Village Farms: Now Is The Time To Invest

Village Farms: Now is The Time To Invest

Summary

Majority owner in PureSunfarms (PSF), a joint cannabis venture with Emerald Health
PSF presents itself as the low cost producer with all in costs below $0.65 CAD/gram(1)
Diversified with legacy produce business, both deemed as ‘essential products’ with the outbreak of COVID-19
A P/E of less than 12, and a forward P/E of less than 5

Background

Cannabis is not the first thing one would think of when they hear the name ‘Village Farms’. Prior to 2018, this company was known exclusively as a produce grower, specializing in the growing of tomatoes, cucumbers, and peppers, which has now become their legacy business. It’s the longest standing greenhouse produce company in Canada and the only one that is also vertically integrated and publicly traded. With over 30 years of experience and investment in greenhouse technology, growing is their forte, if they can grow vegetables at a low cost, why not cannabis?

Source: VillageFarms.com

Transitioning To Cannabis

When Village Farms embarked on their journey into cannabis in mid 2017, it was because they needed a higher margin product to sell. It is difficult to stay competitive as a produce company in North America when growing has slowly shifted to Mexico. In the search for a partner to team up with to grow cannabis, they chose Emerald Health. Together, the 50/50 jointly owned venture branded as ‘Pure Sunfarms’ was created. Essentially, the greenhouses used to grow the cannabis are provided by Village Farms, and the capital required to convert the grow space from produce to cannabis was provided by Emerald. Since 2018, Pure Sunfarms has been ramping up production in the D2, and now D3 greenhouses, both facilities of the magnitude of 1.1 million square feet with growing capacity of approximately 75,000 Kg a year in each for a combined 150,000 Kg, enough to meet demand within Canada(2).

Tug Of War With Partner Emerald Health

At the time of the partnership announcement, Emerald seemed like a good choice as a partner because it had the resources to execute on the drawn out plan. Both, in terms of finances, as well as in the research division of the company which played a role in forming the strains that Pure Sunfarms sells today. However, the cannabis industry has been hit by some tough times. Investor confidence is at all time lows in the sector, as many of the companies in the space that were once highly sought after are now at all time lows, including Emerald. In late 2019, Emerald missed their scheduled contribution to PSF, and chose to not be bound by a cannabis supply agreement from PSF in which it was obligated to buy 25% of production at a fixed price. As of early March, Village Farms announced that they came to a settlement agreement with Emerald, whereby they would acquire an additional 7.4% stake in Pure Sunfarms bringing their total ownership to 57.4%. The terms of the settlement were:

Pure Sunfarms will release Emerald from all liability arising from their supply agreement under which Emerald had the provision to purchase 40% of Pure Sunfarms' aggregate production in 2018 and 2019;
Emerald will transfer 2.5% of additional equity in Pure Sunfarms to Village Farms;
Pure Sunfarms and Emerald will release each other from their current supply agreement under which Emerald has the provision to purchase 25% of Pure Sunfarms' aggregate cannabis production from the Delta facilities in 2020, 2021 and 2022;
Emerald will forfeit and waive repayment by Pure Sunfarms of its outstanding C$13.0 million shareholder loan to Pure Sunfarms (plus accrued interest of C$1.1 million) and Emerald will issue a promissory note to Pure Sunfarms in the amount of C$952,237;
Upon closing of the transactions contemplated in the settlement agreement, including the treasury issuance of the New PSF Shares, Village Farms will own 57.4% of Pure Sunfarms, having made an extra equity contribution of C$8.0 million in 2020 (3),

How Does Village Farms Compare to Others?

Let’s start by getting into just how dire the current situation of the cannabis industry really is. In February 2020, Ello Capital compiled a list of 10 cannabis companies that have less than 12 months to live given the amount of cash on hand:

Green Growth Brands: 0.9 months
4Front Ventures: 1.1 months
Aurora Cannabis (NYSE:ACB): 2.3 months
Tilray: 3.7 months (TLRY)
The Green Organic Dutchman: 3.9 months
MedMen Enterprises (OTC:MMNFF): 6 months
HEXO (NYSE:HEXO): 6.5 months
Canopy Growth (NYSE:CGC): 7.7 months
Harvest Health & Recreation: 9.2 months
iAnthus Capital Holdings: 10 months

