ATB Capital Markets analyst David Kideckel reviewed the latest acquisition by cannabis name The Valens Company (The Valens Company Stock Quote, Chart, News, Analysts, Financial TSX:VLNS), saying in an update to clients on Monday that Valens is positioned to benefit from the expansion of Canada’s cannabis derivatives market.
Kelowna, BC-based cannabis extraction and product development company Valens announced on January 25 a definitive agreement to purchase Kelowna-based edibles manufacturer LYF Food Technologies. The deal is for $24.9 million plus up to $17.5 million more in earnouts.
Valens said the combination of its access to low-cost active ingredients will pair nicely with LYF’s industry-recognized product IP formulations of over 100 recipes, while LYF brings with it “a proven team with significant experience producing high throughput food products,” according to Valens.
“LYF has set the standard of what high quality edibles should be and has developed a diverse and flexible manufacturing platform to play a dominant role in the Canadian edibles market,” said Valens CEO Tyler Robson in a press release.
Also on January 25, Valens announced an equity offering on which it closed on January 29, bought deal of about 19.4 million units at a price of $2.05 per unit (each comprised of one common share and one-half a warrant) including over-allotment for total gross proceeds of about $39.7 million. The company said $32 million of the funds will go towards strategic M&A and expansion opportunities with the rest going to working capital requirements and general corporate purposes.
Kideckel said acquiring LYF offers operational, financial and synergistic benefits for Valens.
“Valens can leverage LYF’s extensive experience and relationships in the CPG and food manufacturing industries, existing infrastructure, pipeline of near-term executable opportunities with LPs and white label customers and definitive supply agreements to capitalize on several market opportunities,” Kideckel wrote.
“We note that Valens will continue to be a third-party manufacturer. With this acquisition, we believe that Valens has expanded its manufacturing capabilities to a full-suite of cannabis-derived products, from vapes to gummies to beverages (and to cannabis 3.0 products in the near-future). In addition, Valens anticipates meaningful cost synergies associated with regulatory, quality assurance, and marketing expenses. Based on Valens’ internal projections, the acquisition will be accretive to EBITDA and EPS for FY2021e,” he said.
Based on the potential added revenue from LYF, Kideckel has increased his estimates and is now calling for Valens to hit 2021 revenue and adjusted EBITDA of $98.6 million and $7.9 million, respectively, and 2022 revenue and adjusted EBITDA of $182.4 million and $28.3 million, respectively.
With the update, Kideckel is maintaining his “Outperform” rating while lifting his one-year target from $3.65 to $3.75, which at the time of publication represented a projected return of 111 per cent.
Kideckel said investors can expect a key catalyst for VLNS when the company reaches positive free cash flow, which he predicts could come by the fourth quarter 2021. The impetus is Valens’ expansion as well as growth in the Canadian derivatives market.
On the former, Kideckel pointed to both the new acquisition of LYF, which has a purpose-built edibles facility, and Valens’ construction of a facility in Ontario which should be completed this year.
On the market in general, Kideckel said cannabis derivatives account for two per cent of the Canadian cannabis market in January 2020 but reached about six per cent by December 2020. The analyst also referred to the mature market in Colorado where edibles account for about 17 per cent of total cannabis sales. In Canada, edibles is currently a $201.7-million market but could be worth about $1.6 billion by 2025, Kideckel said.
“As the Canadian cannabis market expands and more cannabis derivative products are launched into market, we believe that Valens will benefit through increased production volumes, which we expect will drive sales growth at higher margins,” Kideckel wrote.
“We believe [Valens’ expansion efforts] will increase Valens’ manufacturing efficiency and flexibility to produce a larger breadth of product at a lower cost than competitors,” he wrote. “Based on Valens’ margins, cost structure and expected CapEx, we believe the Company may achieve sustainable positive free cash flow in Q4/FY21e. We believe that achieving positive free cash flow will serve as a key catalyst for the stock.”
Valens’ share price finished 2020 down 52 per cent, while so far in 2021 the stock is up eight per cent.
Further to his comment his comments on Valens’ new acquisition, Robson added in the press release, “LYF stood out for its product innovation and marketing teams, as well as its broad range of edible products which will introduce new formats to Canadian consumers that are typically only available in more mature markets. We look forward to further developing our product offering to reach more consumers with high-quality and unique cannabis edibles as this product segment continues to gain in popularity.”