MediPharm Labs Corp (MEDIF)

[FUNMAN]

MediPharm: We Were Wrong

Feb. 24, 2021 10:47 AM ET

MediPharm Labs Corp. (MEDIF)VLNCF

These writers specifically blame changing market conditions and Valens for MediPharm's problems. They do ignore the 30 new international customers, and specifically the biggest one, STADA. 

You can read about STADA here. They are a for real, big company, in a market bigger than Canada. 

https://www.medipharmlabs.com/news/press-releases/detail/153/european-pharmaceutical-company-stada-enters-exclusive

Read the article at this link to see the charts

https://seekingalpha.com/article/4408542-medipharm-we-were-wrong

Summary

* MediPharm shares fell more than 90% since reaching a peak in 2019 as a result of a total collapse in its revenue in just one year.

* The company lost the majority of its wholesale revenue as the market became oversupplied, and its white label business was inadequate.

* The company lost the Canadian white label market to Valens, so it is looking to grow its own private label brands and expand internationally.

* We are Neutral on the stock as a bleak near-term outlook is offset by already depressed share prices.

We have to admit that we were wrong about MediPharm Labs (OTCQX:MEDIF).

The shares are down ~80% since our last update in November 2019 as Q3 revenue dropped ~90% from one year ago. The business was heavily reliant on the wholesale market which evaporated in an oversupplied market.

After reassessing our thesis, the near-term prospect for MediPharm still looks uncertain and challenging. However, we are Neutral on the shares after a significant re-rating to the current share price; the stock could become a comeback story if it could find success in Canada and abroad.

(All amounts in C$)

What Happened?

MediPharm shares are among the worst performers within the sector last year. The stock lost ~90% of its value since reaching its peak of ~$7 during 2019. The significant value destruction was the result of a collapse in the wholesale resin market and a slower roll-out of 2.0 products across Canada.

Revenue in Q3 2020 was down ~90% from one year ago which revealed MediPharm's reliance on the wholesale market. We also looked at its closest peer, The Valens Company (otcqx:VLNCF) which fared much better due to its focus on white-label manufacturing and had a more stable revenue stream.

The extent of the revenue collapse is surprising and we did not expect the company's revenue stream to be so volatile. While the company has sufficient cash to fund its operations for a few more quarters, the damage to the stock has been done. We have learned a few important insights during this episode.



(Source: Google Finance)

First of all, we knew that MediPharm relied heavily on the wholesale market but we thought it also had a growing white-label business. In fact, it turns out that Cronos was likely the largest customer; the two largest customers made up 52% of total revenue during Q3 which was only $4.9M.

Q3 revenue comprised of $2.1M from private label and $2.6M from white label. Revenue from private label collapsed from $43M last year because the Canadian wholesale market for crude resins and distillate became extremely oversupplied.

Similar to the dried flower market, producers simply produced too much cannabis and extracts which resulted in the sudden revenue drop for MediPharm.

In private label, the company buys cannabis from growers and sells processed products to LPs. However, MediPharm incurred negative gross margins during Q3 even after adjusting for write-offs. This proved to be a volatile business given the spread risk (input flower costs do not move in tandem with the wholesale extract prices).

The industry stocked lots of 2.0 products ahead of the launch only to be confronted with an oversupplied market and slow rollout of retail stores (the retail situation is improving but very slowly).

The white label business is far more protected because MediPharm and Valens earn a fee for producing 2.0 products (vapes, tinctures, oils) for LPs so they don't take on the spread risk, similar to oil refineries.

The conclusion here is that the private label business is not a great business due to margin risk; the white label side is far from protected and that's the primary reason why Valens has performed way better than MediPharm.



(Source: Filings)

Outlook

MediPharm is not sitting idle while watching 90% of its revenue evaporating and it is taking a few steps to expand its revenue sources.

First of all, we should not bet on the wholesale market to bounce back anytime soon. The Canadian market sold 1.5 million units of cannabis extracts products in October 2020 but the LPs and provincial sellers together held ~10 million units of inventory which represents 6-7 months of inventory. We believe the inventory level needs to decrease relative to sales in order to remove supply dynamics.

On the other hand, MediPharm is likely going to have a hard time finding new white label customers because Valens already dominated that market with few new entrants likely.

The Canadian cannabis market is entering a phase of consolidation which means that few players will exist in the next phase. The abundance of supply because of the industry-wide overbuilding is going to weigh on the supply/demand balance for years to come.


(Source: Health Canada)

Like many Canadian LPs, MediPharm is looking for growth opportunities outside Canada. The company established its Australian subsidiary early-on and recently gained full control of that business. However, sales from Australia will take a while to become meaningful revenue contributors.

MediPharm is also working on its own branded cannabis products which are so far focused on CBD oils only. The product line is very limited and we expect the company to have limited success in this segment due to inherent conflict of interests with its white label customers.

Therefore, we think MediPharm's near-term prospect will remain challenging and we see few catalysts for meaningful revenue growth.



(Source: IR Deck)

Valuation and Trading

MediPharm currently has a market cap of $105M after its shares remain pressured despite an overall bullish market for cannabis stocks. The company has $37M of cash at the end of Q3 and has $25M of debt including $20M of convertible debt. The company burns $6M of cash per quarter just from SG&A which means that it could be in need of additional capital later in 2021 if it fails to improve its financial performance meaningfully.

The company reported negative Q3 gross profits (excluding write-off) which is very alarming. The depressed share price likely reflects high balance sheet risk for the company. MediPharm shares also underperformed its closest peer Valens in the last year as both companies suffered from industry-wide malaise. However, Valens performed much better with revenue holding flat due to its larger, diversified white label customer base and stronger balance sheet. Valuation metrics are not meaningful given the volatile quarterly performance which reflects the unpredictable and volatile nature of MediPharm's wholesale business model.



(Source: Bloomberg)

Conclusion

In summary, we were too optimistic about the Canadian 2.0 market rollout and MediPharm's white label customer base. As it turned out, the company has few tolling agreements that provided negligible revenues as the wholesale business dried out. In hindsight, we should have been more cautious when MediPharm reported sudden revenue jumps as it indicated its reliance on the spot wholesale market.

Valens turned out to be the leader in white label and has signed up most of the LPs that outsourced 2.0 production, making it very difficult for MediPharm to find new business.

Despite efforts to find new revenue sources from direct sales to Canadian provinces and international expansion, MediPharm is likely facing an uphill battle trying to regain its footing.

Our initial observations were flawed but MediPharm's shares are trading at a depressed valuation which makes it a potential turnaround target.

While there is no evidence of a comeback just yet, we will follow the stock and its progress throughout 2021.