2 Cannabis Stock Picks (Podcast Transcript)

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Editors’ Note: This is the transcript version of the podcast we posted last Wednesday. Please note that due to time and audio constraints, transcription may not be perfect. We encourage you to listen to the podcast embedded below, if you need any clarification. Enjoy!

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Rena Sherbill: Hi again, everybody. Welcome back to the show. It’s always great to have you listening with us. Super happy to bring back Julian Lin, Founder of Cannabis Growth Investor, a cannabis investing marketplace service on Seeking Alpha, that anybody interested in this space should be checking out. Julian’s been on the show many times before, always very elucidating with his perspective and thoughts and analysis.

Today is no different other than the fact that we’re doing a deep dive on two stocks, or one stock and one REIT to be more specific, a border line big MSO and a REIT that Julian was talking about last time he was on the show. Excited to get into two of his top cannabis stocks, why they’re part of that list, risks to that thesis and get into some general cannabis investing talk. Hope you find this one super actionable and helpful in your own investing process.

Julian, welcome back to The Cannabis Investing Podcast. Always fun talking to you, always been a lot of insight talking to you. And well first of all thanks for coming back on the show.

Julian Lin: Thanks for inviting me. I’m always, always excited to talk about cannabis stocks.

RS: Always excited to talk to you about it and also interested to get your thoughts, always like on the sector and on the industry. And we’ve talked a couple of times since the beginning of the year, like I can’t even believe that it’s June already. But today, I wanted to talk to you — I said that I wanted to do like a deeper dive on your top stocks. So that’s what we’re doing today.

So I appreciate you coming on and wanting to get into the nitty gritty of a couple of your top stocks. So talk to us about — let’s start with what those stocks are.

JL: Sure. So two stocks we’re going to talk about today. One is A-Y-R, Ayr Wellness. That’s stock ticker OTCQX:AYRWF. And the other stock ticker is NewLake Capital Partners. That’s stock ticker OTCQX:NLCP. I mean, I could have talked about two different multi-state operators, because right now, I think that’s where the most compelling valuations are. But I think for the sake of interest, I included NewLake Capital Partners, which is more of a cannabis REIT, just to just to make it a little more interesting.

RS: In terms of kind of showcasing a different side of the industry that doesn’t necessarily get talked about with a lot of, I guess, knowledge about the about that specific part of the sector.

JL: Absolutely. And just because I think even though they’re all in the same cannabis industry, they get impacted differently by different regulatory reforms are different — they get impacted differently, if regulatory reforms don’t get passed. So I think it’s — I think both are critical, like this kind of investing in the REITs and investing in the MSOs are both important for a cannabis portfolio.

RS: So talk to us a little bit about that. I guess, in terms of before we get into each specific stock, into the REIT, what would you say is in general, kind of your advice to a to an investor in the cannabis space, a cannabis investor, looking at a portfolio like we’re talking about your top two stocks, but what would you say is your advice for a complete portfolio?

JL: Sure, I think that definitely want to realize that the cannabis sector is not only the plant touching operators, but of course, at the same time when valuations get this distressed for those MSOs, I mean, it’s going to I think the valuations should also sort of drive how you allocate in the sector. For example, I don’t think it really makes sense to be allocating very heavily to the ancillary companies, when the MSOs are trading at a sometimes 3x, 4x EBITDA based on 2023 estimates.

By the same time, it does make sense to have exposure to names like NewLake Capital, because it’s going to — this is a name that could do well, even when the MSOs don’t do well, right? And they could do — and more importantly, could do very well. I mean, I’m not really a fan of investing just for the sake of diversification. So you got to make sure the upsides quite high and it’s quite high at NewLake Capital Partners.

RS: So talk to us a little bit about the upside or a lot of it about the upside. What are some of the things that you like about it, or what are — I guess what are the main things that you like about it?

JL: Yeah, so starting with NewLake Capital Partners. So just a little background, this is a cannabis real estate, cannabis real estate investment trust, short for REIT. Basically, what they do is they mainly own warehouses — or not warehouses, their cultivation facilities for cannabis operators. They also own some dispensaries. And the way this works is that NewLake Capital Partners is a landlord. So they own the underlying property for these assets.

And then the customers, the tenants pay rent, or pay lease payments on these assets. And their customers include the top names in the sector. They’re including names like Curaleaf (OTCPK:CURLF), Columbia Care (OTCQX:CCHWF), Trulieve (OTCQX:TCNNF), PharmaCann.

When you go through that tenant list, it’s a very, very high quality list, arguably higher quality than the elephant in the room, which is Innovative Industrial Properties (IIPR). That’s the most well-known cannabis REIT. And the way this business model works is that because the cannabis operators, the MSOs, they have limited access to capital, which also means that it’s hard for them to grow without capital.

