This morning I stumbled across a piece on Yahoo! Finance that was authored by Motley Fool, titled: “Cannabis Investors: 2 Companies That Have Already Reached Profitability.” The essence of the article was “they have a positive EPS.”
For astute cannabis investors, we know that accounting profit (net income/loss) isn’t exactly meaningful at this stage of the game. Everyone is ramping and making biological revenue adjustments for product yet to be sold. It makes understanding profitability challenging until we have multiple quarters at scale.
At a quick glance, we can see that WeedMD is making an accounting profit in both the last quarter and last six months. Where as Organigram made an accounting loss last quarter and an accounting profit over the last 9 months.
For the purpose of this post, I really want to break this down for WeedMD. I feel they have the most compelling risk/reward profile at this stage of the game. They have a low valuation, clean cap structure, are almost break even after backing out bio adjustments, fully funded, and still early in their ramp looking up. The massive bio adjustment last quarter is both a sign of the ramp up and execution the company is demonstrating. As Keith Mercer said in a recent Reddit AMA, “Now that the industry is maturing, I expect that investors will start to value real operations and performance. To paraphrase Warren Buffett – when the tide goes out you see who is swimming naked. WeedMD is fully clothed!”
WeedMD – A Quick Breakdown
WeedMD cultivates cannabis both indoors and outdoors. For readers relatively new to cannabis, under IFRS cannabis companies recognize revenue and costs for products they haven’t sold yet. In this case, WeedMD saw a $10.9M adjustment from growing outdoors on their 1M square foot grow. This number could be high, it could be low, we really don’t know. This is the first cycle of outdoor grows ever. Both accounting assumptions and growing procedures will evolve greatly over the years as we start see real results over the long haul.
Two Metrics that I would encourage readers to focus on when looking at the financials are EBITDA and OCF.
WeedMD posted a large operating cash flow for Q2 of $6.63M, I repeat that is $6.63M:
And they posted negative EBITDA for the quarter, because as any sane real operator would, they removed the adjustments on biological assets in the adjusted figure:
The differences between the two figures can largely be boiled down to payables, commodity tax receivables, and changes in fair value of biological assets and inventory sold. This is why OCF isn’t a great normalized number, these line items aren’t always smooth. But over the long haul, seeing positive operating cash flow is a strong indication of earning quality.
So is WeedMD Profitable Yet?
On 2 out of 3 metrics, they are: Accounting Net Income and Operating Cash Flow. However, in terms of EBITDA they are just approaching the point of profitability. Understand that EBITDA is a non-IFRS number, so to be clear the company isn’t trying to hide anything. If anything, we have to give them credit essentially saying “slow down, were not profitable yet, but read the rest of the MD&A and come to your own conclusion of where this is heading.”
So if I Invest in WeedMD, What Am I Betting On?
In terms of the blue sky upside, we would argue the big risks are:
- A successful outdoor harvest.
- Demand for outdoor cannabis.
- To a lesser extent, a successful roll out of CX Extraction.
We believe that point 1 (outdoor harvest) will start to show results in early October, when the company hosts an exclusive event for analysts. In terms of point 2 (demand), we will start to see what the demand looks like as early as CYQ4 and into the new year.
Make no mistake, this type of production could disrupt the whole space. Sell side analysts have raised great amounts of capital for indoor growing, and would love nothing more than to see outdoor grows fail. For investors, getting in on a company with a clean cap structure that trades at less than 5x sales run rate, is a wild opportunity if the bet pays off. The company is fully funded to ramp up to 150,000 kg of both outdoor and indoor. And are doing something rarely seen in the space, they are being prudent at each stage.
What About the Downside Risk?
To date the reviews on WeedMD’s product are fantastic. The company is executing on many levels. Even if the outdoor grow fails, investors are fully funded for both the extraction facility and 500k sqft of hybrid and standard greenhouse to fall back on. A quick google or twitter search, will show you the product is already beloved. Grower Derek Pedro is quickly becoming a cannabis legend in Canada.
Anyways, let’s still assume the outdoor grow is a gigantic bust for a minute. We see the biggest downside risk as oversupply in the market leading to price suppression. That being said, WeedMD has still hedged themselves in terms of Pioneer Cannabis (their retail play) and CX Extraction (value added products). So what is the downside? We will let the reader evaluate these risks for themselves.
The purpose of this piece was really to examine the claim that WeedMD is profitable. Which again, “profitability” can be argued on many fronts. Are we talking net income? EBITDA? free cash flow? operating cash flow? etc. Certainly the kind statement to not be looked at out of a vacuum.
I am a huge WeedMD bull, but I wouldn’t tout them as profitable yet. Nor would I for anyone in Canada. For me, I would like to see back-to-back quarters of consistent positive Net Income, OCF and EBITDA. I believe WeedMD gets there very fast.
In my opinion, WeedMD will look like the prudent issuer that didn’t waste mountains of capital on splashy acquisitions that ultimately result in large impairments. Leaving many investors suspicious of the games being played by insiders. For example, I challenge investors to go on Sedar, look at WeedMD’s statements, hit “Ctrl + F” and then type in the word “Goodwill”… Your search will come up empty.
WeedMD isn’t built to fool the capital markets through financial engineering. Management has been criticized in the past for failing to make splashy headlines and acquisitions. We will see what those same critics say in 18 months, if competitors make large goodwill impairments and WeedMD is generating free cash flow at the top of the class. I love the risk/reward profile WeedMD offers from here, and continue to pound the table even in the middle of this bearish period for cannabis stocks.
FULL DISCLOSURE: WeedMD is a client of Canacom Group, the parent company of The Deep Dive. The author has been compensated to cover WeedMD on The Deep Dive, with The Deep Dive having full editorial control. The author is also long WeedMD. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security.
SmallCapSteve started blogging in the Winter of 2009. During that time, he was able to spot many take over candidates and pick a variety of stocks that generated returns in excess of 200%. In the time since, he has taken a heavy focus in the cannabis space with a particular affinity for multi state operators, for which he has become a known thought leader.