Is Village Farms stock cheap?

Investors should be taking advantage of a clear undervaluing of Village Farms (Village Farms Stock Quote, Chart, News TSX:VFF) compared to its cannabis sector peers.

That’s the assessment of Raymond James analyst Rahul Sarugaser, who in a research update to clients on Tuesday reiterated his “Outperform 2” rating and target price of $11.00 for VFF, which last week reported quarterly earnings.

Long-time vegetable grower Village Farms got into the cannabis trade with the joint-venture Pure Sunfarms, of which VFF currently owns 58.7 per cent. Village Farms is also developing a hemp business located in the US.

The company announced its first quarter 2020 financials on May 14, featuring $32.1 million in produce sales and $15.7 million in total gross sales from PSF. PSF’s sales to provincial distributors grew by 118 per cent year-over-year during the Q1 while it held a leading market share of 14.3 per cent of dried flower sales in the Ontario Cannabis Store over the first four months of 2020, with over 20 per cent of sales for the month of April.

“Pure Sunfarms continues to clearly set the standard in the Canadian cannabis industry for cultivation capabilities, best-in-class facilities and operations, cost of greenhouse cultivation, managerial acumen, brand performance and profitability, achieving its fifth consecutive quarter of net income and sixth consecutive quarter of positive EBITDA,” said Michael DeGiglio, CEO of Village Farms, in a press release.

Further numbers on the Q1 featured PSF hitting adjusted EBITDA of $1.1 million and all-in cultivation costs of $0.64 per gram, up from $0.50 per gram for the previous quarter.

Sarugaser said PSF’s continued string of positive EBITDA should be a bigger deal than it has been by VFF’s share price, arguing that while valuation comparisons within the cannabis sector are difficult due to the wildly fluctuating revenue estimates for the various companies, there are nevertheless some obvious points of reference, one of them being PSF’s EBITDA track record.

“We employ a comparables valuation methodology as a sanity check, particularly as it relates to the relative valuation of cannabis companies by revenue versus by EBITDA,” Sarugaser wrote.

“What we find is a clear asymmetry in which the market appears to be valuing PSF—and, hence, VFF—based on a comparison of PSF’s revenue to peers, but seems to be ignoring its boldly advantaged EBITDA relative to peers. Most of PSF’s peers are projected to remain EBITDA-negative throughout 2020, with only a select few projected to turn EBITDA-positive in 2021. PSF has been EBITDA-positive from its first complete quarter of sales. Some of its peers, we expect, may never be,” Sarugaser wrote.

“Based on a comparison of projected EBITDA among its peers, we find VFF undervalued by 53 per cent and 82 per cent based on 2020 and 2021 estimates, providing an implied share price of $9.44 and $24.32, respectively. This, material undervaluation of VFF, in our opinion, is a market asymmetry that our clients can take advantage of in the immediate term,” he wrote.

The analyst has updated his forecast and is now calling for VFF’s fiscal 2020 to generate EBITDA of $9 million on $146 million in revenue and for fiscal 2021 to make $20 million in EBITDA on a top line of $149 million.

At press time, Sarugaser’s $11.00 target price represented a projected return of 250 per cent. (All figures in US dollars.)