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.

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.


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