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How to value cannabis companies has been a sticking point for investors in the years since early 2021 when broad market hype and euphoria would drive the common shares of the tickers across the space to record highs. I’m bearish on most names in the sector on the back of several structural factors from an overzealous tax regime to competitive black market sales. These have entrenched losses for Ayr Wellness (OTCQX:AYRWF) and caused is total debt balance to balloon as consecutive quarters of negative free cash flows continue to deteriorate its financials.
However, the company has surged since the summer in response to the US Drug Enforcement Administration recommending that cannabis be reclassified from a Schedule I to a Schedule III drug. The lower risk tier could be significant and could reduce but not eliminate some of the hurdles faced by cannabis companies that want to access banking services or simply just take debit card payments at their dispensaries.
The most material impact would likely be an expansion of a sales multiple that has collapsed to record lows as investors sought refuge from rising rates away from loss-making cannabis tickers. Ayr is currently trading hands for a 0.26x price-to-sales multiple, a marked deterioration from early 2021 when it traded for a roughly 7x multiple. Critically, whilst it’s highly likely that the DEA will approve marijuana reclassification, such a development won’t reduce Ayr’s large debt burden or invert its losses. The plant will remain illegal on a federal level so it would be hard for cannabis bulls to sketch out a full scope of material benefits from reclassification. Critically, the Schedule III designation would still mean cannabis is a controlled substance. Bernstein came out with a note in August stating that any such move would see cannabis viewed more as a medical product to limit its addressable market as it could limit it from being treated as a consumer packaged good.
Rising Store Count, CapEx Reduction, Significant Debt Burden
AYR Wellness Investor Presentation August 2023
Ayr last reported fiscal 2023 second-quarter revenue of $116.7 million, up 18% over its year-ago comp but missing analyst consensus by $4.15 million. $135 million market cap Ayr operated 85 stores at the end of the second quarter, up from 69 in the year-ago period. The company has been chasing lower CapEx to correct a cash flow profile that saw the vertically integrated multi-state cannabis operator realize a cash burn from operations of $5.3 million, a significant decline from $13.7 million in the year-ago period. Ayr did notch several wins during the second quarter with gross profit margins at 48.5% expanding 750 basis points sequentially from 41% in the first quarter. Net loss came in at just under $30 million, an improvement from a loss of $38.3 million in the year-ago period.
Ayr Wellness Inc. Fiscal 2023 Second Quarter Form 6-K
The MSO reduced its SG&A expenses by just under 2% year-over-year to $46.9 million as its interest expense on what was $470 million in debt at the end of the second quarter ballooned to $11.5 million. The gains in adjusted EBITDA look good but the underlying operations are still making losses and losing cash against a still uncertain backdrop for the federal legalization of cannabis. This would represent the most material development for the future of the industry and its continued absence heightens the risk posed to Ayr as its liquidity is pressured.
Cash Flow Guidance And Higher For Longer
Ayr ended the second quarter with a $60 million cash balance, down sequentially from $96.5 million in the first quarter. The company has raised some additional funds post-period end with its cash balance at $74 million with the bulk of these cash gains coming from a $40 million refinancing and upsizing of its existing mortgage for its Gainesville cultivation facility. The company also anticipates receiving $12.3 million from the Internal Revenue Service for its application for employee retention credits.
This comes with Ayr guiding for positive GAAP cash flow from operations for calendar 2023, a development that would need to remain sticky to have an impact on the underlying trajectory of the company. Bulls would be right to flag that Ayr’s focus on reducing CapEx, the dramatic expansion of gross margins, and the reduction in SG&A despite a corresponding increase in revenue all bode well for its future. Hence, a sell rating on the ticker is not appropriate. Efforts to expand its cash position are also positive against a future increasingly defined by capital market uncertainty and instability. Higher for longer will keep a lid on investor sentiment for a while so I expect near-term returns to remain muted until another significant development on the legalization front springs up.
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