So you’re going to have to — before they — when these licenses or before they come online for medical use or adult use, they have to build out a cultivation facility. They have to have dispensaries. But in general, they tend to have to own it or lease it from a cannabis REIT like NewLake Capital just because for one, the cultivation facilities. The typical industrial REITs are not so willing to just let a cannabis operator come in, because cannabis is still illegal, or a shopping center is not going to just allow a cannabis dispensary to come. I mean, some states might but a lot of states don’t.

So in order to grow they have to buy — they have to first buy these dispensaries or the cultivation facility, basically fund it with that, and then sell it to a cannabis REIT like NewLake Capital Partners. So what NewLake Capital Partners will do is they will give these multi-state operators capital and then in return sign a long term lease agreement, where — so typically if they spend $100 million, it might be like a 12% lease, so they’re going to pay $12 million in rent.

That tends to be quite high. And this is called net lease and the net lease REIT sector. Typically, if you were looking at like a Realty Income, that’s stock ticker (O) for example, like they would be a landlord for like Taco Bell properties or something like that. Those cap rates tend to be around the 6% range. So when NewLake Capital Partners, or IIPR getting 12%, it’s very high. And that’s just — that’s because cannabis operators don’t have access to cheaper forms of capital.

So kind of moving on to why NewLake Capital Partners is so compelling, there’s a couple of reasons. Just like the rest — a lot of growth sectors have fallen, NewLake Capital Partners has fallen a bit too, as well as IIPR. Both of these names, they’re trading quite cheaply. IIPR is yielding about 5%. That’s actually quite compelling here as well. And NewLake Capital Partners is yielding 6.4%.

So typically, when you see a REIT yielding 6.4%, it means that there’s some problem with credit, or there’s some problem with growth or there’s just some underlying problem there. In reality, that’s not really the case. So similar to the MSOs NewLake Capital Partners is listed OTC. This is because IIPR was the last cannabis REIT that the major exchanges allowed to come online. They want to — in general, they want to wait for something like safe banking to occur before they allow another cannabis REIT to trade on the major exchanges. That would be like — so that NewLake Capital Partners has to wait for that. And because it’s traded off the major changes the liquidity is lower. So there tends to be lower institutional involvement, explaining the discount about why it’s yielding 6.4% versus 5% at IIPR.

And if we look at real estate earnings, which is called funds from operations, and just a quick refresher for those who are not familiar with REITs too much, because as a real estate landlord, you could depreciate your properties, which will have the effect of reducing your taxable operating income with a high level account depreciation, that means that net income on a GAAP basis is going to be lower than funds from operations, which basically involves adding back depreciation. And because NewLake Capital Partners uses net leases that means that its tenants pay for the maintenance costs. So there’s not really any depreciation costs on behalf of the landlord, right, since the tenant is paying for it.

So that’s a difference between funds from operations. We could just call it real estate earnings that the stock is trading at less than 15 times, annualized FFO. But this is a company that’s growing really, really fast. So we’re talking about a company that still has $100 — I think it’s around $115 million of cash on its balance sheet. That’s the cash that the company raised at the time of its IPO. Management expects — and there’s no reason to not expect this, they expect to use that to invest their capital quite soon, right. And considering the current environment, where interest rates are rising, stock prices are low in the MSO sector, sale and leaseback transactions are very, very appealing.

It’s perhaps the best way — one of the better ways for MSOs to raise capital in the current environment. So just running some math, right. So right now they’re trading around 14.8 times FFO. Once they invest — this is just using the IPO proceeds, the $115 million, that’s going to increase their, their bottom line by covering up here by about 34%, right?

So you get you get around 34% growth. And that’s happening this year alone, right. This is just from that $115 million in proceeds. There’s no reason they couldn’t do more. In fact, they recently secured a revolving credit facility that gave them some more access to debt capital at a 5.65% interest rate.

So I mean — so this is a company that given the current environment, it’s going to be able to invest a lot of assets at really high rates of return. And it’s going to continue to do this until safe banking or legalization happens. But that kind of brings us to another interesting point where some people might think that NewLake Capital Partners, or IIPR, they’re trading cheaply, because safe banking seems to — there seems to be some hope that safe banking passes this year.

Of course, as cannabis investors, we know, not to hope too much for such a thing. But I mean the stock seem to be implying that. But there’s — I think there’s some confusion regarding how safe banking will impact names like names like IIPR or NewLake Capital Partners.

So the simplistic thinking is that it’s going to crush these names, because they’re not going to be able to invest at such high yields anymore. In reality, it’s not that simple, right. So first, when safe — if safe banking passes, the way I look at it is that it might allow the multi-state operators to refinance their debt at lower interest rates.

But — and that’s helpful, but it actually is going to help the cannabis REITs even more, because it’s going to enable NewLake Capital Partners to raise a ton of debt. And I estimate they could raise around $1 billion of debt at low interest rates, right. So there’s a huge difference between being able to refinance some debt and just raise a ton of debt.

