Located in British Columbia’s wine region, Valens GroWorks Corp. (TSXV:VGW)(OTC:VGWCF) has quietly grown into the world’s largest third-party cannabis processor. And in the last couple quarters, the Kelowna, B.C.-based company has seen a significant ramp up in volumes as the industry prepares for next-generation products like vape pens and edibles to hit the Canadian market by the end of the year.
With the capacity of turning up to 425,000 kilograms of dried cannabis into concentrates on an annual basis, Valens has locked up the most extraction contracts with Canada’s top-10 licensed producers. But with excitement growing for the new product formats that offer higher margins, the company has secured a number of white-label deals, and it’s currently expanding it’s home base facility to have a yearly capacity of more than a million kilograms.
“From a capacity and diversity standpoint, we’re the largest third-party cannabis extraction company that’s publicly traded in the world and we’re the largest one in Canada,” said Everett Knight, Valens’ executive vice president of strategy and investments, in a phone interview with Mugglehead. “But I think the big thing about us that’s different from everybody else, is we have some of the best contracts in the space.”
The company has already inked multi-year extraction deals with Canopy Growth (TSX:WEED), The Green Organic Dutchman (TSX:TGOD), Sundial Growers (NASDAQ:SNDL), Hexo Corp. (TSX:HEXO), and Tilray (NASDAQ:TLRY), which it expanded in June from a minimum annual quantity of 15,000 kilograms to 60,000 kilograms.
“The reason LPs come to us, is because we have the highest quality,” Knight said. “And if you look at our overall recovery rates being higher, we actually are more economical choice anyways.”
Around six years ago, when Knight helped launch Canada’s first institutional cannabis fund at investment firm Matco Financial Inc., he did a deep dive into more than 1,200 pot companies and toured over 85 facilities worldwide. The University of Calgary business graduate said just like how big beer companies don’t grow their own hops, the money in the cannabis space is really is going to be in the formulating the extractions.
Then Knight stumbled upon Valens GroWorks in 2017, and the company’s focus on quality instantly caught his eye.
“I was blown away by their proprietary technology and proprietary knowledge in extraction and how far ahead they were in Canada and the U.S.,” he said. “I ended up becoming their largest institutional investor and I almost joined the board, but I ended up actually joining the company because I thought it was such a great opportunity.”
Valens GroWorks built for Cannabis 2.0
Not only is Valens a leader in capacity, but it’s the only Canadian firm to build a platform with five separate cannabis extraction lines — CO2, ethanol, hydrocarbon, solvent-less and terpene. And Knight says the wide range of options allows the company to make any end product for its clients.
“We can literally customize any service our customers want and because of that we have the ability to provide higher product development capabilities than any of our competitors,” he said.
With the second phase of legalization coming to Canada Oct. 17, the demand for Valens’ proprietary technology is growing as pot producers aim to stock store shelves with cannabis derivative products by mid-December.
Knight said Health Canada’s regulations for the next generation items like pot-laced edibles are so onerous “you could really drive a Mack truck through them.”
After talking to provincial retailers, the veteran cannabis investor said it will be more likely to see the value-add products by late-January.
However, Knight said white-label deals have been pouring in so fast that by spring 2020 they will far exceed the company’s industry-leading extraction contacts.
Last month, Valens secured a deal with Shoppers Drug Mart, Canada’s largest pharmacy chain, with cannabis-based gel caps, tinctures, vape cartridges and topicals for medical patients. Shoppers operates over 1,300 stores nationwide and is the only pharmacy chain with a medical cannabis sales licence.
The company also entered a five-year white-label contract in September with Toronto-based Iconic Brewing for infused beverages. The companies say a minimum of 2.5 million THC and CBD infused beverages will be produced in those five years.
“I think people underestimate the beverage market. Currently in the United States the reason it’s not doing well is because you don’t have the right technology and you don’t have the right capital invested into it,” Knight said.
“But I think it’s an area in Canada where everyone is going to be like, ‘holy crap, this is a bigger segment of the industry than I thought.'”
Valens brought in SōRSE, a U.S.-based water-soluble emulsion technology company, to help develop pot-infused drinks with a clean taste without the funky cannabis odour, while offering precise dosing, and faster onset and offset times.
“I think it’s going to be a game changer because to be able to compete with the black market you need these products on the shelf,” he said.
Cannabis researchers at Deloitte estimate the market for alternative weed products in Canada will be worth $2.7 billion.
The initial rollout of marijuana legalization in Canada was marred with supply shortages and a slow physical retail rollout. But Knight says more stores are opening their doors and legal, high-quality vape-pens and other product formulations, that pot producers are spending millions to develop, will attract millions of new customers.
Vaping illness outbreak presents opportunity for Valens
Knight said the company is set to be the largest third-party vape pen manufacturer for a lot of premier cannabis companies in the space as legalization 2.0 moves forward.
The company is getting a machine that will pump out 40 to 50 vape cartridges per minute with processed cannabis oil.
Vape pens represent in some U.S. states with mature legal markets account for around a quarter of sales. But the ongoing vaping health concerns has scared away sales and led to concerned investors and pot companies.
But there appears to be a widespread consensus that the vaping health crisis is tied to THC-containing vape products from the black market that contain dangerous additives and chemicals.
According to a recent Globe and Mail report, Valens GroWorks tests its cannabis product when it first comes in, during extraction, during the blending, and just before the finished product goes out.
“Trust is built in years and lost in seconds,” said Valens CEO Tyler Robson.
Valens has invested “well over a million dollars” in five pieces of equipment to test for heavy metals, residual solvents, microbes, mycotoxins and it purchased a $500,000 machine that screens for pesticides.
