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Jonathan Kitchen

Introduction

When I first wrote about Ayr Wellness (OTCQX:AYRWF) in July 2020, cannabis in the US was just getting some momentum. Most companies were part of a single large scrum and it was difficult to see which would eventually stand out. There just wasn't enough data. I did not give Ayr a buy rating, saying they looked promising but with only three quarters as a public company the best approach was wait and see. That didn't keep Ayr from going up 325% from $8 to $34 in seven months during the Great Cannabis Boom, and here we are now at $3.22. What a ride! Ayr has changed a lot, and with ten more quarters of results in the books it's time to look at it again. This article will undertake a review of Ayr in light of the recent Q3 2022 earnings report.

Ayr background

Ayr was formed from an early SPAC. They entered the cannabis business by acquiring five private companies in Massachusetts and Nevada on May 24, 2019. Total consideration for the five was $270 million. In their first public quarter revenue was $32.1 million. Today they have cultivation, processing and retail operations in seven states and Q3 revenue was $119 million.

Ayr has been one of the more aggressive names in the sector when it comes to growth strategy. They have funded a number of acquisitions with a combination of cash, shares, and seller notes (debt), with additional cash if performance goals are met. This hybrid technique is one reason why they have been able to grow so rapidly. It's less dependent on one source of funding, and the seller even finances part of the sale. It should also be noted that much of the equity and cash was raised during the boom, when share prices were higher and capital raising easier.

This efficient acquisition record is right in Ayr's wheelhouse. Management believes part of what gives them an "edge" is their background of successful senior-level careers in finance, M&A, and asset management. They are confident they can identify companies that offer value and growth, and apply the most advantageous financing techniques.

Ayr Wellness third quarter results

Ayr has been an acquisition machine, but how is the company doing? In the latest quarter, the answer is pretty good. The table below shows Q3 results in the context of previous six quarters, which corresponds to Ayr's rapid growth period, and Q/Q and Y/Y comparisons. All numbers in million USD except EPS.

Mar 2021 Jun 2021 Sep 2021 Dec 2021 Mar 2022 Jun 2022 Sep 2022 Q/Q Y/Y
Revenues 58.4 91.3 96.2 111.8 111.2 110.1 119.6 +9.5 +28.3
Gross Profit 30.3 48.9 49.1 53.7 48.0 43.5 50.0 +6.5 +0.9
Oper. Income 0.6 3.0 0.9 -7.6 -17.2 -20.9 -17.4 +3.5 -18.3
Earnings: Continuing Ops. -16.6 -20.7 -3.4 23.8 -9.2 -40.2 -37.4 +2.8 -34.0
Net Income -16.6 -20.7 -3.4 23.8 -7.6 -38.4 -36.1 +2.3 -32.7
EPS -0.4 -0.4 -0.1 0.4 -0.1 -0.6 -0.5 +0.1 -0.4
EBITDA 8.0 17.4 16.9 12.3 4.1 -0.1 8.1 +8.2 -8.8
Adj. Gross profit 34.2 53.1 56.6 63.3 57.9 57.2 62.8 +5.6 +6.2
Adj. EBITDA 18.4 27.4 26.0 26.1 19.5 19.6 21.7 +2.1 -4.3

The numbers moved in a positive direction sequentially, and revenue showed a 9th consecutive quarter of growth. Revenue was helped by the first full quarter of sales in New Jersey and Illinois, adult use launch in Massachusetts, and expansion in Florida. Ayr now has 52 Florida retail locations, only 20 months after initiating the acquisition of Liberty and its 28 locations.

As Ayr reminded us again in the conference call, expansion requires a high level of expenditure before results show up on the top or bottom line. There are countless tasks to accomplish in order to open a new facility, and each one has a cost. As Ayr nears the end of a two year capex program, effects of expansion are showing results. They expect further sequential revenue growth in Q4 and 2023, and improvements in cash flow and earnings. The expansion is not finished yet, however. Among other things, they will open 15 more stores in Florida in 2023 and expand facilities in New Jersey.

Capital position

Ayr exited the quarter with $100 million of cash, and plans to reduce capex in 2023 to less than $30 million. For comparison, they have spent $89.7 million on growth so far this year (or $58.3 million net of $31.4 million from asset sales.

Growth doesn't come cheap. This $255 million market cap company has $455 million in debt using Seeking Alpha data, compared to $208 million in Q3 2021 and $157 million in Q32020. They have also liberally accessed the equity market. There are currently 69 million shares outstanding, compared to 60 million in Q3 2021 and 30 million in Q3 2020.

