Cannabis Sector Spotlight: Sunniva Inc.

Chris Thompson | Head of Reseach | Ubika Research | Chris@UbikaResearch.com | 1 (416) 574-0469
Patrick Smith | Analyst | Ubika Research | Patrick@UbikaResearch.com | 1 (647) 444-5506
Richard Waxman | Associate | Ubika Research | Richard@UbikaResearch.com | 1 (647) 770-2185

UMJ20: -15.1% (142.9% Y/Y)

TSX-V: -5.6% (-3.3% Y/Y)

HMMJ: -10.4% (81.3% Y/Y)

Dollar amounts in CAD unless otherwise stated.

The Ubika Marijuana Index continues to outperform on a year-over-year basis, sprouting 143% higher since this time last year. Comparatively, the Horizons
Marijuana Life Sciences Index (HMMJ) climbed 81% while the TSXV declined 3% YoY.

This report examines a growing Canadian marijuana company that has caught our attention with its vertically-integrated business model. Sunniva Inc. (CSE:SNN, OTCQX:SNNVF), a cannabis developer of medical marijuana with operations in British Colombia and California, has underperformed its benchmark, the HMMJ, (11% decline vs 8% decline) since it began trading in January 2018. The full report can be found below.

• In May 2018, Prime Minister Trudeau stated that cannabis would be legal by summer 2018, despite requests by the Senate’s Aboriginal People’s committee for a delay. The senators suggested a year-long delay on the implementation of the decriminalization law (Bill C45), to allow for “culturally-sensitive materials” and special licencing arrangements for aboriginal communities to be included in the new law. Other stakeholders such as the Canadian Real Estate Association have also raised concerns about small scale grow-ops affecting property values and suggested a restriction on home-growing.
• Aurora Cannabis Inc.’s shares were briefly halted on Thursday, May 3, 2018, when the Company confirmed that it had entered into negotiations to purchase MedReleaf Corp. (TSX:LEAF). On May 14, 2018, Aurora confirmed that it had reached an agreement to purchase MedReleaf for $3.2B in an allstock deal. The combined company’s market cap could be as much as $7.5B, and have production capacity of 570,000 kg, making it the largest company in the cannabis space by both measures. The aquisition price implies a 23x 2019 EV/ sales, 9x 2020 EV/sales, 82x 2019 EV/EBITDA, and 23x 2020 EV/EBITDA.
• On May 14, 2018, Canopy Growth Corp. (TSX:WEED) announced that it had applied to list its common shares on the New York Stock Exchange (NYSE) under the ticker CGC. If approved, Canopy would be the first cannabis producer to list on the NYSE. Another Canadian marijuana producer, Cronos Group Inc. (NASDAQ:CRON, TSXV:CRON), already trades on the NASDAQ. However, Canopy CEO Bruce Linton noted in the announcement that he believed the additional history and credibility of the NYSE would attract more institutional investors.

• While the Trudeau administration originally aimed to have full legalization by July 1, it may prove to be an unrealistic timeline. Bill C-45 currently remains in committee (Senate) following its second reading. Several stakeholder groups have pushed back against the rapid timeline, citing social and logistical deficiencies in the legislation. If legalization is delayed, it could have serious effects on companies that expect to sell recreational product in the near future. The Senate expects a final reading on June 7, 2018. However, there may be a trade off as medicinal-focused companies such as SNN should continue to grow, regardless of the outcome. Though, a definitive delay in legalization may affect the cannabis markets, which could possibly precipitate another market correction, regardless of fundamental analysis.
• Lastly, continued industry consolidation in the lead up to Canadian recreational legalization may result in attractive valuations as companies vie for economies of scale and distribution infrastructure. Aurora Cannabis has reached an agreement to purchase MedReleaf, but this is likely not the only M&A we will see in the near future in this industry.

Sunniva Inc. (CSE:SNN, OTCQX:SNNVF)
Sunniva (SNN) is a Canada-based cannabis developer of medical marijuana. The Company’s stock has declined 11% YTD following its IPO in January 2018, underperforming the HMMJ index, which was down 8% over the same period.

Licensed to produce and sell its products in the world’s two largest legal cannabis markets – Canada and California, SNN is vertically integrated through its subsidiaries, operating purpose-built greenhouses, specialized cannabis clinics and a vaporizer-device business. This vertical integration allows the Company to generate revenue from multiple operating segments/verticals.

Sunniva was busy last year, acquiring both Natural Health Services (NHS), a large network of cannabis clinics for $22.5M, and Vapor Connoisseur (VC), a vaporizer distributor for $6.5M. Both acquisitions ensure steady top-line growth during the greenhouse buildout, contributing $11.3M and $4.8M, in 2017, respectively.

