Village Farms is undervalued, says Raymond James

Getting in on the ground floor of legal cannabis production in the Netherlands seems like a strong move for Village Farms (Village Farms Stock Quote, Chart, News TSX:VFF) but the revenue gains could be small, says Raymond James analyst Rahul Sarugaser who nonetheless sees VFF as an undervalued stock.

Sarugaser issued an update to clients Wednesday where he reiterated his “Outperform 2” rating on Village Farms.

Vegetable grower and cannabis and hemp producer Village Farms has majority ownership in cannabis joint venture Pure SunFarms, along with hemp-derived CBD production in the United States. The company announced on Wednesday a definitive agreement with Netherlands-based cannabis business DutchCanGrow (DCG) which will see VFF receive a 16 per cent ownership stake in the DCG JV in return for its expertise in the cannabis business plus a nominal cash investment.

DCG is aiming to be one of a limited number of licensed cannabis growers (up to a maximum of ten) when Holland permits the first legal recreational cannabis market in Europe through its ten-city Experiment to Investigate Closed Cannabis Supply Chains (the “WECG”), which will involve an initial 78 shops in the pilot.

Under current laws, the sale of cannabis is permitted in certain coffee shops in the Netherlands but the growing of cannabis is illegal. With the WECG, the 78 coffee shops will be required to buy from federally licensed producers.

Village Farms CEO Michael DeGiglio is calling the announcement a momentous first step in VFF’s becoming a leader in the burgeoning legal international cannabis trade.

“DCG is an outstanding opportunity for Village Farms, not only providing potential access to the very first legal recreational cannabis market in Europe with the possibility of significant expansion within the Netherlands itself, but also to springboard to future legal cannabis opportunities in other markets in Europe, and around the world,” DeGiglio said in a press release.

Crunching the numbers, Sarugaser said that with the Dutch cannabis market estimated at $2.5 billion per year and with the WECG projected to address about one-tenth of that market ($250 million) and, finally, with VFF now owning 16 per cent of one of ten growers, that equates to potential incremental revenue of $4 million. (All figures in Canadian dollars unless where noted otherwise.)

“While we are enthused to see VFF making an intentional, precise first step into the European cannabis market, we temper our enthusiasm pending a few critical milestones that still must be met: (1) award of one of the ten licenses; and (2) a decision by the Dutch government to roll out the program country-wide, a process that could take three to five years,” Sarugaser wrote.

“Hence, we do not yet ascribe value to VFF from this transaction, but do see this as an opportunity to add positions in a stock that we view as materially undervalued,” he said.

Looking ahead, Sarugaser thinks Village Farms will generate fiscal 2020 revenue and EBITDA of US$146 million and US$9 million, respectively, and fiscal 2021 revenue and EBITDA of US$149 million and US$20 million, respectively.