Source: The Motley Fool

Although these are estimates, several of the companies on this list are relatively large licensed producers, operating at a scale similar to if not bigger than Pure Sunfarms. These include HEXO, Tilray, Aurora Cannabis, and Canopy Growth. One thing common between all of these producers? None of them are profitable. There’s a simple reason why: Cost to produce. Unlike other licensed producers, Pure Sunfarms reports their growing costs as an ‘All In Sustaining Cost’, which is an industry leading C$0.63 (US$0.48) per gram, creating gross margins of almost 70% reported in Q3 2019. By comparison, the next lowest cost producer is Aphria Inc (NYSE:APHA) by Grizzle estimates, producing their cannabis for all in costs at around C$2 per gram(4). The result is high quality cannabis, priced at a level that resonates with consumers including some of the best THC levels given the price. This was evident in the recent PR put out by Village farms, informing shareholders of continued success.

Pure Sunfarms had two of the top four strains by dollars sold and kilograms sold (Afghan Kush and White Rhino)
Pure Sunfarms' Afghan Kush was the top strain by sales dollars and kilograms sold with the OCS
Increase in market share of PSF products from 13% to 13.5% for the first two months of 2020 on the OCS compared to the last three months of 2019 (5).

Source: Ocs.ca

Keep in mind that Pure Sunfarms was not first to the race, infact, it has only been selling higher margin cannabis at the recreational level since late September 2019, yet it has managed to gather over 13% market share in a matter of months, proving that being first has no advantages.

Recent Developments Indicate a Bright Future

Produce Developments

There’s a lot to be excited about, starting with recent developments in their legacy produce business. The produce business currently still accounts for a large part of Village’s revenue. In the Q3 earnings call, ceo Mike DeGiglio said this:

“We continue to make steady progress in a transition of production displays for cannabis and hemp production to third-party growing partners. This allows us to drive revenue higher, while maintaining cost and mitigating the agriculture risk that can negatively impact our produce results” (5).

“We have recently added 125 acres in this regard, 75 in Mexico and 50 in Canada, to bring our total partner acreage just under 300 acres. During this period of transition, we will continue to experience some impact on our financial results.” (5).

“So as much as I'm excited for the growth that will be driven by cannabis and CBD, I'm also thrilled for the potential of our legacy produce business.”

Once the transition is complete in the next two quarters, there is huge potential for the produce business to contribute positively to quarterly results.

Cannabis Developments

In the PR put out by Village Farms dated March 23rd 2020, Pure Sunfarms, has received approval from Health Canada to operate the final components of its 65,000 square foot, state-of-the-art processing center located within the 1.1 million square foot Delta 3 greenhouse facility.

“The significantly expanded processing area will enable Pure Sunfarms to generate additional production cost efficiencies, further elevate the quality of its products, expand its product offerings and increase its processing throughput.”

Health Canada's approval of the additional processing area permits Pure Sunfarms to begin the operation of:

11 additional drying rooms utilizing advanced drying technology and processes to further enhance the quality of Pure Sunfarms product;
5 additional packaging rooms;
2 additional testing areas;
6 additional storage areas; and,
7 extraction rooms with equipment capable of processing 35,000 kilograms of biomass annually (6).

Pure Sunfarms will be able to lower production costs even further, while stepping up the quality of their products. In house processing of biomass will reduce and possibly even eliminate having to rely on extraction companies, which will reduce costs. The additional drying rooms will enhance the quality of the product, as currently some consumers have reported that the PSF buds are too dry or lack in odor.

“The expanded processing center has been designed to satisfy full European Union GMP compliance and certification requirements, which Pure Sunfarms is currently pursuing.”

Pure Sunfarms is going after every competitive niche held by other producers, including soon the ability to steal market share from their international exports.

