Village Farms is our Top Pick in Canadian cannabis, says Stifel

Strong quarterly results have Stifel GMP analyst Andrew Partheniou feeling upbeat about Village Farms International (Village Farms International Stock Quote, Chart, News TSX:VFF) who just posted its third quarter numbers. In an update to clients on Sunday, Partheniou called VFF his Top Pick in Canadian cannabis, while reaffirming his “Buy” rating and raising his target price from $17.00 to $17.50.

Vancouver-based Village Farms is a greenhouse grower of vegetables, cannabis and hemp in North America, with its BC-based Pure Sunfarms, once a joint venture but now fully owned, representing one of the cannabis industry’s lowest-cost producers and one of Canada’s best-selling brands.

The company released its Q3 2020 financials on Friday, showing Pure Sunfarms revenue of $22.6 million, up 75 per cent year-over-year, and adjusted EBITDA of $5.6 million. Since the third quarter, VFF reported 15.2 per cent brand market share in the dried flower category, by kilograms sold, with the Ontario Cannabis Store for the month of October, while staying as the top-selling brand of dried flower for the year-to-date by the end of October. (All figures in Canadian dollars except where noted otherwise.)

Village Farms announced on November 2 that it had acquired all of the remaining shares of Pure Sunfarms from JV partner Emerald Health, a move that has been in the making for a number of months, with VFF and Emerald starting out as 50/50 owners before VFF brought that up to 58.7 per cent earlier this year. Also since the end of the third quarter, Village Farms completed a direct offering of about 9.4 million shares at US $5.30 per unit for gross proceeds of about US$49.8 million, with up to US$40 million of those funds going towards the PSF purchase.

“Pure Sunfarms’ third quarter results are yet further evidence of its earnings power, based on our unique approach to the cannabis industry, with net income nearly tripling from the second quarter of this year, marking Pure Sunfarms seventh consecutive quarter of profitability,” said Village Farms CEO Michael DeGiglio in the third quarter 2020 press release. “It is an achievement that is unmatched in our industry, and further underscores the significant value in acquiring the entirety of Canada’s premier cannabis company.”

“There is no cannabis supplier in Canada or the U.S. with our combination of experience, capabilities and more than ten million square feet of greenhouse assets, and we are encouraged by the evolving regulatory environment in the U.S. and are developing multiple strategies to capitalize on any favourable U.S. regulatory developments in 2021. We will pursue these opportunities with prudent, disciplined capital allocation and focus on return on invested capital,” DeGiglio said.

Partheniou said the company’s third quarter numbers beat his and the Street’s estimates. Where PSF’s cannabis revenues came in at $22.6 million, the analyst had been calling for $15.5 million and where consolidated adjusted EBITDA (excluding writedowns) was $5.2 million, Partheniou had called for $2.6 million and the Street consensus was $1.9 million. Partheniou noted that proforma the full acquisition of PSF, VFF’s adjusted EBITDA was $9.6 million.

Partheniou said the Q3 adjusted EBITDA margin of over 30 per cent solidified VFF’s position as the low-cost leader in Canadian cannabis but that the market has yet to fully account for the company’s dominance.

“In our view, the company continues to showcase a healthy and sustainable business model amid a challenging cannabis market, setting itself apart from its peers, many of whom have yet to achieve profitability. However, VFF shares continue to trade well below these same peers, with its EV at an ~85 per cent discount to the average of the big five in Canada. We believe this presents an attractive opportunity for investors as transparency is set to increase upon PSF’s consolidation, potentially triggering a re-rating for shares. Hence, we increase our target to $17.50 and reiterate our view as the top pick in Canadian cannabis,” Partheniou said.

The analyst said PSF’s sales in the recreational channel benefitted over the second quarter 2020 from the launch of the company’s large-format SKUs, as customers were at that time pantry loading to a greater extent and evidently appreciated PSF’s value proposition. That trend has subsided, according to Partheniou.

“Customer purchasing patterns normalized in Q3/20 with small-format SKUs increasing ~166 per cent QoQ and a -43 per cent sequential decrease in large-format SKUs, driving an increase of ~13 per cent in the average selling price. We believe this was further aided by release of two new strains in small-formats, which likely generated customer enthusiasm. Management indicated strain innovation was ongoing, with more releases potentially sustaining this positive momentum going forward, in our view,” Partheniou wrote.

“Our positive stance on VFF stems from: (1) management’s over 30 years experience in large-scale greenhouse agricultural production, supplying major retailers with strict quality standards; (2) PSF’s low-cost industry leading position enabling the LP to maintain profitability under the most pressured scenarios; and (3) free optionality to pursue other strategic cannabis and hemp opportunities in the US with its existing 5.7-million sq. ft. greenhouse footprint in Texas and key industry relationships,” Partheniou said.

The analyst has updated his forecasts for VFF and is now calling for full 2020 revenue and EBITDA of $174.3 million and $15.0 million, respectively, and for 2021 revenue and EBITDA of $290.4 million and $43.9 million, respectively. Partheniou said the higher forecasts were cause for his target raise to $17.50, which at press time represented a projected 12-month return of 123 per cent.