2021 started off with a bang for cannabis stocks, as optimism for legalization under a Democratic Congress caused most names to surge. Yet as legalization got put on the back burner amid debate and infighting over other priorities, cannabis stocks are going out of 2021 with a whimper:
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The maddening sell-off, even amid solid underlying fundamentals and growth, has made many cannabis stocks look like bargains today, at least on an EBITDA basis. Yet with the prospects of legalization a wildcard in 2022, net margins and access to capital will remain compressed.
That means investors need to differentiate among cannabis stocks in 2022, concentrating on those with the best strategic positions in limited license states, low valuations, and the ability to make profits in spite of high interest and tax rates.
In that light, the following stocks look superior to their peers, and could be in for a rebound in 2022.
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Trulieve Cannabis
Trulieve Cannabis (TCNNF 2.45%) has long had the highest gross and EBITDA margins in the industry, thanks to its dominant position in Florida, where it benefits from economies of scale and vertical integration. However, that changed a bit when Trulieve made the biggest acquisition in industry history, purchasing Harvest Health & Recreation for $2.1 billion back in May.
That will lower Trulieve's overall margins as it diversifies out of Florida, but its margins are still pretty strong. After both the Harvest acquisition as well as smaller acquisitions of dispensaries and licenses, Trulieve is an industry giant, with 155 dispensaries across 11 states as of Nov. 15.
That huge and diversified footprint is still generating impressive EBITDA margins of 44%, and actually positive net income of $18.6 million last quarter, even after punitive interest and tax rates. Trulieve has also been conservative in its capital structure, with more cash than debt.
While Trulieve has rapidly expanded outside of Florida, it has still been very thoughtful about margins and profitability. Its current footprint is designed around three major "hubs" in states that border each other in the southwest, southeast, and northeast. Being in bordering states allows for economies of scale in materials and personnel. If and when legalization happens and interstate commerce is allowed, that setup will lead to even more synergies.
Due to its scale and prudent focus on profits, Trulieve is perhaps the most "defensive" U.S. cannabis stock around.
Jushi Holdings
Although Jushi Holdings (JUSHF 3.06%) is a small-cap stock with roughly a $1 billion market capitalization, it has a large position in several key limited-license markets, especially Pennsylvania and Virginia. Like Trulieve, it has been focused on value-added acquisitions and margins.
The Virginia opportunity is particularly intriguing, as the regulators there divided the medical-only state into five highly regulated zones essentially monopolized by a single company. Jushi bought the license to the Northern Virginia area in 2019, which includes the suburbs of Washington, D.C. -- the most densely populated area in the state. Jushi already has two operational dispensaries there, with another four set to open over 2022-2023.
Virginia has already passed adult-use legislation, but that won't kick in until 2024. While that could open up more competition, Jushi will have over three years to cement its first-mover advantage there.
Image source: Getty Images.
Meanwhile, recent results across Jushi's business have been solid. Last quarter, revenue surged 117% year over year, and adjusted EBITDA margins expanded as EBITDA grew 125%. Management now expects $110 million to $130 million in EBITDA next year, against a current enterprise value (EV) of just $1.11 billion. An EV-to-EBITDA ratio in the range of 9 to 10 is not expensive for a company growing revenue at triple-digit rates, making Jushi a strong value heading into 2022.
Ayr Wellness
Finally, the big reason to own Ayr Wellness (AYRW.F 1.30%) is its low valuation compared to its peers. It only trades at 4.3 times EV-to-EBITDA, based on 2022 estimates for EBITDA -- well below the industry average of between 9 and 10. That could be because the company has rapidly gone from a two-state footprint last year to an eight-state footprint by next year. So investors may not realize Ayr's future could look very different from the past.
Even though it has grown rapidly, Ayr has been thoughtful to only enter limited-license states. Its biggest growth driver for next year could be Florida, where it anticipates growing its store footprint from 42 to 65, while also ramping up production capacity.
For those who don't know, Ayr bought a Florida operator last year that has one of just a few licenses in the highly regulated state. However, Ayr paid a low price, as that operator had struggled with production in Florida's humid climate. Yet Ayr's management has already pointed to production improvements in Florida as it leverages its expertise gleaned from historical operations.
While Ayr has improved cultivation, it is not all the way up to where it could be, and it's still opening new stores to claim attractive sites, so store productivity remains low. Ayr management also noted some pricing pressure in key wholesale markets, but it is holding its pricing as it opens more retail outlets in places like Pennsylvania and Massachusetts.
These pressures may have harmed sentiment around Ayr's stock toward the end of the year. However, with more dispensary openings, the Florida expansion kicking in, and the New Jersey market benefiting from adult-use sales starting in the second quarter of 2022, growth should ramp up strongly next year. Hopefully, Ayr's bargain-priced stock price will follow.
