Meaningful progress at Nextleaf Solutions Ltd.’s (CSE:OILS) facility in 2H/19 points to greater visibility into production ramp
SmallCapPower | December 24, 2019: In mid-November, we visited Nextleaf Solutions Ltd.’s (CSE:OILS) (OTCQB:OILFF) facility, Nextleaf Labs Ltd., in Coquitlam, BC. Our last tour of the facility was more than six months ago, when it was in the process of applying for a processing license from Health Canada (Nextleaf Labs Ltd. received the license in September 2019). Today, most of the processing equipment has arrived, the processing skid system is nearing completion, and management anticipates production could begin by the December month-end.
The macro setup in Canada is favourable to Nextleaf’s facility ramp. Successful outdoor operations grow at ~65% of the cost of indoor grows from small industry players. We anticipate that because of realized economies of scale, as well as general cutbacks across the industry’s largest cultivators, should result in a significant increase in third-party processing needs. This points to opportunities for ramped processors, including Nextleaf.
Additional revenue opportunity announced on 12/17 with the licencing of its non-core IP to a hardware distribution company. On December 17, Nextleaf announced that it is licensing its non-core hardware IP to a British Columbia-based cannabis processing equipment distribution company. Nextleaf will receive a 20% royalty of the Licensee’s gross revenue. The Company believes that based on the Licensee’s current product backlog and 2020E projections, the royalty could yield over $3M in royalty fees in 2020E to Nextleaf.
Recent weakness not justified. We believe Nextleaf’s share-price weakness over the past few months was driven by a wider, sector-wide selling correction. Companies with strong fundamentals were affected regardless of what segment of the cannabis market they were insulated in. To illustrate, we have a U.S. and Canadian publicly-traded sample sets of 61 and 117 companies. Year-to-date, both sample sets are down 42% and 41%, respectively. We estimate that over the next few months, as retailers and consumers’ interest in Cannabis 2.0 spark up, and negative commentary falters, the whole space should benefit. In addition, companies focused on extraction like MediPharm Labs, Valens, and Nextleaf will continue to report strong cash-flowing quarters, and fundamentals will begin to lead the way.
Significant discount to peers. As of yesterday’s close, based on our estimates OILS trades at 0.2x F2021E sales and 0.5x F2021E EBITDA, a discount to extraction peers, which trade at 2.0x and 5.2x, respectively. We are maintaining our one-year price target of $1.75/share.
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