Valens GroWorks Quarterly Results Are Worth Processing

Valens GroWorks Corp. (TSXV:VGW), one of the Canadian cannabis extraction stocks, announced its third-quarter financial results late Tuesday

SmallCapPower | October 17, 2019: Valens GroWorks Corp. (TSXV:VGW) (OTC:VGWCF) reported strong Q3/19 financial results on October 15, 2019, which  beat expectations. The financial results were highlighted by revenue of $16.5M, representing 87.1% growth QoQ, which was in-line with our estimate of $16.5M and a slight beat to the consensus of $16.0M. EBITDA came in at $9.7M, which surpassed our estimate of $5.8M and beat the consensus of $5.9M. In terms of production, the Company processed 26,625 kg of cannabis and hemp biomass in Q3/19, significantly higher than our estimate of 16,000 kg process. VGW’s cash sits at a strong $60.4M. In summary, Valens’ quarter was one of the best reported by a public cannabis company in Canada. Valens GroWorks reported positive net income of $5.9M, which is the highest reported net income derived from cannabis operations in the industry to date, followed by MediPharm Labs, which reported $2.0M in net income during Q2/19.

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Figure 1: Financial HighlightsSource: Company Reports, Ubika

Solid quarter for Valens GroWorks led by a ramp-up in processing services leading up to Cannabis 2.0. Revenue rose to $16.5M, an 87% increase over Q2/19. As well, cannabis and hemp biomass processed increased by 211.5% to 26,625 kg quarter over quarter. We believe that this is due primarily to the Company processing much more trim at lower cannabinoid content than we modelled. Although, this was more than offset by lower-than-expected COGS (hence the EBITDA beat).

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Industry-leading gross margins, positive free cash flow, and solid cash balance. Gross profit increased by 151.2% to $12.8M in Q3/19 (was $5.0M in Q2/19). Gross margins were 78% during the third quarter, compared with 55% margins that we modelled. Management commented that the significant expansion in Q3/19 gross margin was due primarily to a contract opportunity, which they do not anticipate reoccurring in subsequent quarters. Additionally, free cash flow (CFO – CAPEX) was ~$2.0M, compared with our estimate of $2.0M. The variance was due primarily to ~$4.0M higher gross profit and lower CAPEX than what we modelled.

Second cannabis company to report positive net income from operations. Valens GroWorks reported positive net income of $5.9M, which is the highest reported net income derived from cannabis operations in the industry to date, followed by MediPharm Labs, which reported $2.0M in net income during Q2/19. Of note, Aphria reported positive net income during the past two quarters but this was a result of fair-value adjustments and non-operating income.

Likely to sign more tolling agreements as capital crunch in the industry intensifies. The Horizons Marijuana Life Sciences EFT (TSX:HMMJ) is down ~55% since its March 19, 2019 high. We believe that there is likely a liquidity crisis looming, and it will be difficult for cultivators to raise capital in the coming quarter. As a result, we expect that cultivators could delay high capital expenditures, such as extraction equipment. Consequently, cultivators may have no choice but to turn to extraction companies, such as Valens GroWorks, MediPharm Labs, and Nextleaf Solutions, for tolling services to create concentrates and edible products for Cannabis 2.0.

Undervalued compared with mid-to-large cap cultivators. Valens GroWorks stock trades at a 4.6x 2020E and 3.3x 2021E EV/EBITDA multiples, a discount to Canadian majors, which trade at a consensus average of 15.1x and 16.4x multiples, respectively. We believe that this valuation gap should close overtime as the Company books revenues from processing for Cannabis 2.0 and the market realizes the significant value potential of pure-play extraction companies.

Figure 2: Comps Table

Source: Ubika, Capital IQ

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