VFF - Village Farms Q2 Earnings: Strong Positioning With Deep Value Opportunity

2023-08-12 01:35:07 ET

Summary

• Village Farms is a diversified company with controlled environment agriculture produce of vegetables as well as high growth, high margin cannabis segment.
• It has demonstrated strong track record of positive EBITDA in Cannabis segment with its Fresh produce segment also turning around nicely.
• With its strategic partnerships and expansion plans, Village Farms International is poised to capitalize on the growing cannabis market. Initiate with Strong Buy.

Investment Thesis

Village Farms International (VFF) is one of the oldest and leading vertically integrated Controlled Environment Agriculture (CEA) growers focused on fresh produce (forming 50% of total revenue currently) before diversifying with recreational cannabis back in 2017. Since 2017, it has completed several strategic bolt-on acquisitions to consolidate its position and is currently one of the largest cannabis growers in the world (Top 3 in Canada in terms of market share) and one of the lowest-cost producers among Canadian greenhouse/indoor producers. Its strong track record of resilient top line income significantly outpacing the industry with focus on profitability yielding to 19 quarters of positive EBITDA and attractive valuation makes it a buy case.

Strong Earnings Overall

VFF reported strong Q2 earnings, with consolidated sales of $77 mn declining 7% YoY as a result of lower volumes from its third-party growers in fresh produce. Cannabis sales declined a tad 1% significantly outpacing the industry as a result of 24% growth in Retail branded sales along with 200%+ growth in International sales, albeit on a smaller base, offset by decline in non-branded sales. Consolidated Adj. EBITDA improved significantly to $4.5 mn from ($10.3 mn) last year driven by strong improvement in the Fresh Produce segment (Adj. EBITDA of $1 mn vs ($10.3 mn) in previous year) marking fourth straight quarter of positive EBITDA as well as strong growth in Cannabis business which grew 97% YoY on constant currency basis and margins expanding 900 bps. The strong growth in Fresh produce was driven by sustained progress in managing the Brown Rugose virus and strong demand for newer products such as Sensational Sara, a novel variety of tomatoes with a natural balance of sugar and acid.

Sustained Canadian Cannabis Sales with resilient margins (in CAD)

Balance sheet position remains strong with cash position of $32 mn vs $35 mn compared to last quarter and $85 mn in working capital vs $80 mn last quarter. Total debt stands at $51 mn slightly down from $53 mn last quarter on stronger CAD vs USD.

Valuation

We believe VFF trades at a cheap valuation, even factoring slightly conservative estimates, of 8x EV/ 2023E EBITDA compared to average 20x of its peers. We believe its continued strong reception of its new produce (including new tomato varieties) along with stabilising inflation would enable them to continue to post sustainable positive EBITDA for the coming quarters (having demonstrated 4 quarters of positive EBITDA). With Q3 and Q4 generally better quarters for Cannabis as a result of holidays, we believe it to post flattish to slightly negative sales and assuming a sustained double digit margin, we believe it can easily post $10.0 mn in EBITDA for the Cannabis segment. Initiate with a Strong Buy.

Seeking Alpha's Valuation Grade ascribes a favorable 'A' rating to the stock demonstrating the valuation comfort compared to its peers.

Risks to Rating

Risks to rating includes

1) Fresh produce segment is highly competitive which is subject to significant fluctuations on changes in general economic conditions, evolving consumer preferences and inflation which had witnessed operating losses in the past and any significant challenge in maintaining pricing or supply chain issues can materially impact the business

2) Cannabis is still a nascent industry after several countries / states legalized medical and recreational cannabis and any changes in the legislation within Canada and globally can have a significant impact on the overall business

Final Thoughts

VFF is a bright spot within the cannabis industry with sustained revenue due to strong brand resonance and focus on profitability delivering 19-quarters of positive EBITDA. Its Fresh Produce segment has also turned around incredibly well and has shown a robust performance over the last few quarters. We believe the company is poised to consolidate its position within Canada Cannabis market as well as globally sustaining double digit EBITDA margins. With cash/ share of $0.32 and sufficient free cash flows to pay out debt, it provides a deep value buy at current levels of just ~8x EV/ EBITDA. Initiate with a Strong Buy.

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