Liberty Health Sciences (OTCQX:LHSIF) ("LHS") is one of the few pure-play cannabis vertically integrated players operating in Florida and is among the few undervalued stocks providing a well-footed entry into cannabis play.
But the first question to ask is whether one is willing to fasten the belt for a ride on the marijuana magic carpet. The industry is still nascent, there is considerable regulatory overhang even now, many players are still posting losses, and availability of capital will remain a concern as long as investor anxieties about financial and, possibly, ethical ramifications of participation remain. All these concerns are largely offset by one single aspect: the industry's potential for exponential growth, the kind that was probably last seen before the boom in the information technology space.
At ~2.3 times its annualized Q1 FY21 revenue, LHS is a cheap entry ticket for the high growth industry. It is trading at a far more attractive price than close competitor Trulieve (OTCQX:TCNNF), which is valued far higher at ~5.6 times its Q2 FY21 annualized revenue. TCNNF, obviously, benefits from its position as Florida market leader and presence in three others states and its considerably larger scale of operations (~$253 million revenue in last FY, against LHS's ~$50 million), but given the expansion plans outlined by LHS, the gap in the stock's value is an opportunity.
In FY20, LHS expanded to 25 dispensaries from 14 in the previous year, which is expected to further increase to 35 by the end of FY21. The company's revenue growth remained spectacular in Q1 and Q2 FY21 (234% and 71% YOY, respectively), coming on the back of a solid increase in FY20 (401% YOY). The company's expansion plans seem locked in to maintain growth - LHS announced in September 2020 that the next phase of expansion on its 387-acre parcel in Gainesville will double capacity by December 2021. It also announced a partnership with Seed Junky Genetics to launch its first harvest of new premium strains in Florida by the end of this year. In the more routine expansion of business, its product portfolio expanded to 277 SKUs by May 2020 from 144 in November 2019, with the company foraying into the eatables market also in 2020, through a licensing agreement with VCC Brands.
There is obviously some distance before its double capacity and extended product line are truly reflected in revenue. But current and future growth is really only a part of the story that makes LHS compelling.
Profits at Operational Level and Debt
The other side of the coin that makes LHS interesting is that it has a healthy balance sheet and an improving financial strength, a rarity in a high growth sector with known difficulties in raising capital, which will facilitate the expansion plans. In fact, with D/E of ~0.2 (including lease liabilities, on May 31, 2020), LHS's low leverage is likely to be the fulcrum off which the company can take its leap. Leverage will likely increase as it expands by acquiring other smaller assets, but its liquidity position is comfortable, and its operations in FL seem well placed to support future working capital funding. Unless the company undertakes expansion at a hitherto unexpected rate, its balance sheet is a definite positive.
LHS's gross margin, at about 58% in Q1 FY21, is higher than most peers, and its operating efficiency should sustain, if not improve, when its capacity in Gainesville becomes fully operational. And, most encouragingly, LHS began FY21 by posting a cash profit at operating level in Q1, even after excluding the unrealized gains on increased fair value of biological assets.
The company seems to put profit over risky ambition, which should augur well for its future operational performance. LHS sold off its Ohio assets and there is no indication of their expansion plans in Massachusetts, where they acquired interest in William Noyes Webster Foundation (WNWF) in 2018. All of these indicate a company that is prudent even while achieving exceptional growth, which makes it a compelling investment option in the sector. LHS's management seems to be focused on Florida for now, which mitigates the regulatory and operational risks that open up for multi-state operators, especially from the standpoint of US federal laws.
While there are 33 states in the US that have legalized the medical use of cannabis, Florida is among the more attractive markets. The state's registered patient base has seen a spectacular growth in the last few years, increasing from ~0.11 million in May 2018 to about ~0.43 million by October 2020. There are various factors which work in favor of the cannabis industry here: Florida's sizeable population, both resident and tourists, its low proportion of registered patients (1.4% of the state's population as of Jan 2020), the improving supply and distribution infrastructures; and then there is the speculation that Florida might legalize cannabis for all adult users (for recreational purposes) in a couple of years, especially after the 'Make It Legal Florida' campaign which caught wide attention in 2019, by gathering over 700,000 signed petitions for legalizing recreating use.
Fundamentally, there seems no reason for the stock to languish at the levels it has been. But LHS's stock price has largely remained oblivious to the company's expansion plans and performance. The stock remained suppressed, probably indicating that the market is not differentiating the stock from similarly sized peers from the industry, and the financial difficulties faced by them. While it is easy to club LHS with the likes Acreage Holdings (OTCQX:ACRGF) or Columbia Care (OTCQX:CCHWF) (both with about ~CAD 75-100 million topline in the last FY, but with losses at operating level), LHS's stock price does not seem to factor in its stronger financials vis-à-vis its similar-sized peers. And ironically, it is LHS's financials, more than anything else, that make the company a better option than most others in the sector.
Conclusion
The stock fell by ~16% in YTD 2020, it has traded in a wide range between 0.38 and 0.72. The announcement of Q1 FY21 results did provide a fillip to the stock price (it rose over 20% in the ~20 days before the results, and corrected itself gradually thereafter), but Q2 results have not had the same triggering effect. There is, of course, the risk that a new CEO might change things around like ramping up the leverage or expanding at the cost of margin.
Given the limited clarity on the management changes and the stock's still attractive value, the more logical way to view the stock is as a medium-term hold, waiting for the market to build in the steady improvement in financial performance, backed by the astronomical potential inherent to the industry.
With its lowly levered balance sheet and steady operations, LHS presents an unusually attractive mix of factors to investors: it is the rare, well-positioned, fundamentally sound company in an industry with potential for exponential growth. In simpler terms, LHS is the underdog to back.
