Shares of Village Farms International, Inc. (Nasdaq: VFF) took a wild ride this week after a report surfaced that the company could take full ownership of its Pure Sunfarms joint venture.
On Tuesday, Raymond James analysts said in a note if Village Farms entirely owned the joint venture, the company could hit their target of 20 per cent market share of the Canadian cannabis space, which could drive its share price up to US$27.
Currently, Vancouver-based Village Farms owns 58.7 per cent of Pure Sunfarms, with Emerald Health Therapeutics Inc. (TSX-V: EMH) owning the remaining stake.
The news sent Village Farms shares up 15 per cent Tuesday to as high as US$5.73 on the Nasdaq. And while half those gains have since been wiped out, Raymond James sees long-term upside once the market figures out the real value of the company.
$VFF Raymond James out positive sees $17-$27 or 4-5x Upside
VFF management will be additionally motivated to hit their target of 20% market share in the Canadian cannabis space, which would drive a hypothetical share price of $27.00
— Nathan Michaud (@InvestorsLive) August 25, 2020
According to analysts Rahul Sarugaser and Michael Freeman, Village Farms’ valuation is currently misunderstood because the veteran vegetable grower doesn’t yet consolidate its cannabis revenues from Pure Sunfarms. They say this skews the value of the stock because its current share price of around US$5 is based off a multiple of revenues — “an unfair measure.”
Instead, the analysts say Village Farms’ value should be based on its earnings before interest, taxes, depreciation and amortization, over the “hollow” metric of top-line revenue.
And once investors calculate the value of Village Farms based on EBITDA, Raymond James predicts company shares would reach a price between US$12–22.
“This supports our [current] target price of US$14, providing us further confidence in our target, and maintaining our rating at ‘outperform,'” the analysts wrote.
Last week, Raymond James reviewed Village Farms’ second quarter earnings, where the company reported its seventh straight quarter of positive EBITDA: a record for the Canadian cannabis industry.
Despite the milestone, shares have dropped as much as 19.5 per cent since the earnings report was released on Aug. 12. But the analysts say that decline doesn’t make sense as they feel Village Farms is “best-in-class in the Canadian cannabis sector,” ahead of industry bellwethers like Aphria, Inc. (TSX: APHA), which has seen shares rise 3.3 per cent since last reporting its next-best record of five consecutive EBITDA-positive quarters.
And if Village Farms captures 100 per cent ownership of Pure Sunfarms, the analysts see a further share upside at US$17–27. They note that this is a likely scenario because Village Farms’ business partner Emerald Health had under $1 million cash left on its balance sheet in its last reported quarter, offsetting its debt by issuing more shares.
“As we see it, [Village Farms’] acquisition of [Pure Sunfarms] is just a matter of time,” they wrote.
Low production costs, international expansion boosts Village Farms’ opportunities
If Village Farms’ management team does take over the helm of Pure Sunfarms, Raymond James analysts say the company could further take advantage of its sparkling production efficiency.
In a separate note related to Village Farms’ second quarter results, the analysts highlighted Pure Sunfarms’ industry leading all-in cost of production of $0.84 a gram. The next most efficient is Organigram Holdings, Inc. (Nasdaq: OGI) at about $0.98 a gram.
Pure Sunfarms’ production efficiency allows it to offer the lowest price in the bulk value segment at $4.20 a gram — no kidding — on the Ontario Cannabis Store. Raymond James notes this gives Village Farms a big opportunity to go deeper in the low-cost segment across Canada. It already captures 14 per cent of the dried flower market in Ontario.
The analysts also see larger opportunities internationally.
Firstly, they note the firm has plenty of resources standing ready in the U.S. to pounce on should the federal government legalize. With joint ventures in Arkansas and Texas, Village Farms has millions of square-feet of cost-effective greenhouse ready to initiate production, with some already converting to hemp.
But in the last several weeks, Village Farms has begun looking beyond Canada and the U.S.
Raymond James says the company’s strategic investments in Altum International for the Asia-Pacific region and DutchCanGrow in the Netherlands could be a catalyst for long-term revenue growth.
“VFF management made the interesting comment that its effort to expand its international reach may involve the conversion of its VFF-owned 2.6-million square-foot Delta-1 greenhouse to ‘higher value products for export,'” the analysts wrote.
Village Farms expands into 2.0 market
Back in Canada, Village Farms is eyeing the sale of value-add cannabis 2.0 products.
On Tuesday, it began shipping Pure Sunfarms vapes and CBD oil into B.C. with shipments to Ontario and Alberta planned to follow.
Village Farms says it’s looking to build off its commanding position and growing brand reputation in the dried flower market with its 2.0 strategy, by offering “high-quality products that consumers want at an attractive price.”
Village Farms CEO Michael DeGiglio says having the lowest production costs in Canada, gives Pure Sunfarms a significant pricing advantage in the 2.0 market. He expects to be the number-one or number-two brand in every product category the company enters.
“The addition of these high value products is expected to enhance Pure Sunfarms’ already very healthy gross margin going forward, especially when the company begins its own extraction operations, which are ready for start up and subject only to Health Canada licensing, expected in the months ahead,” he said in a statement.
For Raymond James, Village Farms is ripe with opportunities compared to its increasing number of struggling peers.
However, the analysts warn it’s still early days for the industry and investing in pot stocks comes with risks like marketing restrictions, price fluctuations, as well as frequent regulatory and legal changes across different jurisdictions.
“We view Village Farms as a high risk investment based on the volatility and risks inherent in the early cannabis market, as well as its exposure to risks inherent in the agricultural business,” they wrote.
Top image via Pure Sunfarms