So there’s — and furthermore, what’s going to happen is that essentially their tenants, NewLake Capital Partners tenants are going to become even stronger credit profiles after safe banking passes, what you get is like, sure, their cap rates on acquisitions will drop, right. Maybe it’ll drop to around 8%, 10%. But at the same time the credit profile of your tenants increase, they’re going to be able to take on more leverage, they’re going to have more liquidity. I think safe banking actually will be a catalyst for names like NewLake Capital Partners, or especially IIPR, because I could see them trading more in line with industrial REITs, which are the landlords of warehouses.

And this is just because NewLake Capital Partners has these built in annual lease escalators, around 2.5% or 2%. So when you have that kind of internal growth built in into the operating model, I mean, they’re going to — it’s going to justify a big premium on FFO.

RS: Is there any concern with Safe Banking passing, that the company — that the tenants will go elsewhere? That they’ll look to banks, let’s say or something like that?

JL: So that’s certainly reflected in the stock price. But again, I think that we got to look at these tenants, right. When you look at these tenants, they’re all pretty levered — they’re all pretty levered at a pretty healthy ratio. You’re talking about — and by that I mean, they have a lot of numbers. They have a lot of debt. It’s not like, they’re going to be able to just — they’re not going to have the upper hand in negotiations here. Although for starters let’s point out that once safe banking passes, it doesn’t mean that the tenants could just walk away from these properties. That’s the first thing to understand, right. These are long lease terms around 10, 12 years, right.

So they still have another decade before they could decide that they’re going to walk away if they were to. But the other thing to understand is like, a lot of times the licenses for cultivation facility or dispensary, they’re tied to an underlying property right? A lot of the requirements for applying for these licenses, is that you have to first have a property and then apply.

So I mean, I’m sure it’s possible to switch the license to another property, but it’s not necessarily. It’s not a given, right. It’s not a guarantee that they would be able to. I think worst case, they’re not going to just lose the tenants. They might have to just reduce rent, maybe right, in 10 years in worst case, but that even then that’s not guaranteed.

So I mean, I think if you were to just look at it simplistically, I’ll say Safe Banking is going to — it’s going to expose like these high cap rates, it’s going to make the tenants walk away. I think that’s — it’s not quite true, right. In reality these are really long lease terms, and it’s a lot more complicated than that.

RS: So can you think of a reason or a factor of a protracted legal process, like let’s say safe banking doesn’t pass for a few years, is there a thesis that feels like it might be bearish for those operators, in which case, their credit worthiness or their ability to pay rent is kind of affected?

JL: Sure. I mean, that’s a good point. All right. So safe banking takes a long time to pass. That’s obviously going to help NewLake Capital Partners, but then you got to wonder, is it going to make it go under. I’m of the opinion, not quite, especially because NewLake Capital Partners, their tenants are quite strong. We’re not talking about — there’s another REIT, I think I’ve talked about on the show in the past, a Power REIT stock ticker (PW) and they have a lot of tenants in Colorado. When they reported earnings recently, they talked about how some of their tenants are not paying rent, right.

So NewLake Capital Partners on the other hand, a lot of their tenants are in limited license states, right, where their profit margins are high. And especially when more states come online for adult use, the margins are going to get even stronger. So I view it quite interestingly, that sure, safe banking or legalization for the multi-state operators would be kind of an immediate boost to both the margins as well as the stock price, probably. But the longer safe banking takes to pass actually would arguably enable the strong top operators, the multi-state operators. That is to compete on an uneven level playing field with the smaller operators, right.

Like, if you’re trying to compete nowadays with the large operators, you have to find a way to bank — you have to find a way to raise capital, it’s not going to be so simple compared to operators that already are doing that.

So I’d argue that the longer safe banking takes to pass it actually strengthens the credit profile, long term of NewLake Capital Partners tenants just because they’re able to take greater market share, they’re able to keep growing kind of an uninhibited indefinitely.

So that’s perhaps a contrarian take on why delayed legalization is helpful, not just for NewLake Capital Partners, but also for those multi-state operators.

RS: And speaking of delayed legalization, are you hearing that — we’ve we talked about this, I think last time you were on, and we’ve talked about this a bit with NewLake Capital. And they’ve talked about this on earnings calls, about the talk of uplisting. Do you hear — have you heard anything? Do you have any thoughts on that, that process?

JL: So I think news around legalization is very cyclical, every three months or so, on Twitter you’re going to hear people start talking again about the next potential way that safe banking or legalization happens. I think that regardless of your political beliefs, I think it’s good bet to assume that our politicians are probably not going to do very much of anything. They might talk a lot, but I don’t think much will pass.

