INCR - InterCure: Highlighting A Profitable Israeli Cannabis Operator

Summary

• InterCure is the leading cannabis operator in Israel.
• Israel is currently a medical market, with recreational legalization expected to occur over the coming years.
• An astonishing 27% of adults in Israel use cannabis - far higher than in any other country.
• InterCure is profitable and growing rapidly - the stock is a worthy addition to add diversification to a cannabis portfolio.

InterCure ( INCR ) is an Israeli cannabis company whose stock is listed on the Nasdaq exchange. Despite the major exchange listing, INCR hasn't seen its stock bid up to the same multiples seen at Canadian peers. This is surprising considering that the company is profitable, with Israel being a uniquely attractive market for cannabis. INCR may also benefit from legalization of recreational sales in Israel - offering investors a way to diversify their cannabis portfolio without sacrificing on risk or reward.

(Note: all currency is in Canadian dollars, unless otherwise noted)

INCR Stock Price

INCR came public in the U.S. markets via a SPAC merger at a price of $10 per share. The stock is now trading around $4.70 per share.

While INCR is already uplisted to the Nasdaq exchanges, that distinction has not noticeably benefited the company, as the stock trades at discounted valuations in spite of being profitable. With MSOs trading where they are, it is OK to be patient before adding new names to the portfolio.

What Is InterCure?

INCR is the leading cannabis operator in Israel, with approximately 30% share of the medical market. We can see a snapshot below:

Cannabis investors typically focus on the US or Canadian market, but rarely the Israeli market. That is a shame, because Israel is surprisingly a strong growth market for cannabis. The medical market has been growing rapidly and is expected to continue its rapid growth over the coming years.

The illicit market is estimated to be $1.7 billion, greatly outpacing the roughly $300 million legal medical market. It is interesting to note that 27% of Israeli adults use cannabis - the highest of any country in the world.

From my discussions with Israeli friends, this appears to be due to smoking being a crucial part of Israeli culture. When Israel legalizes recreational sales, the potential growth may be even greater than that of the United States due to the greater addressable market.

INCR sells cannabis in Israel via its subsidiary Canndoc. If you are investing in Canadian names, you may have seen many announcements of Canadian operators exporting medical cannabis to Israel. Those deals are for real: for whatever reason, Israeli cannabis operators tend to import much of their product. Apparently, it isn't easy to grow high-quality product in Israel (and European countries have much stricter standards than the United States).

These partnerships included import arrangements with Canadian operators Tilray ( TLRY ) and OrganiGram ( OGI ), as well as a licensing partnership with Cookies. INCR now has 4 Cookies retail-branded dispensaries.

Candoc sells across 100% of the authorized pharmacies in Israel, and also owns a handful of retail locations of its own.

One of the retail locations is located in the high-traffic Tel Aviv, which has seen rapid growth and sells over 100 kg of cannabis monthly.

Interesting to note is that Chairman Ehud Barak was a former prime minister of Israel.

InterCure Financials

I wouldn't be highlighting a non-US cannabis operator if it wasn't growing rapidly with solid profitability. INCR achieved $64.1 million (USD, all other currency is in CAD unless otherwise noted) in 2021, falling short of its the guidance of $74.4 million given when it came public via SPAC.

Through the first two quarters of 2022, INCR has seen growth remain strong:

It should be noted that INCR's strong growth appears to be mainly coming from new stores coming online. INCR doubled its operational store count to 16 (up from 8 in the second quarter of last year).

Gross margin stood at 42.3% and adjusted EBITDA margin stood at 23.8% in the quarter - both well below the initial SPAC projections. INCR did generate $9.5 million of net income (I have adjusted for unrealized gains on biological assets), representing a net margin of 16%.

INCR has guided for gross margins to expand above 50% once it reduces its reliance on importing product and relies on vertical integration.

INCR ended the quarter with $96 million of cash versus $61.8 million of debt.

Valuation and Price Target

A problem with investing in an international stock like INCR is that calculating the share count can be a bit hairy. We can see that the company initially projected 69 million shares at its SPAC presentation.

However, not all the SPAC shares chose to hold through the transaction, so that number isn't reliable. INCR noted 45.1 million ordinary shares and 2.2 million warrants as of its latest report .

To be conservative, I use 50 million shares, giving a market cap of $235 million. INCR is generating a $150 million annualized revenue run rate. That places the stock at around 1.6x sales, 7.2x EBITDA, and around 14x earnings. This stock is very cheap and INCR benefits from the lack of obscene tax rates and the fact that it has already been uplisted to the Nasdaq exchange. If INCR can sustain its growth and margin profile, then I expect the stock to re-rate substantially. It is worth noting that CEO Rabinovitch owns 12 million shares.

The main problem is that the country may begin to see similar price compression as that witnessed in the United States. On the conference call , management stated that while it projects the potential number of medical patients to be about 5% of the population, there are currently only 168,000 medical cannabis patients in the country representing 1.3% of the population. That was their answer to an analyst question regarding price competition in the country - management also stated that there are companies with weak balance sheets that are just trying to get rid of products to cash out. INCR believes that Canndoc's focus on high-end products should insulate it from those pressures.

But TLRY, one of their suppliers, noted on their conference call that they are seeing great weakness in the Israeli market, such that they chose to skip on a scheduled $6 million shipment due to "concern about ability to receive payment." TLRY management stated that the Israeli market "has become oversupplied with cannabis from the Canadian market." Given that commentary, investors should be careful in extrapolating the recently strong growth rates out indefinitely, as INCR may eventually face both decelerating growth and margin compression.

What's more, I don't see INCR as having material growth prospects outside of Israel, at least not yet. Just like how Canadian producers are struggling to enter the United States market, it may not be so trivial for INCR to enter other European countries such as Germany. It remains to be seen if INCR deserves either a premium for its stronger profitability or discount for its international status relative to US operators. The company is generating strong fundamental results and does not trade richly, but there remains the risk of a slowdown in the country - at least with the MSOs one can hope for tail-end boost from more states coming online for adult-use sales. I rate INCR a Buy on account of valuation.

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