Black market vape cartridges have been taken to testing labs which often came back positive for myclobutanil, a fungicide that transforms into hydrogen cyanide when heated.
The company said the actual testing process is relatively cheap and fast, as it can get results anywhere from 20 minutes to three days, depending on the exact test. Whereas the average industry waiting time currently sits at three weeks. It also provides third-party testing services for other companies
Quality is key for cannabis branding
Because Valens dedicates ample resources to ensure quality, Knight says feedback from Canadian producers has been positive.
“On average, across the spectrum, our customers have told us they are blown away with the quality … and their products are flying off the shelves,” said Knight.
The company has been working every day to refine its proprietary process since 2012, and the Valens’ team has over 100 years of cannabis extraction experience combined, according to Knight.
The company was the first in Canada to receive organic certification for cannabis oil production, and it’s the first to be ISO 17025 accredited, which is one of the highest industry standards for laboratory testing and competence. Also, Valens was named the “Centre of Excellence in Plant-Based Science” by Thermo Fisher Scientific, a $100 billion market cap scientific instruments company.
Knight says quality is key especially with the Canadian federal government’s strict rules on marketing and packaging, which include warning labels similar to tobacco products “like you are going to die.”
“In Canada, what branding really comes down to is product quality, so what we’re really proud of and try to give the best product quality to our customers and that’s what we think about every day,” he said.
Some investors are cautious of cannabis stocks with a primary focus on extraction, as major pot producers start to build out their own processing facilities. But Knight said not every company is going to invest $40 million in over 25 pieces of extraction equipment and the century of experience, and five extraction methods separates Valens as an option of choice for years ahead.
“We had to build a bomb proof room, put in fire suppression and reinforced concrete,” he said.
Company eyes Europe, international markets
After building the world’s largest third-party extraction company that services the Canadian industry the next logical step for Valens is to tap overseas markets, Knight said.
“We are so much farther ahead with our proprietary technology in Canada and what we want to do is copy and paste it abroad,” he said.
The company has expansion plans to make a stake in the burgeoning U.S. market for CBD, access cheaper cannabis cultivation in South America, ship to Australia, and to enter the medical cannabis markets inside the European Union.
In August, Valens opened an office in Toronto — Canada’s business capital — to help the company “realize a number of international opportunities,” according to the CEO.
From a population standpoint, tapping the European market where there’s 700 million people is huge when you compare it to Canada’s population of 36 million, Knight adds.
“With our international strategy we are going to have boots on the ground in months,” Knight said. “And I think you could even see revenue line items on our balance sheet next year coming from international marketplaces.”
But to get inside the continent, Valens has been working for more than a year to get Good Manufacturing Practices (GMP) certification from the E.U. — the highest and hardest level of GMP certification that exists.
Knight said it is targeting getting the E.U. GMP stamp of approval in the next six months and its a big deal for the company.
Only seven Canadian pot firms have been E.U. GMP certified, and no extraction companies as the process is tedious. Every part of each of piece of equipment — including all incoming items — has to be validated at the highest degree.
“To give an example, we had to take out nickel plating in one of our extraction cylinders because you can’t actually have that for E.U. GMP certification,” said Knight.
The company is well-funded for expansion with $61.8 million in cash on its books, as of October.
Different extraction methods require different mill sizes for optimal results. At Valens, we provide strict details on how to prep your product for extraction so you can get the most out of your plant matter. Every milligram of output counts. #valens #extraction pic.twitter.com/aBdULlxJ8I
— The Valens Company (@TheValensCo) October 9, 2019
Company moving forward
Despite the black cloud hanging over the cannabis sector this year, Knight is still seeing green in the years ahead.
“We’re really in the second inning of a long-term growth industry,” he said.
Valens is one of the rare companies in the nascent pot sector to post a positive adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $2 million in the second quarter.
Knight understands that investors are losing patience with pot firms posting massive losses, and he not only expects the company will keep up the positive EBITDA, but also post a net income in the coming quarters.
“We want to be profitable and we want to live within our means and we want to be the largest cannabis extraction company in the world.”
Valens announced last month revenue guidance for the recently completed third quarter ended Aug. 31 to a tune of $16 million to $17 million — which nearly doubles Q2 revenues of $8.8 million, and blows the first quarter $2.2 million out of the water.
The company also estimated its extraction volume will reach 26,000 kilograms in the third quarter, which has been growing almost exponentially as Cannabis 2.0 contracts have been piling up. In the second quarter volume was at 8,547 kilograms and the first quarter it poured 1,796 kilograms of cannabis oil.
“We continue to see a significant ramp up in volumes month over month with August seeing almost 50% of the volumes in the third quarter,” said Jeffrey Fallows, Valens president. “That pace has continued to accelerate into September as we look to fill our existing capacity on a run-rate basis in the next 6 months.”
Because of the ongoing growth, some analysts believe Valens’ share price has a lot more room to run.
GMP Securities analyst Ryan Macdonell said Valens is an under appreciated stock with one of the lowest valuations in the cannabis space.
“At a mere 4.7x our CY20 EBITDA forecast, Valens holds one of the lowest multiples in our coverage universe compared to an average of 7x for the extractors and 13x for the traditional LPs,” writes Macdonell.
The analyst has set a $10 price target on the stock with a “Buy” rating, which represents a 248 per cent return at the time of publication.
Valens share price — which sits at $2.87 as of Oct. 10 — has surged 82 per cent since the start of the year, as other pot stocks have been hammered in that span.
For long-time pot investor Knight, however, it’s still a long game.
“I think that we’re so under-supplied in the extraction space that I think that people still underestimate how big that market is going to be for all of us,” he said.