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Steer clear of Aleafia Health, says Raymond James

Raymond James analyst Rahul Sarugaser appears to have lost confidence in Canadian cannabis name Aleafia Health (Aleafia Health Stock Quote, Charts, News, Analysts, Financials TSX:AH), switching in a Tuesday client note from a “Market Perform” rating to “Underperform,” while dropping his target from $0.30 to $0.10.

Aleafia Health is an Ontario-based cannabis LP for the medical and adult-use markets and is the largest provider of cannabis health services in Canada, acting as exclusive partner for insurance-reimbursed medical cannabis with some of Canada’s largest unions and employers. 

Last week, the company announced a restatement of its quarterly results for the period ended March 31, 2022, which Aleafia is now calling its year-end, thus making the quarterly results its Q5 for 2022. For the fiscal year, the company said it posted a branded cannabis net revenue increase of 151 per cent year-over-year to $47.5 million for the fiscal year, while for the quarter, revenue was $10.7 million compared to $7.5 million a year earlier. Adjusted EBITDA for the quarter was negative $4.4 million compared to negative $3.0 million a year earlier.

In the press release, management described Aleafia’s evolution from wholesale LP to a branded cannabis producer, one which it said has increased its average net realized price per gram and delivered a higher gross profit margin. Aleafia said it’s now positioned to be a top-ten licensed producer in Canada, with its market share position having gone from 28th at the first quarter of 2021 to now 13th by the end of March.

“There are four strategic objectives that once accomplished we believe will drive Aleafia Health forward to a successful future,” said CEO Tricia Symmes in the June 28 press release. “Portfolio optimization has improved adult-use margins. We are leveraging our outdoor grow facility, one of the largest and most successful in Canada, and two indoor facilities, to build a consistent and growing supply of high-quality usable flower. This diverse grow supply and nimble, agile team can redirect flower to the highest margin sales channel, whether that be adult-use, medical or international, sets us apart from our peers.”

Commenting on the news, Sarugaser said the $7.0 million Q5 topline was a miss from the consensus call of $9.35 million, while the adjusted EBITDA loss of $4.4 million was also a miss of the Street’s negative $3.7 million. Sarugaser noted Aleafia’s cash of $11.2 million and debit of $53.5 million at the quarter’s end.

Sarugaser had some questions about Aleafia’s new approach.

“With AH’s strategic shift toward prioritizing adult-use sales — we have trouble seeing how AH will muster the competitive capacity to gain relevant (>5 per cent) market share — and away from capitalizing on the potential of its union contracts’ sticky, high-margin medical cannabis revenue, AH’s key differentiating trait within the Canadian cannabis sector, in our view, combined with the (highly-likely) significant dilution from its much-needed revised convertible debt, we adjust our thesis on AH and cut our target to $0.10/share and rating to Underperform,” Sarugaser wrote.

Aleafia recently announced a $5.6 million private placement along with the completion of its debt amendment whereby the company revised its $39.4 million in convertible debt into three tranches, all at 8.5 per cent and maturing in June 2024, 2026 and 2028 with conversion prices of $0.25, $0.35 and $0.45, respectively.

Aleafia said the two moves increase its liquidity by up to $11.6 million, improve cash flow and increase the company’s financial flexibility. 

On the closing of the debt amendment, Symmes said in a press release, “Coupled with the closing of the $5.6 million private placement announced last week, the Company is now much better positioned to execute on its ambitious growth plans in all key segments of its business: adult-use, medical and international.”

Again, Sarugaser was less than optimistic, saying, “Our EBITDA calculations here imply that AH will not be in a position to repay its revised debt on schedule, so we calculate the issuance of 143.9 million additional shares by way of conversion, for a fully diluted share count of 545.3 million, representing 36 per cent dilution.”

The analyst has revised his projections for Aleafia and is now calling for fiscal 2023 revenue and adjusted EBITDA of $40.3 million and negative $9.8 million, respectively, and for fiscal 2024 revenue and EBITDA of $59.5 million and $0.9 million, respectively. Sarugaser said his valuation stems from a blended 2022 and 2023 EV/Revenue multiple of 1.5x and 1.2x respectively with a sanity check against a discounted cash flow analysis of ten per cent with a two per cent terminal.

The entire cannabis space has been faring poorly over the past year-and-a-half and that’s also been the case for Aleafia, whose share price went from a very brief high of $1.27 per share last February to $0.135 by the end of 2021. So far in 2022, the stock is down a further 48 per cent and is trading around $0.075 per share.

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