Part of the reason for Sunniva’s strong value proposition in California relates to a strict new regulatory environment. Effective Jan. 1, 2019, some very strict and complicated compliance and licencing standards were finally phased in.
This puts in place a very high bar for businesses in all aspects of cultivation, manufacturing, testing, transport, tracking, and retailing. In essence, it creates a strong chain of custody that tracks seed to sale and ensures that cannabis products are completely free of chemical contaminants and pathogens.
At the end of this long and winding road, Sunniva is one of the few industry participants with compliant statewide operations on a large scale to support full vertical integration that now touches virtually every aspect of the cannabis supply chain. It cannot be over-emphasised that as government policy and law enforcement funding put ever-increasing pressure on non-compliant ventures, this gives Sunniva a huge first-mover advantage in all the right places.
Sunniva’s Cathedral City Campus, in the Coachella Valley, Southern California.
In fact, it places the near-term expansion of Sunniva’s high-margin core operations and brands within an ideal economic framework for growth in California. The results are just starting to show now with millions of dollars worth of purchasing contracts steadily rolling in so far this year.
Canadian Growing Pains Are No Longer a Drag on the Share Price
However, this successful California execution has been overshadowed by the unforeseen delays for the proposed build-out of Sunniva’s Canadian greenhouse facility in Okanagan Falls, BC. Many of these setbacks are also the result of construction suppliers failing to deliver in a timely manner and from Health Canada’s slow licensing process early on.
Of course, delays are nothing new in the world of cannabis corporate development or largescale construction projects. Initially Sunniva had a perfect situation brewing on both sides of the border, having secured a very large offtake agreement with the industry leader Canopy Growth in Canada. However, due to the delays and change in the Canadian cannabis landscape, Sunniva management was forced to adapt and assess the best use of shareholder capital moving forward.
Now, one year later, it’s clear that the original timeline of the Canopy agreement can’t be met and since then significant cultivation supply has been built in Canada.
However, management has fully acknowledged the problem and continues to work towards maximizing the value of its Canadian assets, which includes ownership of the seven physician-run cannabis clinics, Natural Health Services, as well as a 125-acre land base in Okanagan Falls. According to management, previously announced strategic evaluations are ongoing and are expected to resolve by the second quarter of 2019.
All in all, this ‘Canadian uncertainty’ was clearly disclosed to investors and appears to be already factored in the share price, causing the share price decline at the end of 2018. From lows of around $3 at the bottom of the December market meltdown, the stock price has steadily recovered on sizable volumes and continues to consolidate around $5.
But as the California order book continues to grow, and production and revenue increases month by month, Sunniva investors are getting their first good look at the kind of results they have long expected to see. Indeed, Sunniva is beginning to shine again, brighter than ever.
Another key factor that initially propelled Sunniva into favour with investors was the exceptional quality of the seasoned executive management team. This same factor still makes a compelling case for Sunniva achieving its goals going forward.
Sunniva’s Management is Among the Best in the Business
Senior management and directors at Sunniva continue to demonstrate the business discipline and sound judgement required to pivot when necessary and build solid long-term shareholder value. Since 2014, everything management has done to date validates this thesis.
A recent example of the company’s savvy business smarts involves the acquisition of LTYR Logistics in California. This provides a fully compliant logistics and technology distribution platform to drive sales through state-wide distribution of branded products. And it integrates LTYR’s seasoned, successful management team to steer the Sunniva marketing expansion going forward, including dispensary and retail outlet developments.
A schematic of Sunniva’s innovative onsite dispensary featuring grow-room views from the retail floor
Another example of management’s savoir faire relates to its handling of setbacks. To this point, Sunniva has devised plans to divest of its Canadian assets, the company says. This likely involves spinning off the company’s Canadian assets into a separate corporation and thereby streamlining Sunniva’s business model to more effectively unlock the value of its Californian business ventures.
Such a spin-off venture would prove to be a smart move. It would leverage both the proven pharmaceutical-grade purity of Sunniva’s production systems, as well as the ongoing investments in NHS clinics and patient acquisition initiatives.