And regarding cannabis, I mean, I just hope today that the Biden administration, and this is the Democratic Party, right, the party that’s supposed to be more favorable for cannabis reform. The Biden administration in their job application screening is going to check for cannabis use. And this was posted by Marijuana Moment. I mean, I would say, if even the Democratic Party is doing things like this, but the odds of material cannabis reform are not so high, right?

I mean, to people who know and understand cannabis, of course, we think it should have. Cannabis reform is long overdue, it should have been decades ago. But I mean, we’re not the ones making the calls. The ones making the calls are the people in the Senate, and they don’t seem to show an interest really, in that regard. So I would love if safe banking passes, I think that will be great for the industry, great for safety. It will be great for investors, but I don’t think we should be counting on that.

RS: Specifically, with NewLake Capital, like wanting to go to a more major exchange, do you have any thoughts on them specifically?

JL: So the interesting thing with these REITs is that when their stock prices are higher, they’re going to have stronger growth rates, just because they’re able to issue stock to acquire more properties. It becomes quite easy. So the higher growth rate helps to offset the higher valuation. But when the stock prices are lower, the growth might be slower, just because, for one, I mean, you may not want to issue stock at a low valuation.

But the other thing is, even if you were to do that, the properties you acquire will not be as accretive, right, because you’re issuing a higher cost of capital. But the thing — and NewLake Capital Partners have mentioned that they’re discussing. But I mean — again, I wouldn’t count on them uplisting. I definitely wouldn’t invest based on that thesis.

But I think one thing to consider for sure is that even with their high, even with their stock trading where it is right, they could end up trading around what 15 times FFO or maybe, 11, 12 times FFO after they invested cash on hand. They could theoretically use a combination of internally generated cash, as well as issue a little stock at worst case. And it will still be accretive to their bottom line just because of how high the cap rates are in the sector.

So it just goes to say that the stock is priced for no growth. That’s what you think when you think of a 6.4% dividend yield. For example, like in the net lease sector, the only other retail that might trade at a 6% yield might be like WPC, W. P. Carey. And that company is growing at like a 2% rate, right?

And NewLake Capital Partners in comparison should do at least 30% every year for a while, right? So there’s a huge disconnect here in terms of what’s implied in the growth, implied in the stock price versus what is actually going to happen here.

RS: So let’s us switch gears to one of our favorite multi-state operators, I suppose. Ayr Wellness (OTCQX:AYRWF). We had Jonathan Sandelman on, the CEO. We had him on a few times on the show. We’ve talked about Ayr Wellness. I’m personally invested in that stock. Not doing very well. But talk to us about why you like that stock and why you like it specifically now.

JL: Ayr Wellness is one of my larger positions in the cannabis sector. And this is a very interesting one. So I just wrote a piece for Cannabis Growth Portfolio subscribers. The title is Ayr Wellness is a call option on U.S. cannabis. And the idea here is to explain why Ayr Wellness — why there’s so much volatility in the stock price. There’s — so as we know, there isn’t really any way to buy call options on individual operators in the cannabis sector, just because they’re not listed on the major exchange and OTC tickers don’t get options. You could buy options like on the ETFs. But I mean, it’s not quite the same thing.

And I mean, before we talk about, I guess really a valuation discussion let me just kind of discuss Ayr Wellness again. So the current stock price is very low. The stock’s trading around 2.8 times 2023 estimates for EBITDA. The stocks trading — the way I view it, the market seems to think it’s very risky, right? It’s looking at the high debt load, and it definitely has a high debt load. It has like $300 million of net debt. And that’s comparable with Tier 1 operators, like it’s the amount of debt they have is very similar to the larger operators.

So yes, there is some elevated risk here. And the implication is like oh, this is going to be a name that just has a lot of debt. It doesn’t execute well. So there’s a really low valuation. But I think the market is missing the fact that AYR, they have a history of strong execution right? They’re one of the top operators in Nevada. Their current footprint is still with limited license states, right? So if you just think logically it makes sense to believe that their margins will increase dramatically over the long term, as their — as more states come online for adult use.

And so this is a company just over the past month, or past 30 days, they received approval for bringing their Massachusetts — one of their Massachusetts dispensaries online for adult use. That that dispensary is located really close to an Apple Store. So that should be a very, very profitable store, right, doing adult use sales. They also received approval for all three of their New Jersey dispensaries to come online for adult use sales. This was unfortunately one month after all the other MSOs got approval. But they finally got approved for all three. They also got approval for their second cultivation facility in New Jersey. So like right now, of course, they’re going to have to purchase wholesale products for their stores, just because they didn’t have as much cultivation as other operators.

But once they build up that second cultivation facility, they’re going to be able to increase margins even further in New Jersey. And so those are some near term catalysts for Ayr Wellness.

RS: Can I ask you a question, just about New Jersey quickly? I’m just curious. Do you have thoughts on the delay there? Like why that was delayed? Do you feel like it’s a negative? It’s a negative reflection on them?

