Village Farms Is Deep Value (NASDAQ:VFF)
Village Farms ( NASDAQ:VFF ) traded near a multi-year low this past week at a deep discount to its tangible book value, even at Monday’s close of $1.68, up 25.4% YTD. It priced an offering of 18.35 million share units on Thursday morning that briefly dropped the stock below $0.90 in the premarket. I held a small amount in my Beat the Global Cannabis Stock Index model portfolio and more than doubled the position size to what is now, after a small rally, 10% of the model portfolio. In this piece, I discuss the company’s operations and its finances and explain why I like the stock so much.
In 2014, I started closely following the Canadian marijuana industry. Village Farms was quite late to the game, announcing its entry into cannabis in June 2017. I didn’t really like their plan at first because they partnered with a company that I did. t cares for, Emerald Health Care, which is no longer a publicly traded stock after it merged with Skye Bioscience (OTCQB: SKYE ), formerly Nemus Biosciences and then Emerald Bioscience. Skye CEO Punit Dhillon is the cousin of Avtar Dhillon, who was the founder and CEO of Emerald Health Care until he was later arrested and then convicted of violating securities laws.
The plan that Village Farms announced made little sense to me. Village Farms aimed to be a very large greenhouse grower of marijuana, an area where Emerald Health Care had no experience. The goal was to be a low-cost producer in the country that moved from a medical market to full adult use. In my opinion, Village Farms chose a poor partner. Yet they have done very well in cannabis. In the first three quarters of 2022, they generated $82 million in sales of cannabis in Canada, up 18% from the first three quarters of 2021. The company operates Pure Sunfarms in 2 facilities in British Columbia, and it owns 70% of Quebec- based ROSE LifeScience. It now reports about 8% market share in Canada. The company owns 85% of Leli Holland, one of 10 companies with a Dutch Cannabis Supply Experiment production license, and it owns 12% of Altum International Hong Kong and Australia. In January, it began exporting to Israel from Canada.
I’m not a fan of the company’s other businesses. The company was originally a product company, and the majority of its revenue is generated by this unit. That business is not profitable, even at the gross margin level. It has two other segments including the tiny Energy and also “Cannabis – United States”, which is CBD. I think there are a lot of investors who like the company’s ownership of product assets in Texas that could theoretically be converted to THC production, but I don’t think that’s likely in the near term since the governor of Texas is so anti-cannabis .
You can learn more about the company in this presentation they published this month:
Village Farms has decent finances in my opinion. The company generates slightly negative adjusted EBITDA but does not have a lot of debt. It used cash to fund its operations in 2022. In the first three quarters, it used $13.2 million, which was an improvement from the $21.1 million it used in the first three quarters of 2021. It invested $12.9 million in purchases of property, plant and equipment, down from $15.1 million in the first three quarters of 2021. At the end of Q3, the company had $43.8 million in net debt, primarily in 2024 and 2025 are due.
The company generated total sales of $224.1 million in the first three quarters of 2022, up 15% from 2021. Canadian marijuana sales represented more than 36% of revenue year-to-date and were 43% of the quarter’s revenue at $30.4 million. Adjusted EBITDA for the year was -$18.4 million. In the third quarter, adjusted EBITDA was -$2.2 million, with products at -$4.9 million, but Canadian cannabis at $5.4 million. The company shifted its business in Canadian marijuana from wholesale flowers and trimmings to retail, which accounted for 81% of marijuana revenue in the third quarter, compared to 59% a year ago. I would like to see its derivative business do better, as it fell from 7% a year ago to just 4% in the third quarter.
The company issued a prospectus, so investors should not have been blindsided by a capital increase. Yet the sacrifice was atrocious! They priced the deal with warrants at $1.35, up $0.01 from its year-end 2022 closing price and down more than 10% from its previous close the previous day. From the $1.68 close on 1/23, the stock was priced nearly 20% lower. The $1.65 warrants expiring in 5 years were worth about $0.47-$0.57 at 40-50% volatility. The fall in the price of the share after the pricing was almost as much as the value of the warrants that were issued.
One of the reasons I included VFF in my model portfolio I set up at the end of the year was that its market cap at the time was only 0.6X tangible book value. While the company lowered tangible book value per share with this offering, the large drop in price leaves it at just 0.43X tangible book value. I think that the stock should trade at or above tangible book value, although there are some other major Canadian LPs currently trading below tangible book value.
Analysts forecast revenue to be $294 million in 2022, up more than 9%. They predict that overall revenue will increase by 12% to $330 million in 2023 and then by 9% in 2024 to $359 million. Adjusted EBITDA is expected to be -$20 million in 2022, ending years of profitability, but it is expected to recover to $10 million in 2023 and $27 million in 2024.
As I look toward year-end, I expect the Village Farms enterprise value to trade at 8X adjusted EBITDA projected for 2024, which will be $216 million. Adjusted for the cash and debt, that works out to $1.58, less than the warrant exercise price but up 61%. I think my valuation outlook may be conservative. 10X will convert the warrants and yield a price of $1.94, almost doubling the price.
In my opinion, the company’s production unit is worth more than zero, but it does not resonate with investors. I think the company needs to spin it out, but it doesn’t seem to be on management’s agenda. The Canadian LP business is worth more than the total market cap of $107 million in my opinion, which is less than 1X annual federal legal cannabis sales in Canada. The stock is very cheap.
Village Farms traded at $1.40 when the entry into cannabis was announced, and now trades under $1 more than 5 years later:
The price set a new low on the financing, as a record number of shares traded on the day of the pricing (with a high number also the following day). This price is more than 95% lower than two years ago. It’s possible that the buyers sold the stock just to keep the warrants, but it’s more likely that investors just concluded that the sale was very bad for the company’s momentum, with outstanding shares rising 20% has after a sale below tangible book value.
I believe that the company’s financial health was good and is now better, and the stock should recover to fill the entire gap. A return to its previous multi-year low would offer more than 20% upside, but a full gap would push it up 48% to $1.45, which is still very cheap in my opinion. A short-term chart shows the action more clearly:
I think that Village Farms is very cheap. I thought so before the presentation, but I reduced my position size in my model portfolio. I see both fundamental and technical reasons to own it in size. The New Cannabis Ventures Global Cannabis Stock Index, which is up 7% so far in 2023, includes Village Farms, which is only 2.7% of the index after the decline. I currently invest 10% of my model portfolio in this stock, and I think it can recover a lot of its recent losses and 2022 losses as well.
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