The Company’s operating segments, which includes its greenhouse operations, network of cannabis clinics and its cannabis paraphernalia distributor, can be seen in the image below. The greenhouses are under construction and are scheduled to commence operations in Q3/2018. The other two operating segments are already generating revenue (Figure 2).

SNN has committed to a two-phase construction program at its Sunniva cGMP California greenhouse. Phase One construction is currently underway on the 325,000 sq. ft. facility in Cathedral City, California. The Company estimates annual production of 60,000+ kg/year of premium cannabis product when the first phase becomes fully operational.

Phase Two of the project will add an additional 164,000 sq. ft. to this location. Phase Two is then expected to add another 40,000 kg/year, for a combined total of more than 100,000 kg/year with 30% expected to source higher-margin extracted products.

Sunniva’s U.S. subsidiaries hold eight 10,000 sq. ft. cultivation licenses, two manufacturing licenses, one 22,000 sq. ft. cultivation license, one 22,000 sq. ft. nursery license, and another 10,000 sq. ft. nursery license. It will also lease seven 22,000 sq. ft. cultivation bays to other select growers. The allocation of the remaining 37,000 sq. ft. is unknown at this time.

Source: Company Presentation

SNN’s second cGMP greenhouse facility, located in Canada, is expected to break ground in late 2018. The production facility, housed in B.C., will be 700,000+ sq. ft. and is expected to produce 100,000 kg/year. The Company estimates that 75% of the Canadian production will be sold under long-term contracts (negotiations ongoing), with the remaining 25% reserved for Sunniva’s Natural Health Services (NHS) clinics.

Complementary to its greenhouse operation, SNN completed construction of an extraction facility in April 2018 located in Cathedral City, California. Operations at this facility commenced in May 2018. The “Sun-Oil” facility is expected to process 500 lbs/day of biomass to produce oils and other cannabis extracts. Additionally, the genetics for the larger greenhouse operation is also expected to be housed there.

Vertical integration separates SNN from many of its cannabis-growing competitors. The Company’s seven NHS clinics have experienced cannabis doctors and nurses on staff to serve over 100,000 existing patients. SNN supplies these clinics with its own product, cutting out the intermediary between grower and customer. These same customers are also the target market for SNN’s other subsidiary, Vapor Connoisseur (VC), which markets more than 80 brands of leading cannabis paraphernalia and accessories. As such, SNN has the synergistic opportunity to cross-sell its VC products with its clinics in addition to normal retailers.

On February 21, 2018, Sunniva signed a deal with Canopy Growth Corp. (TSX:WEED) to supply up to 45,000 kg of dried cannabis annually for two years commencing in 2019. The two companies will revenue share product as it is sold through Canopy’s distribution network. In our opinion, supply-partnerships or agreements are important factors for investors to look out for when researching cannabis companies. Longer term, it is possible that an oversaturation of the Canadian/ American cannabis market could lead to issues with growing cannabis supply and lower wholesale costs. Therefore, we believe it is prudent for investors to take notice of companies that are executing various supply agreements to limit longer-term risk.

On March 27, 2018, Sunniva completed a $28M bought deal public offering of 1.3M units. Each unit consisted of one common share at an issue price $9.75/share and half of a warrant with a strike price of $12.50/share for 24 months.

On April 12, 2018, Sunniva announced that it had received all necessary temporary state licenses for Phase One and Two of its operations in California.

On May 3, 2018, SNN announced that it had selected a 126-acre site in Okanagan Falls, British Columbia, to construct its Canadian campus. The Company’s wholly-owned subsidiary has entered into an agreement to purchase the property for $7M.

Outlook & Valuation

At US$1,200/lb, the 60,000 kg/year, generated by Phase 1 in CA, represents potential for US$132M in annual revenue. This implies a 2019E EV/Sales multiple of ~1.5x, a discount to the median Canadian producer, which trades at a median of 4.3x. In our opinion, SNN’s discount could be associated with a U.S. regulatory discount, relative to Canada-based operations. We have found that cannabis companies with operations in the U.S. have generally led to discounted multiples. We believe this gap should close over the next 12 months as this arbitrage is realized by the market over time.

Sunniva has one analyst covering the stock with a Buy rating and a target of $16.50, representing 106% in upside. SNN trades at $8.00 as of May 16, 2018. It has a projected EV/EBITDA of 8.8x for 2019, a discount to peers, which have a mean forward EV/EBITDA value of 16.4x for 2019.