Investors looking for value in the Canadian cannabis sector should go beyond the lineup of licensed producers and start thinking about retail, says Echelon Wealth Partners analyst Matthew Pallotta, who likes Alberta-based Fire & Flower Holdings (Fire & Flower Holdings Stock Quote, Chart, News TSX:FAF).
In a review on Tuesday of the company’s latest quarterly results, Pallotta nudged his target on FAF upwards, saying that the company is showing resilience in the face of tough headwinds in the cannabis space.
Retailer and distributor of consumer cannabis products, Fire & Flower released its third quarter ended November 2, 2019, financials on Tuesday, showing revenue for the quarter of $13.7 million and an EBITDA loss of $2.7 million.
By the quarter’s end, FAF had 30 retail outlets in operation across Alberta, Manitoba, Saskatchewan and the Yukon, with ten of these having opened up during the Q3. The company also closed over the quarter a strategic investment with Alimentation Couche-Tard of $25.9 million, which would see the latter obtaining a controlling interest in Fire & Flower if all securities issued are converted or exercised in full. Since the quarter’s end, FAF has received nine more retail store licenses and continued its application process for retail licensing in the province of BC.
“We anticipate meeting our goal of 45 open and operating stores by the end of our fiscal year. Our industry-leading Spark Perks members program ensures that our customers are engaged with the Fire & Flower brand as their cannabis retailer of choice,” said Trevor Fencott, CEO, in a press release.
FAF’s quarterly numbers proved a beat of both Pallotta’s and the Street’s estimates, with the $13.7-million in sales beating the analyst’s $11.5-million forecast and the consensus $12.5 million. The $2.7-million EBITDA loss was also better than Pallotta’s $3.7-million estimate.
“The Company demonstrated some resilience in the face of several industry headwinds, including a slowdown in cannabis sales faced by Licensed Operators, and challenges faced in provinces with government-owned distribution monopolies, leading to difficulties with product availability,” wrote Pallotta.
“Increasing competitive pressures, particularly Alberta, have also challenged retailers’ performance on a per-store basis, which we forecasted in our Q319 earnings preview,” he said.
Pallotta said that the Ontario government’s new retail licensing system should support “significant growth” for Fire & Flower in 2020 and 2021. The new plan implies the issuing of about 180 new retail licenses by the end of 2020, making for a total of about 250 stores, and the analyst thinks that the new timeline for retail stores should allow FAF to open more stores than previously forecasted, causing Pallotta to adjust his expectations. The analyst noted that on the day of the Ontario licensing announcement last week, FAF was up about 11 per cent.
“Overall, despite these aforementioned challenges, the outlook for 2020 found some additional clarity, with Ontario government’s announcement last week of a move to an open licensing system in 2020. Based on these developments, we continue to view retailers as the more favoured vertical for investors in the Canadian cannabis space, relative to Licensed Operators,” he wrote.
Pallotta is now calling for fiscal 2019 revenue and adjusted EBITDA of $51.6 million and negative $11.6 million, respectively, and for fiscal 2020 revenue and adjusted EBITDA of $144.0 million and $5.1 million, respectively.
The analyst maintained his “Speculative Buy” recommendation but raised his price target from $2.00 to $2.10, which at press time reflected a 12-month projected return of 133 per cent.