It's instructive to see how Ayr compares to other cannabis companies on debt, most of which are also implementing growth strategies. The chart below compares Ayr with five companies with market caps in the same tier: Village Farms (VFF), OrganiGram (OGI), TerrAscend (OTCQX:TRSSF), Sundial (SNDL), and Aurora (ACB). Y-charts is behind on the most recent data, but the chart is clear. Ayr has significantly more debt than market cap peers.

Ayr Wellness Long-term Debt
Data by YCharts

The chart below shows long term debt for companies with an amount of debt similar to Ayr. They are Green Thumb (OTCQX:GTBIF), Trulieve (OTCQX:TCNNF), Curaleaf (OTCPK:CURLF), Verano (OTCQX:VRNOF) and Cresco (OTCQX:CRLBF). Again, Y-charts doesn't have the most recent data. These companies are much larger than Ayr, averaging a $2.408 billion market cap compared to Ayr's $234 million.

Ayr Wellness vs peers debt
Data by YCharts

Companies use a variety of methods for financing. There are many aspects to debt, such as current vs non-current, capitalized leases, net vs. gross, debt-to-equity, and so on. Ayr uses sale-leasebacks to a great degree, whereas a company such as Verano does not. Then there's the factor of income taxes, where Ayr is current but a company such as Green Thumb owes over $200 million. My view is that deferring taxes is a smart form of "borrowing," but that's a story for another time. Suffice it to say that the comparisons here are good representations of debt positions.

The SPAC factor

Ayr was founded via a SPAC in 2019, before most people knew what a SPAC is. Since then, SPACs have gained a reputation as an arrangement that often enriches founders and insiders while average shareholders get left behind. Ayr went public at $10 a share, and now sits at $3.22. Admittedly the cannabis sector has not done well in the intervening years, but one has to wonder if the SPAC structure played a role. I remember asking Ayr IR in 2020 about a grant of 1,700,000 restricted stock units to COO Jennifer Drake, which at the time was worth about $40 million CAD. He responded that it was to put Drake's compensation in line with other executives. I didn't pursue the issue, but did wonder what could possibly make those executives worth so much money.

Summing up Ayr Wellness

Ayr's investments have led to impressive revenue growth and business expansion. According to CEO Jon Sandelman, the business is now at the point where they will reap the rewards of investments over the past couple of years. Sandelman and his team have shown marvelous ability to raise capital, which is not surprising considering their long experience in capital markets. Sandelman has said Ayr's goal is to be a top five cannabis company, and they have made much progress. But if there is one lesson the broader investment community has learned in the past few years, it's that ability to raise money and grow revenue is not a guarantee of anything. In many cases it has caused only heartache for companies and investors. We are obligated to look at any high growth emerging industry company and consider where their strategy might lead. This becomes particularly important under adverse economic conditions.

Conclusion

In Q3 2022, the financials trended positively. Before this quarter, the record is uneven on important financials like operating income, net income, and earnings per share; nor is GAAP EBITDA consistently trending in a positive direction. Management maintains that the company is now in a position where that will change, and investors will want to watch the next several quarters closely.

There are several aspects to the company that might give investors pause. The rapid expansion has had consequences for the balance sheet, putting debt levels at the higher end of the industry. Investors will also want to keep an eye on the share count, which has doubled in two years. We also need to remember Ayr's origin as a SPAC. Although they converted almost three years ago, it can still have lingering consequences for capital structure and the way the company is run.

Investment recommendation

My recommendation is in two parts:

First, for those who own shares Ayr is a HOLD. If we take management at its word, financials should take an upturn as a result of multi-year investments in growth. This should become manifest in the next few quarters, and the downside in that time is minimal considering to the cost basis of most investors. In addition, there is the prospect of SAFE banking passing in Congress before January, which will be a big boost to the entire sector.

Second, for those who do not own shares, the recommendation is to wait. Ayr has elements of higher than average risk. Ayr might be fine for anyone with an above average risk tolerance, and might be a perfect choice for those individuals. For the average investor, though, there is little downside to watching and waiting. There will be plenty of time to buy if we see that management's strategy is playing out as planned - it won't be an overnight phenomenon. In the meantime, there are other companies with equal potential that in my view are on a firmer foundation with less risk. I have written about several of these companies recently: Green Thumb, Trulieve, and InterCure (INCR).