JL: Yeah. I actually was thinking about, okay, sure. So I guess two things on New Jersey. The first one would be just a general delay. Just how it took so many months for New Jersey to come online. I’ve seen a lot of talk on that, on Twitter kind of blaming a democratic regime for that. But in reality I mean, I think we have to remember that cannabis is a medicinal product. And I think it’s a legitimate concern to make sure that the current medical customers in the state will still have access after something comes online.

And you kind of just look at New Jersey right now where things are selling out. There’s long lines. I mean. I think I think it’s pretty clear that it probably made sense to wait a little to make sure there’s enough product for both adult use and medical. But anyways, regarding Ayr, why did they miss out on the first month? I think it’s related to relate to that — it’s the regulatory commission in New Jersey has been consistent. They said that they wanted to delay adult use sales for everyone until there’s enough products.

I’m not sure they really — and I’m not sure that really succeeded, just considering the strong business. But based on that narrative, it makes sense because it makes sense for Ayr Wellness to miss out that first month just because they didn’t have that much cultivation in the state to begin with. So I mean, just kind of mathematically, it makes sense that they’re probably going to — they didn’t have enough product to supply their stores in that first month.

So it’s not — obviously not a great benefit.

RS: I was just going to say, and the other MSOs that were ready you’re saying that was largely due to the fact that they already had a stronger existing cultivation?

JL: Yes. Like, for example, like TerrAscend (OTCQX:TRSSF) or a Curaleaf or a Verano (OTCQX:VRNOF) they not only had enough to supply their own stores, they’re producing enough to sell wholesale, right? So it’s just kind of night and day between those larger operators and a smaller operators like Ayr or Ascend Wellness (OTCQX:AAWH). Of course they’re going to — the smaller operators will catch up as their cultivation comes online.

For right now it’s definitely a case of the big boys taking over there.

RS: Okay, please don’t let me detract you from the rest of your bullish — laying out the bullish thesis there.

JL: Yeah. So what I was just about to say was — so the market is not giving Ayr credit for execution, right. It’s clear that the market is worried about execution risk. But I mean, this is a management team that they acquired Liberty Health in Florida very cheaply. And arguably, they’ve done a wonderful job there, right? Liberty Health, they’ve gone from being one of the subpar operators to one of — I mean, I wouldn’t say one of the top operators, but there’s a huge improvement.

I think. Jennifer Drake, the Chief Operating Officer at Ayr Wellness has recently said that they doubled the yield, cultivation yield in Florida, right? So here we’re seeing an operator, they frequently, maybe perhaps a little too frequently talk about how good they are at growing cannabis and how good their quality is. They like to talk about how — it’s not about the box but what’s in the box. But I mean, they not only do they talk, it is showing, right. It is showing in their performance.

And I think the market is under estimating, the execution ability of this team. And I mean, I’ve talked before about how bullish I am on Florida, right? This is a state where the medical market is very profitable. But it still only represents 2% penetration, right? So once adult use comes online, it opens up the market to 20% of the population, right. So of course, it’s not going to grow 10x overnight, a bigger market. But the addressable market increases 10x, once adult use sales happen.

And then of course, once mobilization happens, gets even more. So I think Ayr provides exposure to Florida. But let’s return to discussing why I view it as a call option. So it really comes down to how much — to two factors. One is how much debt is on the balance sheet, which ironically could be a positive when we’re thinking about upside. And the second thing is just overall undervaluation. So with regard to debt, right, so at current prices, about half or like a big chunk of the enterprise value comes from debt.

And when you think about — if you think about like projected upside, where you say, oh its current stock’s around 2.8 EBITDA, and you think that it’s going to get to like — it’s going to get to five times EBITDA, right? If you just look at 2.8 and 5, you might think the projected upside’s around 79%. That’s just kind of doing 5 divided by 2.8. But in reality, the projected upside is higher. It’s around 128%.

The reason is because — it’s because the upside value doesn’t accrue to the debt. It accrues to the stock, right? So when you have the debt making up so much of the enterprise value, it leverages that stock position, right. Hence, why I view as a call option. So — but the other thing is just because of its — just because of how cheap it’s trading, right? So here’s an example. Curaleaf’s trading around 7.8 times EBITDA, and this is all 2023 numbers. And Ayr is trading around 2.8.

Given a couple of years, Ayr’s footprint’s going to be built out. They’re going to have — there’s not going to be the execution risk just because everything’s done, right. Everything’s — they’ve proven, they’ve hit their numbers or come close to hit their numbers.

There wouldn’t be a reason for their stock to trade execution risks. And let’s say uplisting happens, right? You could easily see Curaleaf trading at 25 times EBITDA. And that’s fair value. That’s like conservative fair value. A lot of the alcohol companies trade around that level with a lot lower growth, right? But this is just for the sake of math, right?

