Valens Company: Time To Take Profits After 100% Rally
I don't know if I agree with this because they are seemingly doing everything right, but it's obvious that some people agreed with it today. - FUNMAN
Apr. 28, 2021 3:36 PM ET
The Valens Company Inc. https://seekingalpha.com/article/4422081-valens-company-stock-vlncf-time-to-take-profits-after-rally?mail_subject=vlncf-valens-company-time-to-take-profits-after-100-rally&utm_campaign=rta-stock-article&utm_content=link-0&utm_medium=email&utm_source=seeking_alpha
We think Valens is one of few Canadian cannabis stocks worth considering at current prices; our bullish call in February was followed by an almost 100% share price appreciation.
The stock is no longer dirt cheap but remains significantly cheaper than peers; however, we are now Neutral given reduced upside potential.
Given the current margin profile and uncertainty around the U.S. CBD market, Valens shares are reasonably valued with potential catalysts that require further execution and evidence.
We shared our bullish assessment of The Valens Company (OTCQX:VLNCF) in February 2021. We viewed the stock as cheap and saw promising results after its successful pivot from tolling to contracted manufacturing. Since our article, the stock has gone up almost 100% on the back of decent results and several strategic movements. We continue to like the stock but the recent rally has us worried the stock has gone up too much too fast. We think some profit-taking could be wise given Valens still has a long way to go before it could reverse its revenue declines and profitability erosions.
Valens shares have outperformed the broader cannabis market significantly in recent months. The stock has risen more than 100% in 2021 so far while the broader cannabis market has been treading water. The stock initially lagged its Canadian peers when the U.S. election results kicked off a period of the rally. Since then, Valens has performed better than peers through a strong quarter and strategic moves including entry into the U.S. market.
Valens reported Q1 F2021 results that showed continued improvement in sales and margin. Revenue grew 25% from the previous quarter to $20M while EBITDA losses narrowed to $2M. While Valens is still trying to reposition the business by transitioning away from tolling and focusing on customized third-party manufacturing, the progress has been slow but steady. For example, Valens has continued to expand its product offerings by introducing topical products to the Shoppers platform and launching new 2.0 products with its partner such as Verse Cannabis. The company today does very little tolling revenue which made up ~2% of the Q1 revenue. The successful transition away from tolling saved Valens from the troubles that have hurt its largest domestic competitor MediPharm (OTCQX:MEDIF) which is still fighting to live another day.
Valens still has its own challenges as profitability remains well below previous levels and it is burning cash from operations. However, the progress is encouraging and at least Valens is demonstrating a path towards profitability and a sustainable business model. On the contrary, it is safe to pronounce the death of tolling in Canada as most LPs now have in-house processing capability. After all, as the cannabis market shifts from flower products to 2.0/3.0 products, processing becomes a core part of the execution and it doesn't make sense for LPs to outsource that. The wholesale pricing also collapsed due to a supply glut which is causing pains for service providers.
Valens benefits from its unique business model that doesn't include any cultivation or flower sales. Valens focuses on 2.0/3.0 products and purchases cheap raw materials from the wholesale market which has seen pricing collapsed since the 2018 legalization. We think the Canadian cannabis market will remain oversupplied for the foreseeable future and Valens has a massive advantage over unsophisticated LPs such as Canopy (CGC) and Aurora (ACB) that spent billions on huge greenhouses only to shut them down recently with basically no return of their investments. Valens is more nimble and has a lower headcount and it is working with a wide range of customers to maximize its market reach. Valens works with LPs on white label products but more importantly, it works with newer brands that outsource their entire manufacturing to third parties. We have seen from 2020 data that most of the large Canadian LPs lost market share by ~50% as their revenue stayed unchanged while the market doubled in Canada. Therefore, the market is becoming more competitive with smaller growers and new brands taking share from early incumbents such as Canopy and Aurora.
(Source: IR Deck)
In our last assessment "Arming The Rebels In Cannabis 2.0", we concluded that Valens is well-positioned to benefit from the ongoing shift of market dynamics in Canada. As the market continues to shift away from flower to extracted products, Valens will stand to benefit. The losers from this transition will be companies that focus on wholesale and cultivation and lack brands and product development, such as Village Farms (VFF). Valens also announced the acquisition of Green Roads, a U.S. CBD company for up to US$60M. Green Roads generated $40M of sales in 2020 so Valens paid ~2x sales and 4.5x 2022 EBITDA if earn-out is achieved. We have seen the U.S. CBD market undergoing a period of consolidation and stagnation as detailed in our past analyses for industry leader Charlotte's Web (OTCQX:CWBHF). This acquisition will further improve Valens valuation multiple given it is trading at ~6x sales currently and the deal is a sizeable one. We look forward to learning more about this asset and the go-forward strategy.
Valens is one of the cheapest cannabis stocks in Canada trading at just 6.1x EV/Sales. Most of the Canadian cannabis firms are still reporting negative EBITDA including Valens so revenue is the primary metric for comparison. All of the top 10 Canadian LPs have a net cash position because the sector has faced difficulty supporting debt and firms have used the recent rally to raise equity at inflated share prices. Valens is no different by raising equity to buttress its balance sheet. We think Valens offers the clearest path to profitability and a reasonable valuation. Assuming a 30% EBITDA margin would imply that Valens is trading at just under 20x EBITDA which is much more palatable than its peers that are trading at more than 20x. Therefore, we think Valens shares are reasonably valued at current levels but they are not cheap anymore. When we reached our bullish thesis for Valens in February, the stock was trading at 3.5x EV/Sales which was very attractive. After more than doubling its share price in 2021, we think the remaining upside is less.
We think Valens is one of the more promising Canadian cannabis stocks given its sensible business model and solid execution. More importantly, the stock is trading at high but not ridiculous valuation levels. We saw significant upside in Valens back in February and the stock has doubled since then. Therefore, we are now Neutral on the stock. In contrast, we are negative on almost all Canadian LPs given the challenging industry backdrop and astronomical valuation. If Valens could improve its margin and prove out its U.S. strategy, there will be further upside to the stock. Given the current margin profile and challenging state of the U.S. CBD market, we see Valens shares reasonably valued at current prices.
This article was written by
Long/Short Equity, Long-Term Horizon, cannabis industry
Contributor Since 2014
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.