markets in the next few years as a source of growth.

• Next Green Wave (OTC QX: NXGWF): Next Green Wave is a producer of branded cannabis products servicing the California market. The company maintains a portfolio of craft premium products including concentrates and flower and plans to acquire dispensary assets in the near term.

Next Green Wave today has a 35K sq. foot cultivation facility in Central California and recently announced the receipt of a building permit for a new 62K sq. foot premium indoor cultivation facility. Importantly, Next Green Wave is focused on the production of premium flower that is less susceptible to price declines in California as additional cultivation comes online. During the recent pricing crunch in the state, indoor premium flower prices have held up much better with only modest price declines. Additionally, the premium flower production capabilities could make Next Green Wave a takeout candidate for a larger MSO looking to lock in premium supply capabilities for owned dispensaries. Next Green Wave stock is down roughly 35% since late-August despite a lack of negative news catalysts presenting a potential favorable entry point for investors at current levels.

• Vext Science VEXTF: Vext is a profitable vertically integrated operator in Arizona and a leading branded product offering in the state (Vapen brands). Vext is building out production capacity and is positioned to capitalize on strong growth in the Arizona market. Next year, Vext will report as a for-profit operator which will boost profits and we expect brands to become increasingly important as the market matures. Beyond Arizona, Vext plans to expand into additional markets with retail and production assets including California, Massachusetts, Nevada, Ohio and Oklahoma in the near term through joint venture.

US Cannabis Valuations

EV/Sales EV/EBITDA

	2021E	2022E	2021E	2022E
Curaleaf	6 .9	4 .7	24 .4	14 .1
Green Thumb	7 .5	5 .7	20 .8	15 .1
Trulieve	4 .0	3 .1	9 .1	7 .0
Verano Holdings	4 .2	2 .7	9 .8	6 .1
Cresco Labs	4 .2	3 .0	17 .3	9 .4
Ascend Wellness	5 .6	3 .1	22 .3	8 .8
Terrascend	7 .4	4 .0	18 .5	9 .2
Columbia Care	3 .2	2 .0	16 .6	7 .2
AYR Wellness	4 .5	2 .2	16 .0	6 .1
Planet 13	6 .5	4 .1	27 .0	13 .6
4Front Ventures	10 .8	8 .0	38 .6	23 .9
Jushi Holdings	4 .8	2 .8	32 .0	9 .5
Schwazze	2 .4	1 .3	8 .3	3 .7
Lowell Farms	3 .9	1 .9	28 .8	5 .7
Goodness Growth Ho	3 .5	1 .5	53 .3	5 .2
Cansortium	2 .5	1 .7	8 .1	4 .0
TILT Holdings	1 .6	1 .2	8 .4	4 .4
Red White & Bloom	0 .4	0 .2	1 .7	0 .8
STEM Holdings	0 .8	0 .4		3 .2
Slang Worldwide	1 .2	1 .0	7 .3	5 .9
Flower One	0 .9	0 .6	5 .2	2 .5
Mean	3 .8	2 .6	18 .4	7 .9
Median	3 .7	2 .1	17 .3	6 .1

Source: Viridian Capital Estimates, Priced Intraday 9/29/2021

Required Research Disclosures

Distribution of Ratings/IB Services
			IB Services in Past 12 months
Rating	Count	Percent	Count	Percent
Buy (Buy)	10	100%	0	0%
Hold (Hold)	0	0%	0	0%
Sell (Sell)	0	0%	0	0%
Not Rated (NR)	0	0%	0	0%

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