VFF - Village Farms: Entering New Cannabis Markets Looks Undervalued

Summary

• With farms distributed throughout the United States and Canada, Village Farms offers cannabis products as well as different products made from agricultural materials for different purposes.
• If management continues to bring products to new regions, the target market will likely increase business growth.
• Village Farms reported 16 consecutive quarters of positive adjusted EBITDA since commencing sales.

Village Farms International, Inc. ( VFF ) recently reported an impressive cannabis production capacity in Canada, and announced new business expansion in Europe and Asia. In my view, if new products released by Balance Health Botanics are successful, and new regulations are approved in new countries, free cash flow will likely trend higher. I obviously see risks from high competition, increasing transportation costs, and lower acceptance of cannabis products. With that, in my view, the company appears quite undervalued.

Village Farms

With farms distributed throughout the United States and Canada, Village Farms offers cannabis products as well as different products made from agricultural materials for different purposes.

The company reports business interests in many facilities around Canada and Texas, which indicates not only the magnitude of Village Farms' production, but also the growth and development it has recently had in North America.

One of its newest segments, the most publicized by Village Farms, is its cannabis plantation in Canada. In a recent presentation, management noted that its plants are capable of supplying more than one third of the forecasted Canadian market, a lot of future free cash flow for Village Farms.

Since the beginning of its activities, Village's cannabis segment has given great results, and has allowed it to be one of the pioneers regarding the cultivation and trade of cannabis within current legal frameworks. Somehow, this is a demonstration of the projection of the company's crop, based on recent discoveries in the scientific field about the medicinal properties of cannabis-derived products. In line with these lines, let's note that Village Farms reported 16 consecutive quarters of positive adjusted EBITDA since commencing sales. Considering the company's accumulated know-how, I don't see any reason why new results would not continue.

The company currently reports close to 1,800 employees, through which it develops and fulfills social responsibility programs, which have to do with operations integrated with the interests of the regions. It is also worth noting that Village Farms was named to Corporate Knights' inaugural Future 50, which lists the fastest growing sustainable companies in Canada.

Village Farms was selected from a pool of 6,115 companies (1,100 public and 4,015 private) as one of 25 publicly traded companies with the highest year-over-year percentage increase in "clean revenue". Source: Village Farms International Named to Corporate Knights' Inaugural Future 50

Analysts Believe That 2023 Sales Growth Could Reach 14%

Analysts out there are expecting impressive sales growth for 2023 and 2024, with growing EBITDA margin and positive net income from 2024. I did have a look at the work of other analysts before designing my financial model, so in my view, it is fair including market estimates in this article. Expected figures include 2024 net sales of CAD510 million, 2024 operating margin of 3.9%, and 2024 net income of CAD11 million.

With that about the income statement, in my view, the best factors were included in the cash flow statement. Analysts are expecting 2024 free cash flow of CAD13 million and FCF margin of 2.57%.

Stable Balance Sheet

As of September 30, 2022, cash stands at CAD18 million, with inventories of CAD74 million and total current assets of CAD143 million. Total current assets are equal to two times total current liabilities , so I wouldn't expect any liquidity issue.

With lines of credit of close to CAD7.6 million, short term debt close to CAD25 million, and long-term debt of CAD44.8 million, Village Farms does not declare a lot of financial debt. Besides, the asset/liability ratio stands at more than 3x. In sum, the balance sheet appears quite stable.

New Products Launched In 2022 By Balance Health Botanics An Expansion In Asia And Europe Could Imply A Valuation Of $2.6 Per Share

Under my base case scenario, I included several catalysts for revenue. First, I believe that Village Farms will benefit from the new products released by Balance Health Botanics, which was acquired in 2021. In 2022, management announced two new products in the new Synergy line, which will likely affect 2023 net sales.

I am quite optimistic about the company's long-term strategy in the Netherlands and other European countries, where Village Farms expects to offer products. Let's keep in mind that recently Malta approved some form of cannabis legalization, and Luxembourg and Germany recently announced new cannabis laws.

