4Front Ventures is a Buy in US cannabis, says Haywood

Strong earnings growth in its latest quarter has Haywood Capital Markets analyst Neal Gilmer staying bullish on 4Front Ventures (4Front Ventures Stock Quote, Chart, News CSE:FFNT). Gilmer maintained a “Buy” rating and C$1.50/share target price for a projected return of 67 per cent in an update to clients on Tuesday.

Phoenix-based 4Front Ventures owns and manages licensed cannabis facilities in state-licensed markets in the United States, with a focus on the cultivation, processing, packaging, distribution and retail of cannabis in its THC Cannabis and CBD Wellness segments.

Gilmer’s latest analysis comes after 4Front released its first quarter financial results for the 2022 fiscal year, which Gilmer noted to be slightly below expectations on the topline although he noted EBITDA to be ahead of expectations.

“Management reiterated its focus on the California market with its Commerce facility fully operational and expectations for that market to drive sequential revenue growth,” Gilmer said. “4Front continues to explore other acquisition opportunities in the market, similar to the Island acquisition that closed last month.”

4Front’s financial report was headlined by $32.4 million in managed revenue, adjusted to $26 million on GAAP principles. In terms of managed revenue, 4Front’s report came in as a miss in relation to the Haywood estimate of $35.1 million ($29.8 million GAAP adjustment), as well as missing on the consensus estimate of $38.7 million. (All figures in US dollars except where noted otherwise.)

The margins provided mixed results for 4Front, as the reported gross margin of 45 per cent ($10.5 million adjusted gross profit) was a miss in relation to the 53 per cent ($14.3 million adjusted gross profit) estimate set out by Haywood. However, the adjusted EBITDA gave reason for optimism at $9 million for a 53 per cent year-over-year increase and a margin of 28 per cent, while beating the Haywood projection of $7.6 million and a 22 per cent margin, along with the consensus forecast of $8.3 million and a 21.3 per cent margin.

“Our business inflected during the first quarter of 2022 as a result of the investments and efficiencies we made over the last 18 months to meet our long-term strategic goals,” said Leo Gontmakher, Chief Executive Officer of 4Front Ventures in a May 23 press release. “We now have a fully-capitalized infrastructure in place to drive robust growth through this year and well into the future. Our thesis of providing consistent, low-cost production at scale continues to play out as designed, with the operational achievements from 2021 continuing to provide a solid foundation for the expected growth of our production and sales.”

After the end of the quarter, 4Front completed the acquisition of Island Cannabis Company, a California-based producer of pre-rolls, flower and concentrate products, to expand its reach in the Golden State, with management noting that it has successfully integrated Island into its production and distribution channels, according to Gilmer.

In addition, company management also announced that the first phase of its Matteson, Illinois expansion is expected to be completed ahead of schedule, with operations in the 250,000 square foot first phase expected to begin in the opening quarter of 2023.

With first quarter results now official, Gilmer has made slight revisions to his future financial projections for the company, lowering his GAAP revenue target from $143.2 million to $125.4 million for 2022 for a potential year-over-year increase of 19.9 per cent. Looking ahead to 2023, Gilmer lowered his GAAP revenue projection from $199.8 million to $182.6 million, suggesting a year-over-year increase of 45.6 per cent.

From a valuation standpoint, Gilmer forecasts the company’s EV/Revenue multiple to drop from the reported 4.9x in 2021 to a projected 4.1x in 2022, then to a forecasted 2.8x in 2023, which represents a premium compared to its fellow Tier 2 US operator peer group average of 1.5x.

The more noticeable changes to Gilmer’s forecasts come on the margins on account of how non-cash items are calculated. As a result, Gilmer lowered his adjusted gross margin forecast from 54 per cent ($71.1 million gross profit) to 48 per cent ($54.5 million) in 2022, and lowering that margin for 2023 from 55 per cent ($103.5 million) to a projected 50 per cent ($86.3 million).

Consequently, Gilmer raised his adjusted EBITDA margin forecast for 2022 from 23.8 per cent ($39.9 million in adjusted EBITDA) to 27 per cent ($40.5 million), which he maintains for 2023 ($57.9 million).

In terms of valuation, Gilmer projects the company’s EV/EBITDA multiple to drop from the reported 15x in 2021 to a projected 12.6x in 2022, then dropping to a projected 8.8x in 2023, which would be a premium on the Tier 2 US operator peer group average of 7.4x.

4Front Ventures has seen its stock price drop by 24.2 per cent since the start of 2022, having started the year at $1.24/share but staying relatively level since hitting a 2022 low of $0.79/share on January 28.