Back in October 2019, Village Farms (NASDAQ:VFF), got tangled in a dispute with business partner Emerald Health Therapeutics over their joint venture, Pure Sunfarms, owned 50/50 by Village Farms and Emerald.

Under a previous supply agreement, Emerald had agreed to purchase 40% of Pure Sunfarms’ cannabis production.

However, Emerald failed to make good on its purchase contracts, forcing Pure Sunfarms to sell some of its supply at much lower prices on the wholesale market than the agreed-upon price in the original contract.

Pure Sunfarms claimed that as a result of Emerald’s refusal to honour the contract, Emerald owed the company approximately $7 million for lost revenue.

Emerald disputed that claim, until yesterday.

Yesterday, the news broke that VFF and Emerald Health Therapeutics came to an agreement to settle the dispute.

There are lots of details, which we’ve printed below, but all investors really need to know is that Village Farms now owns 57.4% of the Pure Sunfarms JV, up from 50% before the announcement. 
  • The 5,940,000 common shares of Pure Sunfarms that were placed in escrow pending Emerald’s C$5.94 million equity contribution to Pure Sunfarms (originally due in November 2019) will be canceled, effective as of November 19, 2019, and Village Farms and Emerald will cease arbitration proceedings on the matter;
  • Emerald will forfeit and waive repayment by Pure Sunfarms of its outstanding C$13.0 million shareholder loan to Pure Sunfarms (plus accrued interest of C$1.1 million) and Emerald will issue a promissory note to Pure Sunfarms in the amount of C$952,237;
  • Pure Sunfarms will release Emerald from all liability arising from their supply agreement under which Emerald had the provision to purchase 40% of Pure Sunfarms’ aggregate production in 2018 and 2019;
  • Emerald will transfer 2.5% of additional equity in Pure Sunfarms to VFF;
  • Pure Sunfarms and Emerald will release each other from their current supply agreement under which Emerald has the provision to purchase 25% of Pure Sunfarms’ aggregate cannabis production from the Delta facilities in 2020, 2021 and 2022; and
  • VFF and Emerald will mutually release each other from all claims related to or arising from the disputes.

Under the settlement, VFF’s equity in Pure Sunfarms will increase to 53.5%.

In addition, VFF has agreed to contribute a further $8 million to Pure Sunfarms in 2020, bringing their stake in the company to 57.4% and valuing Pure Sunfarms at C$205 million.

All the news yesterday is good for Village Farms as it now has a majority stake in the lowest-cost greenhouse cannabis grower in Canada.

Marijuana stocks / cannabis stocks - mj

What is the Value of Pure Sunfarms?

Pure Sunfarms is already solidly EBITDA positive, a rarity in the cannabis market.

Based on data from Pure Sunfarm’s latest quarter, EBITDA is running at $53.3 million a year.

Accounting for Village Farm’s new 57.4% stake, Pure Sunfarms is contributing $30.6 million per year of EBITDA to Village Farms.

What is Pure Sunfarms Worth?

Village Farms put another C$8 million into Pure Sunfarms yesterday for 3.9% of the company, valuing Pure Sunfarms at $205 million.

It looks like VFF got a sweetheart deal, paying only 3.9x (current EBITDA) for the new stake while the market is pricing Pure Sunfarms far higher. VFF’s 57.4% stake is worth $118 million according to them, but the market thinks it’s worth up to 2.3x more based on VFF’s market cap of $275 million. VFF did a great deal for current shareholders.

Is Village Farms Cheap or Expensive?

With the additional EBITDA from Pure Sunfarms, VFF’s annualized EBITDA is running at $19.6 million and the stock is trading at 12.7x EBITDA.

A 12.7x EBITDA multiple is in line with where cannabis leaders in the U.S. trade, like Trulieve, and considering VFF is one of the few cannabis companies with positive EBITDA, it is head and shoulders above money-losing Canadian peers.

So from an EBITDA basis VFF is already being fairly valued by the market, however based on revenue, VFF still looks dirt cheap.

At first glance VFF’s ridiculously low multiple tells us the stock is undervalued, but what if it’s actually telling us that all the other Canadian LPs are extremely overpriced instead?

This chart below doesn’t even accurately include revenue from Pure Sunfarms, so VFF’s multiple is even lower than 1.28x revenue.

Even if we assume the market thinks the tomato business is worthless and is only giving VFF credit for revenue from Pure Sunfarms, VFF still trades at a discount to peers at only 2.9x  trailing revenue.

Trailing Price/Sales of VFF and Cannabis Peers

So the question now becomes is there any reason for VFF not to be the core of any investor’s cannabis portfolio?

After much digging the last piece of the puzzle is the cash balance.

Though Pure Sunfarms is profitable, management is sinking every dollar and more back into the construction of additional capacity which the industry doesn’t really need.

Pure Sunfarms Cashflow Statement

Turning to VFF specifically, the company has C$34 million of cash when we include a capital raise done in October, but is on the hook for an additional C$36 million to fund two hemp joint ventures, the C$8 million for Pure Sunfarms and assorted extraction equipment.

The company also has C$33 million of debt due in the next 2-3 years.

VFF has the ability to borrow C$9 million on a revolving line of credit so all-in the company may need to issue some more shares to bridge the gap until Pure Sunfarms finishes greenhouse construction and starts throwing off serious cash.

Check the cash situation off the list of red flags.

 

Village Farms Coming for Your Favourite Licensed Producer…

Although Village Farms (VFF) stock has fallen with the rest of the industry, this company is in our opinion every other Canadian LP’s worst nightmare.

VFF is putting out 75,000 kg of cannabis a year at a cost of only $0.63/gram while other LPs can’t get their costs below $1.00/gram.  

By the end of 2020, VFF will be growing enough cannabis to supply half of Canada on its own.

Lowest cost + Better Quality = WINNING

The big risk to keep an eye on for VFF is outdoor flower, but at this point VFF is in a league of its own with a combination of scale, cost, and quality that is unmatched in Canada.

We still think VFF stock could go lower while the cannabis market continues its meltdown, but once industry supply begins to meet demand and bankruptcies slow, this stock is looking like a must-own for any Canadian cannabis investor.

Disclosure: The author holds no positions in VFF.

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