VFF - Village Farms Remains Bullish In Current Cannabis Rally

2023-09-19 02:17:20 ET

Summary

• Canadian cannabis stocks, US MSOs, and cannabis support stocks are all experiencing rallies in the current market conditions.
• The possible rescheduling of cannabis and the passage of the SAFE Banking Act in the US are driving the ongoing cannabis rally.
• Village Farms, a Canadian cannabis LP, is still in a stage of recovery and operates at a net loss with negative free cash flow.
• Village Farms' financial performance is improving, and the company holds a top three share of the national Canadian cannabis market.
• I rate the company as a strong buy, but with a high risk in the short-term.

Village Farms ( VFF ) remains bullish along with the rest of the Canadian cannabis stocks, like Canopy Growth ( CGC ), and United States MSOs, like Verano Holdings (VRNOF). Cannabis support stocks, like GrowGeneration ( GRWG ) and WeedMaps ( MAPS ), are also undergoing rallies. The US MSO ETF ( MSOS ) has gained 88% over the last month. Considering the current market conditions (for cannabis and the greater market), I rate Village Farms as a strong buy, but it comes with a high-risk rating.

Many investors will wonder why Canadian cannabis LPs are experiencing rallies, when the news on cannabis this month really affects US Multistate Operators (MSOs) and US cannabis support stocks. Investors, who watched the cannabis rallies in 2021, know well that all cannabis stocks undergo the rally. Some investors prefer to play the OTC markets, while others catch the steam on the major exchanges. I happen to play both markets and encourage you, in addition to these cannabis producers, to watch cannabis support stocks.

Village Farms, like all other Canadian cannabis LPs, is still in a stage of recovery and growth. The company has little to gain from the passage of new cannabis legislation in the US, unless federal legalization occurs. Village Farms operates at a net loss with negative free cash flow and there is no promise of this situation changing anytime soon. Besides its Canadian cannabis operations, the company operates in the US under its fresh produce segment and under its CBD segment. Village Farms is prepared to convert its US assets to cannabis facilities when the law allows. The company recently applied for a cannabis license in Texas, where its grow facilities are located. There is no direct connection between the cannabis rally and Village Farms current operations. Caution is advised.

Ongoing Cannabis Rally

Canadian cannabis LPs are rallying alongside US Multistate Operators on news of the possible rescheduling of cannabis and a markup of the SAFE Banking Act in the Senate, scheduled for September 27 ^th . These legislative changes apply to US cannabis producers, manufacturers, and retail operators. It should be emphasized that these possible changes will not affect Canadian cannabis operators, unless they have stock buyout deals with US MSOs, for instance Canopy Growth ( CGC ).

If the US DEA reschedules cannabis from Schedule I to Schedule II of the Controlled Substances Act ((CSA)), then US cannabis companies will be able to claim additional tax exemptions on their income tax returns. The companies should report better financial performance because they get to keep more of their cash flow from operations. The rescheduling of cannabis in the US will also foster a positive public sentiment around the plant, which has been increasing over the last decade. The move to reschedule will indicate that the federal government views cannabis as less harmful than Schedule I substances and that it has valid medical applications.

Passage of the SAFE Banking Act would be a game changer for the US cannabis markets. Cannabis operators would be able to use banking systems for business operations, including bank deposits and customer transactions, like credit cards. The act would turn a multitude of cannabis business nationwide into legitimate businesses with the same safeguards of banking offered to all business. US cannabis companies will report stronger financial performance and have better balance sheets under the new legislation. A massive amount of cash, seemingly stored in private vaults, will move from cannabis operators to the US banking system.

The synergies of cannabis rescheduling and the SAFE Banking Act have not been enacted. The rally is on the possibility and not the actuality of these things. Since the Canadian companies have less to gain than the US companies, extreme caution is advised in playing the current cannabis rally. At best it is a short-term rally, which may end with new and higher price channels for all cannabis stocks. The rally is long awaited for cannabis investors and the cannabis market.

Village Farms Q2-2023 Performance

The recent rally with Village Farms’ stock began with its Q2-2023 earnings release . The company beat market expectations on GAAP EPS and Revenue. It reported revenues of $77.21 million, showing a decrease of 6.9% YOY and an increase of 19.33% from the previous quarter. The company reported a gross profit of $11.5 million, representing an 82.53% increase YoY. Village Farms reported a net loss of $1.4 million, representing a 96% improvement YoY. Overall, the company’s financial performance is improving, but investors will still want to see positive free cash flow and net income.