If you thought that C$7-$10 per gram of high quality, high THC cannabis was decent, now you can buy a whole ounce (28 grams) of cannabis for only 99$ plus taxes! That comes out to C$3.45 a gram plus taxes. Even the black market is going to have trouble competing with these prices. This development will hit other growers hard, especially those who are selling their low cost ounces at prices of C$5 per gram or higher with significantly lower margins than Pure Sunfarms (7):

Source: BCCannabis Store Website

Hemp & CBD Developments

Village is ready to go all out in the hemp and CBD space, just as it has in the cannabis space. In May of 2019, Village Farms put out the following announcement:

“Village Farms announces it has entered into an agreement with Arkansas Valley Hemp, LLC (“AV Hemp”) to form a joint venture for the outdoor cultivation of high-cannabidiol (CBD) hemp and CBD extraction in Colorado. The joint venture, Arkansas Valley Green and Gold Hemp LLC (“Arkansas Valley Green and Gold”), will be 60%-owned by Village Farms, 35%-owned by AV Hemp, and 5%-owned by Village Fields Hemp (Village Farms’ 65%- owned joint venture for hemp cultivation and CBD extraction in the U.S. states other than Colorado).

The CEO further added the following: “Village Farms is uniquely positioned for the significant opportunity in hemp-derived CBD. We are moving quickly to scale outdoor cultivation to complement our existing, state-of-the-art greenhouse operations in Texas and further strengthen the foundation for our national, vertically integrated, consumer packaged strategy for hemp-derived CBD.” (8)

Source: VillageFarms.com

As seen above, the roadmap for Village farms in 2020 indicates huge developments in the production and sale of hemp derived CBD, as well as hemp biomass, which could potentially add tens of millions in revenue beyond 2020. Village Farms’ 5.7 million square foot greenhouse facility in Texas ready for production, of which 1.3 million square feet has already been converted into a space to grow high quality hemp:

“We believe a significant proportion of the market for CBD, such as that for the high-end health and wellness products and the pharmaceutical industry will demand premium-grade product derived from hemp that is grown sustainably and to the highest standards and exacting specifications.” (9).

Unlocking The Value Offered By Village Farms

A look at the last one year of the share price action paints a bleak picture that the company is headed for bankruptcy, however the reality couldn’t be further from it. Management has been consistently executing on their objectives outlined in each quarter thus far. Village farms is one of a handful of companies in the cannabis space that actually has a positive price to earnings ratio currently at 11.28 at the time of this writing. For a company in a high growth industry, that is very very low.

A recent share offering at C$3.20 per share for total proceeds of C$10.0 million was also conducted. A lot of investors could easily view this as a negative. However there are few reasons why the raise is significant despite the low price (10).

The truth is that only good companies with relatively strong balance sheets have access to capital in current environments such as a COVID-19 outbreak
The offering has put a floor on the share price and short term down-side will be limited
Balance sheet is strengthened, and as indicated by management, the funds could be used to acquire an even larger percentage of Pure Sunfarms

A low total share float of under 60 million shares with the management team owning close to 20% shows that management believes strongly in their company and are itching to unlock the true potential. Several analysts have given Village farms an outperform rating, including Raymond James and GMP, and have issued price targets ranging from C$15 to C$30 and even higher (11). Within the current environment with COVID-19 taking up all the headlines, and potentially a recession on the horizon, sales of marijuana, have doubled week over week at the OCS following the call by Ontario to shut down all non essential services. All of the products sold by village at the retail level are essentials, and are quickly flying off the shelves. If a recession does present itself, similar to alcohol, marijuana has shown to be a recession proof industry, and in short Village Farms will weather the storm just fine under such conditions, as cannabis and produce are always going to be essential products that people will buy.

Conclusion

2020 will be a significant year for Pure Sunfarms, and Village Farms. With a market capitalization of C$200 million, there’s plenty of room for upside, given that the stock is currently priced right around book value, with a forward P/E of less than 5. At a current price of C$4, the stock is a steal and has room to grow upward of 300% or more from current levels within the next 18 months (assuming a forward P/E of 16).

Disclaimer

The thoughts and opinions expressed in this article are my own, and are not financial advice. Please do your own research and due diligence when making investment decisions.

About The Author

I am an electrical engineering graduate from Carleton University, and have always had a keen interest in investing. I have been following events as they unfold in the cannabis space in Canada since 2017 and have always had the opinion that decriminalization is the way to go as it reduces drug related crime and can be monetized as a source of tax revenue for the government. My goal is to help people who invest in a risky space like cannabis understand what to look for, as the amount of information available is often overwhelming for new investors. Aside from that, there are several companies all competing with each other to get your investment dollars!

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