It also gives the spinoff company ready access to Canada’s higher-margin medical cannabis market. This will ensure that the build-out is de-risked as much as possible, and calibrated to match the Canadian market potential, whether that includes the Canopy off-take agreement or not.
Additionally, with all the different financing options available to Sunniva, the company’s management has consistently demonstrated a level of fiscal restraint that is all too rare in the fledgling cannabis industry.
As a result, the company continues to be conservatively capitalized. It has a tendency to raise capital only when necessary. And with many of its shares are relatively closely held by insiders. In fact, approximately 27% of the shares outstanding are owned by officers and directors, and none have been sold to date.
This high insider ownership ratio, and the fact that insiders recently contributed over $2.5 million to the last financing, shows just how closely senior management’s interests are aligned with those of the company’s other shareholders.
High-tech, Low Costs, High Margins to Drive Sunniva’s Growth
With sales of high-margin extracted products increasing month by month, the company’s sprawling 489,000 square foot cGMP-certified cultivation greenhouse in Cathedral City is preparing to launch its own proprietary crop cycle.
Using clones sourced from Sunniva’s strategic relationship with the Oakland Vision Project (an established leader in genetics and cultivation), this milestone will mark the beginning of seed-to-sale vertical integration in action. And it’s all in support of the Sunniva “house of brands” approach to marketing.
As previously mentioned, Phase One at Cathedral City encompasses a 324,000 square-foot purpose-built greenhouse facility, translating into 50,000 kgs/year of dried flower capacity. And Phase Two will involve an additional 165,000 sq. ft of growing capacity, leading to an additional 22,500 kgs/year of dried flower output per annum.
Also the Phase One monthly output from the nearby Sun Oil extraction facility is estimated to be 180,000 grams of distillate and 125,000 grams of live resin extracts. I am also told that Sunniva is already looking to expand its extraction facility footprint due to increased demand.
Some of these metrics have been repeated because they are so significant; they offer the advent of hockey stick sales growth and high margins as Sunniva transitions into 2020. Even the sales projections for 2019 alone are stunningly impressive.
In time, the sprawling Cathedral City greenhouse will afford Sunniva’s house of brands the huge competitive advantages of low-cost, high-margin production.
Current wholesale prices for premium branded dried flower in California are around US$5 a gram. Yet Sunniva should be able to grow for less than US$1 a gram. And much of that will be converted into very high margin oils and other extractions that can wholesale for as much as $20 per gram.Such compelling economics will over the next couple of quarters prove to be a powerful catalyst for a resurgent stock price and market cap value.
Investment Summary
Despite this bright future scenario, the share price decline seen at the end of 2018 continues to offer what appears to be a heavily discounted entry point for new investors -- and an opportunity for longer-term shareholders to consider averaging down. Given the rapid recovery in the share price so far this year, the opportunity may not be this compelling for very much longer.
After all, it is worth noting that Sunniva is very undervalued relative to its US comparable peer group. The US peer group on average trade at 7.1x 2019 estimated revenues. Estimating Sunniva to achieve CDN $90-100 million in revenues in 2019, that would imply a market capitalization of over CDN $600 million. Sunniva currently trades at a market capitalization of around CDN $185 million.
With only about 38.3 million shares outstanding (53.0 million fully diluted), and having just raised CND $18 million, Sunniva benefits from one of the tightest share structures in the industry.
The near-term value driver for share growth will be Sunniva continuing to execute on the accelerating sales of its house of brands products in California. It cannot be over-emphasised that this should translate into significant revenue and margin growth as Sunniva ramps-up its operations in 2019.
Accordingly, I also anticipate that analysts from some or even all of the major investment banking institutions will likely commence coverage after Sunniva’s Q1 earnings call in late April. That’s how attention-grabbing these sales figures are expected to be. So stay tuned.
About the Authors: Marc Davis has a deep background in the capital markets spanning 30 years, having mostly worked as an analyst and stock market commentator. He is also a longstanding financial journalist. Over the years, his articles have also appeared in dozens of digital publications worldwide. They include USA Today, CBS Money Watch, Investors’ Business Daily, the Financial Post, Reuters, National Post, Google News, Barron’s, China Daily, Huffington Post and AOL. And Daniel Brooks is the head writer at www.CannabisCapitalist.ca