MedReleaf Corp. Looks Attractive Given its Market Position, Profitability

Pullback in Canadian marijuana stocks, including MedReleaf (TSE:LEAF), over the past six months on valuation concerns seems unjustified

SmallCapPower | June 27, 2017: We believe the pull back in marijuana stocks over the past six months on valuation concerns is unjustified and represents a buying opportunity for investors given the large and growing opportunity in medical and recreational (starting 2018) marijuana market. MedReleaf Corp. (TSX: LEAF), the newest kid on the block, trading below the IPO price, could be an ideal addition to an investor’s marijuana stock basket.

Related: For Our Complete Coverage Of Canadian Marijuana Stocks Click Here 

Although MedReleaf Corp. shares fell 22% on its trading debut, it bounced 16% the following day and currently trades at $8.63, below the IPO price of $9.50, presenting an entry point for investors. MedReleaf is a licensed producer of dried cannabis and cannabis oil and commands a 19% share of cannabis volume sold in Canada. MedReleaf’s focus on premium products and measured investments in expansion continues to help it report strong growth in revenues while maintaining profitability, unlike some listed peers which continue to invest aggressively in expansion resulting in negative EBITDA margins.

INVESTMENT THESIS

Premium cannabis producer with dominant market share

MedReleaf distinguishes itself from other cannabis producers by focusing on high-quality premium products. The Company is the first and only ICH-GMP (granted 19th June 2017) and ISO 9001 certified cannabis producer in North America and is the only LP authorized to sell cannabis oil capsules in Canada. As of December 31, 2016, the Company held a dominant market share of 19% for cannabis volume sold in Canada. Priced higher than competitors, the Company’s premium products have won numerous awards including five awards at the Lift 2016 Canadian Cannabis Awards. We believe the Company could maintain and extend its leading market position if it can hold its niche as a premium producer going forward.

Growth while remaining profitable

Similar to other listed cannabis producers (Canopy Growth, Aphria Inc, Aurora Cannabis Inc) MedReleaf has also witnessed rapid growth in revenues over the past couple of years. However unlike Aurora, the Company is profitable at the net level ($8.7 million for 9M:FY17), generates positive operating cash flows, and has the highest TTM EBITDA of $14.2 million among the publicly-listed peers. One of the primary reasons for its profitability is its cautious investments in production capacity. Although profitable, Canopy Growth continues to report negative operating cash flows due to higher investments in acquisitions/capacity.

Production expansion post growth capital

MedReleaf currently has a production capacity of 5,000 kilograms of dried cannabis at its 55,000 sq.ft. Markham facility. However post the proceeds from the IPO, the Company plans to expand the capacity though its 210,000 sq.ft. New Bradford facility. Phase 1 of the new facility was completed in April 2017, and has commenced cultivation of its first crop. After full completion by end 2018, MedReleaf would have a combined facility of 265,000 sq.ft, producing about 35,000 kilograms of dried cannabis. We note that unlike Canopy Growth and Aurora, which continue to aggressively invest in building capacity, MedReleaf has been measured and cautious in capacity expansion. Each of the three publicly-listed peers (Aphria, Aurora, and Canopy) of MedReleaf will likely have ~1.0 million sqft facilities capable of producing about ~100,000 kilograms of dried cannabis.

Growing medical marijuana market

MedReleaf is well positioned to capture the rapidly-growing Canadian cannabis market, both medical and recreational. The annual medical marijuana market in Canada is forecast to grow tenfold to $1.3 billion by 2024 from $118 million in 2016. With the passage of legislation to legalize the recreational use of marijuana in Canada in April 2017, and sales expected to begin in mid-2018, all cannabis producers including MedReleaf will stand to benefit immensely.

COMPARABLE ANALYSIS

MedReleaf looks undervalued when compared to its peers from a Market Cap to Sales and EV to Sales multiples. The mean Market Cap to Sales ratio of the peer group is 46.9x vis-à-vis MedReleaf’s 20.6x. Similarly, MedReleaf trades at 19.9x EV to Sales compared to the peer group’s mean of 41.5x

Source: Bloomberg, Company Filings

CONCLUSION

We believe MedReleaf is trading at an attractive valuation as compared to its peer companies and even if the general consensus believes the cannabis sector is overvalued, we see limited downside to MedReleaf.

Disclosure: Neither the author nor any of the principals at Small Cap Power, or their family members, own shares in any of the companies mentioned above.

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