The Supreme Cannabis Company1,6
FIRE-TSX
September 18, 2019
Nice Q4/FY19 EBITDA beat, outlook remains solid
FIRE reported Q4/FY19 results yesterday that beat profitability expectations. Q4 sales were pre-released and thus in-line but were up an impressive 91% QoQ, at $19m. Adj. EBITDA however came in at $3.2m, well-above our street-high forecast of $1.5m and consensus of $0.8m, driven by higher than expected gross margin.
Impressive production scale efficiencies. FIRE achieved its highest gross margin on record in Q4/FY19 at 64%, up a surprising 1,400bps QoQ, and higher than our 50% forecast. This was not driven by pricing as management indicated its average dry flower prices were roughly stable YoY, and rather explained by significant production scale efficiencies. During the quarter, FIRE increased its capacity by ~90% with 23 total licensed flowering rooms and 230,000 sq.ft. of cultivation space. We also believe FIRE’s profitability benefitted from a right-sizing of its employee base, initiatives to improve yields taking hold, and the realization of some efficiencies from automation.
Pathway to Cannabis 2.0 products. We expect FIRE to continue ramping up its premium flower and pre-roll offering while also introducing more proprietary strains going forward. However, we expect FIRE could take a more measured approach to infrastructure development to manufacture its own Cannabis 2.0 products. To this end, we expect FIRE to continue to utilize contract manufacturers in coming quarters, accelerating its time to market for vape and concentrate products and leveraging its relationship with PAX and KKE to capture market share. As demand trends for extractproducts evolve, we would expect this to guide managements’ capital allocationstrategy with respect to deploying its own extract capacity with a view towards maximizing its margins and ROIC over the medium term.
FY20 guidance reiterated. Management maintained confidence in FIRE’s stronggrowth outlook by reiterating its FY20 guidance, calling for revenues of $150–180m.That said, the company’s margin profile could have some lumpiness in the comingquarters. We expect a ramp up in S&M expenses to support the launch of Cannabis 2.0 products, combined with greater reliance on contract manufacturing partners, ahead of FIRE’s own extraction capacity coming online later in FY20 with the Truverra acquisition. As a result, we expect FY20 EBITDA could be more back-half weighted.
Maintaining $3.25 target; BUY. With strong Q4/FY19 results and meaningful positive EBITDA for the first time, in our view, FIRE has joined the relatively exclusive club of profitable Canadian LPs, which we believe argues for stronger valuation metrics. In addition, despite Q4/FY19’s strong top line growth, we note FIRE ended the quarter with its highest inventory position on record, up more than 2.5x QoQ to $19m. This should provide good support for future revenue growth and flexibility for inventory allocation towards Cannabis 2.0 products. Our target is based on a DCF using: 1) a 9.5%
discount rate, 2) avg. market share of ~8%, and 3) 3% terminal growth.