Auxly Cannabis Group Inc. (TSXV:XLY) expects to generate a high internal rate of return of 60% owing to the fixed-cost streaming model
SmallCapPower | June 25, 2018: Auxly Cannabis Group Inc. (TSXV:XLY), formerly known as Cannabis Wheaton, is the world’s first cannabis streaming company that invests in cannabis facilities across Canada in exchange for minority equity interests and portions of cultivated production. In addition to streaming, the Company has significantly expanded the business to cover the entire cannabis value chain. To reflect this expanded scope, the Company has recently changed its name to Auxly Cannabis.
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Although Auxly Cannabis is a unique play in the cannabis space with long-term potential, oversupply concerns and the likely resulting price decline could have a significant impact on the Company’s financials. Additionally, more dilutive equity raises could negatively impact the share price. Consequently, the share price has more than halved year to date and any price appreciation going forward would be primarily dependant on how well the Company performs in the upcoming quarters, as the recreational opportunity in Canada opens up.
Investment thesis
- Unique business model
- Recent name change reflects presence across entire cannabis value chain
- Dilution remains a key concern
World’s first cannabis streaming company
Auxly Cannabis is the world’s first cannabis streaming company and has developed its streaming platform by funding numerous cannabis facilities/partners across Canada in exchange for minority equity interests and portions of cultivated production. Currently, the Company has more than 15 streaming partners spread across Canada and expects to receive/sell over 230,000 kilograms of cannabis from these partners by 2019 and over 400,000 kgs by 2021, making it one of the world’s largest producers of cannabis. Key investments/streaming partners of Auxly Cannabis include ABCann Global (50% stake for $55.0 million-$15 million already paid) in July 2017, FV Pharma (49.9% stake in March 2018) and GreenhouseCo (JV with Peter Quiring in Feb 2018).
Auxly’s key upstream partners
Along with huge production, Auxly Cannabis expects to generate a high internal rate of return of 60% owing to the fixed-cost streaming model, where in it pays an agreed-upon rate to its partners. EBITDA is expected to also be high at ~$5.50 per gram, as the cost averages $2.50 per gram while the average selling price is ~$8.00 per gram.
But price concerns remain on expected oversupply: The high margins estimated by the Company are on the premise that the prices are anticipated to continue to be high at $8.00 per gram. However, as cannabis players, both big and small, scramble to increase capacity, there are now growing concerns of oversupply in the Canadian market and realization that the recreational opportunity may not be as large as was originally envisioned. Forecasts by Grizzle, as well as the University of Ottawa, have estimated the recreational market opportunity in Canada at just ~800,000 kilograms per annum. The top two players, Canopy Growth and Aurora Cannabis, could have combined capacity exceeding 800,000 kilograms by 2019. Hence, consolidation could intensify as smaller players try to cash out.
More than just a streaming company, the recent name change reflects presence across the entire cannabis value chain including distribution and varied brands
Whilst continuing to be the leader in streaming, Auxly Cannabis has spread its business to cover the entire cannabis value chain. To reflect this expanded business scope, the Company has changed its name to the current Auxly Cannabis Group Inc., with the ticker XLY on the TSXV.
To ensure that production from their partners is distributed effectively, Auxly Cannabis has inked a slew of agreements, both domestic and international. Auxly will leverage its ACMPR-licensed facility, KoLab, in Carleton Place, Ontario, to access the medical cannabis regime and distribute cannabis products directly to patients across Canada. Some of the key distribution alliances that the Company has signed recently include an exclusive distribution alliance with a national chain of independent pharmacies in Sept 2017; alliance with a national chain of convenience stores in October 2017; and the recent (Jan 2018) partnership and investment in retail franchisee, Inner Spirit, that gives Auxly Cannabis the exclusive right to supply up to 50% of Inner Spirit’s annual inventory requirements for any cannabis, cannabis-infused or cannabis-derived products. For international distribution, the Company’s recent supply deal with Aphria ensures enough cannabis supply to establish a strong presence in various federally legal international jurisdictions.
In May 2018, Auxly Cannabis signed a definitive licensing agreement with Colorado-based Dixie Brands, Inc., a firm specializing in developing intellectual property related to cannabinoid (CBD)-infused products. Pursuant to the agreement, Dixie granted Auxly exclusive license to Dixie’s intellectual property (IP) including formulation methodologies and associated branding related to over 100 CBD-infused products in Canada and Mexico. Valid for an initial term of 10 years, the agreement can be renewed by Auxly for up to two additional five-year periods. Other strategic partnerships are with Province Brands, Dixie Brands, and NAC.
Strategic Partnerships
Seasoned management team
Auxly Cannabis has a seasoned management team with vast experience in the cannabis sector. At the helm is Chuck Rifici (Chairman, Chief Executive Officer), who founded Canopy Growth (formerly Tweed Marijuana) and built it into 500,000 square feet of marijuana growing capacity as its CEO. Chuck is also currently CEO of Nesta Holding Co., a private equity firm that builds partnerships and brands within the cannabis space and Chairman of National Access Cannabis, a clinical chain helping patients access the Canadian federal cannabis program. Other key members of the management team include Hugo Alves Director (President), who specializes in complex domestic and international transactions and Mike Lickver (Executive Vice President of Strategy), who specializes in domestic and international commercial transactions.
Dilution remains a key concern
Along with oversupply concerns that may result in a significant per-gram price decline, dilution is another major concern for investors. As with other streaming companies, Auxly Cannabis has raised significant capital for its investments through equity issues. With the recent $100 million raise and other smaller offerings, the share count currently stands at 550 million.
Outlook and valuation
Although Auxly Cannabis is a unique play in the cannabis space with significant long-term potential, oversupply concerns and the resulting price decline could have a significant impact on the Company’s fixed-cost streaming model. Additionally, the raising of capital through a stock sale will continue to have significant dilution for existing equity holders. Consequently, the stock price of Auxly Cannabis has been cut in half year to date and any price appreciation going forward would be dependent on how well the Company performs in the coming quarters as the recreational opportunity opens up both domestically and internationally.
Disclosure: Neither the author nor his family own shares in the company mentioned above.
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