So if Curaleaf were to trade up to 25 times EBITDA, then it would have around 190% upside. That’s pretty good, right? 190% upside is nothing to sneeze at. But if Curaleaf was at 25 times EBITDA, I mean, Ayr Wellness, I mean, it’s not going to trade that much lower. It’s going to trade perhaps — I mean, even if you give a huge discount and say, Ayr trades at 15 times EBITDA right? Although it’s arguable that you really shouldn’t be assigning a discount, a huge discount just because enterprise value already accounts for that.

But let’s say there’s a huge discount, right, a 60% discount on like EBITDA, Ayr would be trading at $47 per share. That would be 700% upside from here, right? So what you’re seeing is because Ayr has so much debt in the enterprise value, and it’s trading so much cheaper than some of the more richly valued Tier 1 operators, it’s presenting a lot more upside, exponentially more upside right then those Tier 1 operators.

So here’s what that means. I mean, to me, I think when you’re investing in the cannabis sector, we got to acknowledge — especially one of the multi-state operators that there’s a considerable amount of risk, right? This is not the same as if you’re buying a Google (GOOGL) or an Amazon (AMZN). This is just a totally different level of risk.

So when you’re investing in the sector, you really got to make sure you’re getting the right amount of potential return for your capital, right? So I think — I mean, obviously, everyone could do things differently, but I think it might be perhaps, a little misguided, right to be trying to invest mainly in the blue chips, when they’re offering only like 190% upside, when something like Ayr is offering, 700% outside, to much lower target.

You could potentially lower your risk of your portfolio, instead of investing so much in a Curaleaf you can invest less in Ayr and still get all of the potential upside with less invested capital, right. So there’s many ways to look at that. But the main idea here is that when the discount is this much, right, it really makes it worthwhile to increase your risk tolerance and the amount of risk you’re taking, because the amount of increased upside here just in my view justifies it.

RS: And would you say that that amount of upside, the justification there and kind of you talked about kind of qualifying, I would guess, their high debt, which is what some detractors point to as being too high, their debt level, do you feel like that, that some of the discounted valuation comes from that misunderstanding?

JL: Sure. So let’s — I guess, let’s talk about some of the risks here. I mean, obviously, when the upside is so much higher, it’s not going to come without some additional risks. So yes Ayr has a lot of debt. But at the same time, right, when you look at their portfolio, these are all limited license states, right? So it makes sense to believe that margins and growth are going to be quite strong as these states come online for adult use, right? And again, they just — and that’s already happening. They already — they’re going to start in New Jersey quite soon. They’re going to start in Massachusetts quite soon, for adult use sales.

So that’s going to help them support that debt. And even without all of that stuff, I believe their debt-to-EBITDA was around like two times. So it’s true that they’re high in the sector. But it’s still quite reasonable, like when you compare it to like alcohol companies. But of course, until legalization or decriminalization happens, it’s still not quite the same just because they have to pay 280E taxes.

But my point here is that, yeah, the stock price is definitely implying that the debt is a huge concern. But I’m just saying that’s not overstated there. But I think, perhaps one overlooked risk at Ayr is that their management team is not really founder led. So they don’t have nearly as much insider ownership as any of the other operators. Like when you look across the U.S. cannabis space typically, you see unusually high amounts of insider ownership, right?

We’re talking about like 10%, 15%, 20%, insider ownership at like Verano, Trulieve, Curaleaf, Columbia, all these names are founder-led, and the insiders have stakes, have skin in the game. Ayr unfortunately is not really the case. If you were to, like include warrants, the CEO of Ayr has maybe 6% of shares outstanding.

And I guess another thing to consider is that even though Ayr is fairly small, I mean, they’re not really shy about paying their executives very rich salaries. They’re getting paid $400,000 a year. That’s more than some tech companies. So the compensation here is really big. I would say if Ayr didn’t have the Limited License portfolio with it, and if they didn’t have the track record there would be enough red flags, to say, okay, the valuation is justified based on the risk compared to other peers.

But I think there isn’t yet reason to think that this management team is not aligned with shareholders or is not going to execute, right? I mean, everything they’ve done on the past couple years have supported the case that they’re doing a good job. I definitely see this valuation disconnect disappearing over time, just as more of their assets come online for adult use and more of the cultivation facilities come online, boosting their margins.

I mean, it just doesn’t — it wouldn’t make sense for Ayr to continue to trade so cheaply once the execution risk disappears.

RS: What are your thoughts on the lack of insider ownership and the high compensation?

