Nextleaf Receives a Processing License; Our Target Price Rises

Equity Research Healthcare – Cannabis | September 11, 2019
Patrick Smith | Analyst | Ubika Research Patrick@UbikaResearch.com | (647) 444-5506
Christopher, Bednarz MBA | Associate | Chris.B@UbikaResearch.com | (416) 558-5548

SmallCapPower | September 11, 2019: Received Health Canada Processing License. On September 9, 2019, Nextleaf announced it had received its Standard Processing License from Health Canada on September 6, 2019. This was ahead of our expectations and we consider it a significant de-risking milestone as it transitions the Company from a start-up to an operator. Recall, on July 8, 2019, Nextleaf submitted its Affirmation of Readiness and Video Evidence Package to Health Canada, which suggested the Company received its license exactly 60 days from when it was submitted. We believe this is a strong sentiment to the strength of management to know how to submit a license without any further delay. Although still at an earlier stage compared to larger extraction players, in terms of market cap and the amount of time in operation, the Company can now be seriously discussed as a processing option in competition to MediPharm Labs (TSX:LABS), Valens GroWorks (TSXV:VGW), Neptune Wellness (TSX:NEPT), and Radient Technologies (TSXV:RTI).

Next steps – tolling and supply agreements leading up to a sales license. We anticipate the next few months will roll out similarly to MediPharm, the first company to receive an oil processing license without being a cultivator. After MediPharm received a process license on March 29, 2018, the Company began to build inventory, and subsequently announced that it had received its sales license on November 12, 2019. With the announcement, MediPharm also announced that it had processed 180 kg and had secured four tolling agreements with Emerald Therapeutics (TSX:EMH), INDIVA Limited (TSXV:NDVA), Bonify (Private), and James E. Wagner Cultivation (TSXV:JWCA). On January 12, 2019, LABS announced that its first shipments were sold for $10M in December 2018. Of note, it took MediPharm ~8 months to receive its sales license after receiving its processing license and to book first revenues. Following a similar pattern, we believe Nextleaf should be able to book revenues by FQ2/20 (ending March 31, 2020) and, in the meantime, should begin to start announcing supply/tolling agreements. MediPharm ramped up quickly and surpassed many cultivators in terms of reported revenue and profitability. MediPharm reported Q2/19 revenue of $31.5M on August 12, 2019, and is currently the third-highest revenue generating Canadian cannabis company behind Aurora Cannabis and Canopy Growth. In our view, Nextleaf could ramp up even faster than MediPharm.

Licensing milestone significantly reduces risk – raising target to $1.75. Receipt of the Standard Processing License on time attests to the strength of the management team and increases our confidence in the Company. We expect more institutional interest to occur, which should lead to more financing opportunity, coverage and liquidity. As such, we reduced our discount rate to 8% (was 10%), which was the main driver for our increase in NAV to $2.37/share (was $2.16/share) and EBITDA to $1.10/share (was $1.14/share). As a result, our blended one-year target price increased to $1.75 (was $1.65). Of note, our target F2021E EBITDA multiple remains at 4.0x, which we believe is reasonable, given the weakness of the cannabis space in general of late (Canopy is down 17% in the last 30 days and 37% in the last 90 days) and that MediPharm, the leader in the extraction space by market cap, currently trades at a similar F2021E  EBITDA multiple of 4.5x.

Discount to peers. As of yesterday’s close, OILS trades at 0.5x F2021E sales and 1.2x F2021E EBITDA, a discount to extraction peers, which trade at 20.x and 5.2x, respectively. Once supply agreements with other Canadian cultivators start and continue to be announced, the market should continue to pay more attention to Nextleaf stock, which we believe will gradually close this valuation gap and drive the stock higher and closer to our one-year target price of $1.75/share.

NEXTLEAF SOLUTIONS LTD. CSE:OILS

(Currency is CAD$, unless noted otherwise) (Fiscal year-end is as of Sept. 30)

Last Price $0.60

Target Price$1.75

Potential Return192%

Net Asset Value Per Share $2.37

52 Week Low / High$0.30 / $0.83

Average Daily Volume (30-Day)398K

CAPITALIZATION Basic Diluted
Shares Outstanding (M) 107.8 147.3
Market Capitalization ($M) $64.7
Enterprise Value ($M) $61.1
Last Reported Cash ($M) $3.6
Last Reported Debt Balance ($M) $0.0
OILS OPERATIONS f2020E f2021E f2022E
Biomass Processing Volume (kg) 6,720 24,900 52,600
Crude Produced (kg) 560 1,890 3,420
Distillate Produced (kg) 240 1,000 2,520
Total Revenue ($M) $35.8 $119.4 $232.1
EBITDA ($M) $1.5 $49.4 $134.9
FCF ($M) -$6.0 $28.6 $86.4
Total CAPEX ($M) $6.0 $4.0 $3.0
CFPS $0.00 $0.23 $0.58
EPS -$0.02 $0.20 $0.56
Cash At Year End ($M) $1.4 $50.2 $136.6
Debt At Year End ($M) $0.0 $0.0 $0.0
Relative Valuation EV/EBITDA EV/SALES
2020E 2021E 2020E 2021E
Nextleaf Solutions 39.8x 1.2x 1.7x 0.5x
Extraction Companies 15.1x 5.2x 4.1x 2.0x
CAN-Based Major Cultivators 23.3x 17.2x 6.2x 3.5x
US-Based Operations 9.3x 4.7x 2.5x 1.6x
MAJOR SHAREHOLDERS
Management and Insiders (17%)
Disclosure: 1, 3 (See back page for further details)

VALUATION

Licensing milestone significantly reduces risk – raising target to $1.75. Receipt of the Standard Processing License on time attests to the strength of the management team and increases our confidence in the Company. We expect more institutional interest to occur, which should lead to more financing opportunity, coverage and liquidity. As such, we reduced our discount rate to 8% (was 10%), which was the main driver for our increase in NAV to $2.37/share (was $2.16/share). As a result, our blended one-year target price increased to $1.75 (was $1.65). Of note, our target F2021E EBITDA multiple remains at 4.0x, which we believe is reasonable, given the weakness of the cannabis space in general of late (Canopy is down 17% in the last 30 days and 37% in the last 90 days) and that MediPharm, the leader in the extraction space by market cap, currently trades at a similar F2021E EBITDA multiple of 4.1x.

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