Fire & Flower loses Buy-equivalent rating with ATB Capital

A new financing round looks to be a good move for Canadian cannabis retailer Fire & Flower (Fire & Flower Stock Quote, Charts, News, Analysts, Financials TSX:FAF), but the resulting share dilution is cause for a reconsideration on the stock, according to ATB Capital Markets analyst Frederico Gomes, who reported on the company on Tuesday and moved his rating from “Outperform” to “Sector Perform.”

Toronto-based Fire & Flower announced on Tuesday an agreement with strategic investor Alimentation Couche-Tard (ACT) for a $5.0 million private placement, an $11.0 million loan and certain amendments to the Series C warrants held by ACT. 

“These financings with our strategic partner, Alimentation Couche-Tard, provide Fire & Flower with access to capital on favourable terms and demonstrate continued strategic alignment between the two companies as we continue to execute our technology-enabled retail strategy,” said Stéphane Trudel, Chief Executive Officer of Fire & Flower, in a press release.

“The Company will prudently use this capital to continue to grow the business and build upon the recent success we have seen through improvements in our retail, wholesale and logistics, and digital business segments,” he said.

FAF, which last week announced the resignation of its CFO, Judy Adam, is a cannabis retailer with over 90 stores across Canada, with further, related business in cannabis analytics through its Hifyre platform. The company recently opened its first Spark Perks store in Brampton, a convenience-store model for cannabis retail, with the store adjacent to an existing ACT Circle K store.

Like the rest of the pot sector, FAF’s stock has fallen a long way over the past year-and-a-half, going from a high of $14.50 in mid-February, 2021, and over a gradual decline to now just below the $2 mark. 

Gomes is predicting upside from there over the next 12 months but he is less positive at the moment on the risk-reward of buying FAF. Gomes dropped his target price from $4.50 previously to now $2.80 per share, which at the time of publication represented a projected one-year return of 46 per cent.

“We believe the private placement and loan will immediately strengthen FAF’s capital position, and the proposed amendments increase the certainty that ACT will exercise the warrants. However, the amendments also reduce the warrants’ exercise price, thus having a (material) dilutive impact to shareholders,” Gomes wrote.

“We have reduced our price target to $2.80 to account for this dilutive impact, a higher discount rate (on higher risk-free rates), and slightly lower growth estimates. We have downgraded the stock to Sector Perform due to a less attractive risk-reward implied by our lower price target, in line with the peer group,” he said.

Gomes said FAF ended its most recently reported quarter with cash of $18.6 million and he estimated the resulting Q4 2022 pro-forma cash balance at $25.2 million.

Fire & Flower announced its second quarter 2022 financials (ended July 31) in mid-September, coming in with revenue of $40.7 million compared to $43.3 million a year earlier and an adjusted EBITDA loss of $6.0 million compared to positive $3.1 million a year earlier. 

Looking to the fiscal Q3, Gomes thinks FAF will generate $41.4 million in revenue and negative $7.3 million in EBITDA and moving to Q4 revenue and EBITDA of $32.1 million and negative $4.0 million, respectively. The result is a fiscal 2022 full year revenue and EBITDA of $155.2 million and negative $19.6 million, respectively, compared to $175.5 million and positive $5.1 million, respectively, for 2021. Onto 2023, Gomes is calling for revenue and EBITDA of $197.3 million and negative $9.8 million, respectively.

On the opening of its first Spark Perks store, Trudel said the convenience-based model is a major step change for the cannabis industry and it gives FAF and Circle K a competitive advantage.

“Fire & Flower anticipates reaching a total of ten Circle K co-located stores operating using its technology and brands within the next twelve months. The opening of this store in the GTA demonstrates our progress towards this goal and builds upon the two pilot stores that are already open and operating in Alberta,” Trudel said in a press release.