JL: So I mean, of course, when you’re not founder-led, and because Ayr is like, more of like a SPAC and kind of more, it wasn’t founder led, like as other peers. Of course, insider ownership is going to be less. So from that perspective, it’s understandable. The main issue is if you have to wonder if the company or the management team will be more concerned about just paying their cash salaries versus trying to get their stock to do well. That’s the risk. It’s not a given, though, right? Because, I mean, this company is still — they’re still hustling. They’re still working hard on — I mean, they’ve done a lot of really smart acquisitions, right over the past couple of years. Remember, this was a no name company just two years ago. And now it has this footprint spanning New Jersey, Illinois, Massachusetts, Nevada, Florida. I mean, it’s quite impressive, right? So it’s more just — it’s a potential risk. It’s a potential possibility that just because their competition is high, insider ownership is low. It’s a potential risk that there might be misalignment. Or they might act not fully aligned. But that hasn’t played out. So it’s not necessarily a risk we need to worry about yet.

RS: And you talked about the smart acquisitions. What are your thoughts on the Liberty Health acquisition? You mentioned what Jennifer Drake said. How do you look at that, because there’s also some kind of complaints about that integration, or whether they should have bought it in the first place? But there’s also another side about it succeeding in a state that has kind of more room to grow. Yeah, I’m interested to hear your take on it.

JL: Well, I think considering that there’s so much anger from Liberty shareholders about that acquisition that actually probably indicates how good the acquisition was for Ayr, right? So like, if Ayr was able to get it at such a dirt cheap valuation that’s obviously very beneficial for shareholders of Ayr especially now we’re getting Ayr at a lower price than the stock was trading back then.

I mean, Liberty Health was not the best operator. It’s going to take time for Ayr to improve things there. I forget. I’m not sure if they’ve already done the full conversion. But I remember CEO, Sandelman was talking about how they haven’t — they were waiting to change the name of all their stores in Liberty Health in Florida to Ayr only until the quality met their standards, right. So it’s going to take them some time to make sure the quality is up to par, and they can compete in Florida.

But I think it definitely made sense to get something like Florida, right? I assume Florida is a cash cow for Ayr at this point. It makes sense to have this kind of states to help fund cash to fund to build out growth in other limited license states. And again with Florida, I think I think the market is just totally under estimating the opportunity there, considering that it’s a huge population and medical market is so successful. And there’s so much tourism there. I mean, I think I think the quote was like around 100 million tourists every year go to Florida outside of the pandemic of course.

And so this is a state that should be a huge profit driver for those MSOs in the state. But the market is sleeping on it right and Ayr has this — has a very meaningful presence in Florida. I expect once as they get more cash from like New Jersey or Massachusetts they are going to be able to build out even more dispensaries in Florida. So it’s — I definitely view Florida as being a crucial part of that thesis for Ayr.

RS: And would you say that there are any kind of takeaways from their recent earnings report that either you feel like it’s important to highlight or you feel like investors aren’t paying enough attention to or any anything noteworthy there?

JL: So I think I’m across basically all earnings calls, margin has been an issue, where I mean, definitely these management teams were not guided — not guide for a lot of the margin compression. But they are seeing a lot of margin compression, just from the last couple of quarters. I think I think it’s important to just to remember that the legal market is — it’s really artificial, right? You’re competing among other legal operators for a really small legal market. This is just because the illicit market is really big in these adult use areas. So until cannabis becomes more generally accepted, right, there is going to be volatility where, after a year of adult use sales, prices will come down, right?

You’re going to see some stalled growth. That makes sense. But definitely, I think the bigger takeaway is that the second half of this year is shaping up to be very strong, with New Jersey, and Massachusetts going to be meaningful contributions, especially to the smaller names I gave.

RS: The other thing if we can go back to NewLake for a second, we actually had Anthony Coniglio, on CEO interviews before he was technically CEO. But now that’s official. Do you have any thoughts on that management change? Do you feel like it’s more — do you have any thoughts on that?

JL: I mean, I think — I mean, even before the change, I had assumed he was CEO, and he was already acting like CEO. Yeah, I think, definitely, with NewLake Capital Partners, the stock is implying, if you were to just look at that, compared to IIPR there’s some shade being thrown at NewLake Capital Partner stock as if it’s like a kind of a smaller, not so professional version of IIPR. That’s the implication. But probably it’s not what I think.

But I think the company just needs to execute. It just needs to continue growing. And the key difference there is that they already — they have the immediate catalysts of being able to pay dividends and grow that dividend. That’s something that the multi-state operators can’t and just won’t do right now, right. So even though for example, Ayr are so cheap, they’re not going to pay a dividend or buy back stock. I know they did before. But really, none of these companies really can buy back stock, as long as 280E taxes is in force.

But NewLake Capital can. NewLake Capital is paying a 6.4% yield, that’s growing. I mean, at some point, I mean, yield is arguably the most popular investment class in Wall Street. Everyone wants a passive income. So when you talk about a high yield, that’s growing, that’s going to grow really, really fast, right? That’s an immediate — that’s a catalyst in itself, right? So that’s how NewLake Capital. It’s not nearly as cheap as the multi state operators. But there’s the immediate catalysts in play to reward shareholders right now.