The company reported an increase of 24% YoY in its Canadian cannabis retail sales. Village Farms continues to hold a top three market share position nationally in the Canadian cannabis retail market. The company reported an increase of over 200% YoY in its export of cannabis to international markets. Sales in the company’s produce segment decreased 7% YoY, but the segment still reported an adjusted positive EBITDA of $1.3 million compared to a negative $10.3 million YoY. Each individual segment, Canadian Cannabis, US Cannabis, and Produce, reported positive adjusted EBITDA. The Canadian and US cannabis segments posted net income.

Cannabis revenue broke down into the following categories: Retail Branded Sales - $37.2 million, International Sales - $1.4 million, Non-Branded Sales - $2.9 million, Other - $0.6 million. Cannabis excise tax amounted to $14.0 million for the quarter. Net cannabis revenue equaled $28.1 million. Produce revenue was $43.8 million and Cannabis US, consisting of CBD sales, was $5.3 million.

This table contains the last nine quarterly reports:

Financial data from Seeking Alpha and Valuations from TIKR

The company’s financial recovery from volatile Canadian cannabis markets and US produce markets is slow going. Over the last five quarters, the company’s net loss has decreased, while revenue has increased slightly. Gross profit has increased over the last two quarters.

The market estimate for Village Farms’ Q3-2023 revenue is $70.13 million and an EPS of -$0.03. The revenue amount would represent a decrease from Q2-2023 and Q3-2022. There are no foreseeable surprises or synergies to the company’s current strategy. It is hoped that we see continued improvement across the its business segments.

Stock Price Rally

3-month price performance chart from StockCharts.com

Village Farm’s stock price has been down 59% over the last year and is currently down 24.60% YTD. The stock price went from $2.58 per share to $0.55 per share over this time, but now sits at $1.00 per share. The cannabis rally, based on rescheduling news, began on August 30 ^th and Village Farm’s stock price had already been rallying over its Q2-2023 earnings release. The rally continues with news of the SAFE Banking Act.

The stock price has begun a new uptrend, showing 51% gains at the 3-mo performance mark, 9.14% at 1-mo, and 11% over the last 5 days. The larger rally has produced an increase in momentum and volume for Canadian cannabis stocks. Village Farm’s stock has seen an increase in On Balance Volume and has entered a stage (short-term) of accumulation. The current trend lines point towards a median price of $1.20 per share. The company’s book value per share is $2.96 per share.

Valuation / Risk / Investment Strategy

Village Farms is at low risk of liquidity or poor financial performance. The company has a history of staying afloat in competitive market conditions in Canada and the US. Its long-term business strategy remains strong. Village Farms has a book value per share of $2.96. Its NTM Total EV / Revenues ratio is 0.59x. The company’s stock price is undervalued. The median street target price is $6.65 per share. Assuming a continued rally, Village Farms may arrive at the $2.00 per share price channel. In this case, gains of 100% may be realized from its current position.

The larger risk concerns the extent of the current cannabis market rally and the ongoing volatility of the greater markets. The bullish sentiment, which emerged late last spring and over the summer, has not fully overtaken market sentiment. Interest rate hikes from the FED have caused continued volatility, including an announcement scheduled this Wednesday. Although rates are expected to stay the same, the volatility around the announcement and specific language of the FED will rock the markets. The issues of inflation and rising WTI crude oil contracts will remain problematic the rest of the year. This type of volatility will likely crush any cannabis rally which is not met with actual legislative change. With this trend in mind, I rate any short-term strategy with Village Farms as high-risk and a “told you so” kind of scenario. We all remember how the 2021 rally ended.

With this week’s volatility in mind, it may be best to watch the rally up to the announcement of the FED concerning rate hikes and buy any dips which occur. If the stock price falls to anything below $0.80 per share, a 20% decrease, than an exit strategy may be applied. If Village Farms’ stock price stabilizes around the $1.00 mark, then an entry point will present itself. As a high-risk strategy, one should watch the news around the possible legislative changes and other market conditions. For options players , one might consider the $2.00 strike price on call options expiring Oct 20 and the $1.00 in the money call option expiring Oct 20. Remember that strategies involving call options can cause a 100% loss of the investment.

Conclusion

The recent wave of seemingly good news for the cannabis industry has caused an ongoing rally in cannabis stocks. Investors have been waiting for such a rally for over a year or more. There is no guarantee that the US government will reschedule cannabis or pass the SAFE Banking Act. This ongoing rally could cease at any moment. Some investors are looking at Canadian cannabis LPs as a fit strategy for playing the rally and the possibility of a greater long-term rally. I recommended Canopy Growth two weeks ago and now I am recommending Village Farms. Village Farms may find a new stable price channel at $2.00 per share, which would offer investors a chance of 100% gains. The short-term risk is high, but market sentiment on cannabis stocks remains strong.

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