Malta is not the only European nation pursuing this path. Luxembourg and Germany have both announced plans to reform their cannabis laws, and there are ongoing pilot trials or experiments involving the supply of cannabis in the Netherlands and Switzerland. Source: Cannabis Legalization in Europe: Planning Ahead

Besides, I would be expecting that the company's new interest in Altum International in Asia will likely drive revenue up. In line with these thoughts, impressive momentum is reported in Australia, where Q3 2022 more than tripled from the Q1 2022. In sum, if management continues to bring products to new regions, the target market will likely increase business growth.

Under this scenario, I assumed that the company's FCF margin and EBITDA margin will likely increase as the production of cannabis in Canada and the US increases. Let's keep in mind that Village Farms also produces tomatoes, bell peppers, and cucumbers, which offer lower EBITDA margin than cannabis products.

Under this case scenario, I assumed sales growth close to 13% and growing EBITDA margin. 2033 figures would include net sales of CAD1.51 billion, 2023 EBITDA of CAD95.3 billion, and 2023 EBITDA margin of 6.27%.

If we use a WACC of 12% and FCF margin close to 2.57%-3.47%, the implied net present value of future free cash flow would stand at CAD119 million. Now, with an EV/EBITDA multiple of 8.77x, the net present value of future terminal value would be CAD238 million. Finally, the equity valuation would stand at CAD318 million, with a fair price of $2.6 per share and an IRR of 4.83%.

Dependency On Favorable New Cannabis Regulations Could Bring The Fair Price To $1.112 Per Share

Within the consistency of its operations, the particular fact that a large part of the company's revenue comes from cannabis is a bit worrying. This demonstrates the lack of diversification that the company has in its production, the direct dependence on the demand for this product, and of course a profit that fluctuates according to the price it has in the market at the time it is traded. If the price per gram of cannabis declines in the future, Village Farms' inventory and future production would be worth a bit less, which would bring revenue down.

Besides, management has bet heavily on the success of the operations of Pure SunFarms, which is still a company with very young activities within an industry in permanent revolution and transformation such as the cannabis market. If new governments decide to lower the approval of new cannabis laws in Europe or new states in the US, in my view, expectations of free cash flow would lower.

In line with my previous words, the cannabis market has a series of regulations greater than those that are common in other markets, and they also depend on regional regulators, each one with its particularities, which limits and restricts many of the possibilities for innovation and expansion in the business. Besides, high competitiveness and the lack of predictability could also affect future performance. Let's keep in mind that previous success does not guarantee future business growth.

Finally, it is relevant noting the company's high exposure to the development of higher quality technologies as well as the lower cost of production and higher transportation costs. Changes in the price of agricultural equipment, increase in the price of oil, or labor costs increases will likely bring the company's FCF growth down.

My financial model in this scenario includes sales growth of 8.5% and EBITDA margin close to 5.55%, which would imply 2023 EBITDA of CAD58 million. 2023 net revenue would also be CAD1.063 billion.

If we also include a WACC of 14.15% and a FCF margin close to 2.5%, the net present value of the FCF from 2023 to 2024 stands at CAD71.5 million. Also, with an EV/EBITDA multiple of 7.5x, the implied net present value of the terminal value is equal to around CAD103.5 million. The results also included an enterprise value of CAD175 million. Also, with cash of CAD23 million and debt close to CAD61.5 million, the equity is close to $101.3 million. Finally, the fair price would stand at CAD1.5 or $1.112 per share, and an IRR would be -2.05%.

My Takeaway

Village Farms notes that its cannabis facilities could be capable of supplying more than one third of the forecasted Canadian market. Besides, management is currently increasing its exposure to growing markets in Europe and Asia. With a proven business model in the United States and Canada, I believe that Village Farms will likely be successful elsewhere. I obviously see risks from lower acceptance of cannabis products in new or existing markets and issues with respect to new regulations. With that, I believe that future free cash flow would most likely imply a higher valuation than what the market shows today.

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