RS: I’m curious, what subscribers at Cannabis Growth Portfolio, what are they mainly asking you to do? Is it mainly like complaining, like, what is happening with our portfolio? Like, why are stocks down? And how much more down are they going to go? Is that basically the main topic of discussion that you’re getting?

JL: Yeah, that’s a very interesting question. I think the most common question is very similar. It is basically what you said. They wonder, is the falling done yet? When are stock is going to — when are they going to go up, right? When is this going to happen? Or they might even ask something like, does this mean that legalization really was the only thing at play, right? Since the stocks still going down, the financials seem good? Why does the stock keep falling?

It’s very natural to be asking these things. And it’s hard for me — it’s definitely hard to explain. But I really — you got to view this with a sense of patience, right? Like if — like, we have this opportunity to keep buying these stocks at a low valuation, right, like, if you were, I mean, let’s just set up a situation where you could be locked up in a room. And the room is going to spit out a $10 bill every 30 minutes. That’s creating value. You get this opportunity. Or let’s say you’re able to buy the $10 bill for $8, right. And you can keep doing that.

If I were to present the situation, you’re going to want to be locked in the room for as long as possible. You’re going to want to be able to buy as much of those $10 bills for $8 for as long as possible with as much capital as you can. That’s easy. That’s easy to understand. But when you talk about stock prices, then people — they certainly think about it differently. They start thinking about oh, the stock prices keep falling. Oh, it’s taking too long. They don’t realize that the lower the price is, the more value they’re getting, and the longer it takes, the more capital they’re able to put into the sector, right?

So I mean, obviously, maybe it’s all sounding like a glass half full and nobody likes that kind of perspective. But this is true. And I’m going to just think about mathematically. I guess the biggest — another big argument I can make is that if cannabis stocks were to go up right now, right, and you will get some upside, that’s great. You have to think about where you’re going to invest that capital. I mean, I do like tech stocks. But besides type stocks, right? It’s not going to be so easy to find other stocks, with that kind of ROI, right?

So like, in general, you want to be buying compounders that compound your value over the long term, because it’s not any individual year that makes a lot of money for you. It’s going to be many, many, many years of compounding that makes the biggest return. So yes, I mean, if cannabis stocks were to go up, if uplisting were to happen and institutional comes in, the multiples probably expand to around the 20, 25, maybe even more, but probably, right now with the bearish sentiment in growth stocks, you’re probably talking about 20 times EBITDA.

Ayr goes up, 700%, you make a ton of money. But if we were to wait, you’re still going to get a very similar multiple expansion there. But it’s going to be off a higher base, which means that you’re going to make even more money just because it’s more projected upside. And I think there’s a saying that says the best — you have to wait for the best things right. The best things take a long time. I think this is definitely one of those situations that I would be more concerned if we start seeing cannabis operators raise a ton of stock at these levels. If that were to happen, then you might have to start wondering, okay I could see the low stock prices hurting these names, right? Because obviously, if there’s — if they need to dilute at these low levels, that will hurt.

But that hasn’t happened in the U.S. cannabis sector, not from the top operators. That has happened recently in Canada, right Aurora Cannabis (ACB) doing a bought deal with ton of warrants at like all-time lows, or at least recent lows. That hurts the Canadian shareholders. But that’s not happening at the U.S. cannabis names just because they have — they’re having strong profit margins. So yeah, I think the way to view it is there’s higher projected upside from a growing fundamental base, as well, as us being able to put more money in the sector, I think, got to do it that way.

And it will definitely keep — I mean, it will be better for the portfolio to have greater upside from greater amounts of capital. That’s how I view it.

RS: Good food for thought. Good food for thought, Julian. I appreciate you coming on. I feel like I’m excited to re-listen to this before I release it and just kind of pick up all the good nuggets, as a shareholder for Ayr Wellness, and also just kind of like ways to think about REITs in the space. And I think it’s good for investors that are so worried about what’s happening to their capital. When’s it coming back, to think about ways to get kind of a little bit more passive income from the sector.

Really great stuff, Julian, thanks for coming on. I appreciate it.

JL: Thanks for having me on. I always love talking about cannabis stocks.

Thanks so much for listening to The Cannabis Investing Podcast. Subscribe or follow us on Seeking Alpha, Libsyn, Apple Podcast, Spotify or Stitcher and we’d really appreciate it if you left us a review on Apple Podcast. It helps other investors find our show and makes us feel fantastic. If you have feedback or questions, we’d love to hear from you at Rena+canpod@seekingalpha.com.

Nothing on this podcast should be taken as investment advice of any sort. I’m long Trulieve Khiron, Isracann Biosciences, The Parent Company, Ayr Wellness, and the ETF MSOS. Subscribe to us on Libsyn, Apple Podcast, Spotify or Stitcher. Thanks so much for listening and see you next time.