Supreme Execution from Supreme Cannabis

Supreme Cannabis (TSX:FIRE) is a mid-tier Canadian Licensed Producer with a very unique sales model.

The company cultivates high-end cannabis for both the medicinal market and the recreational market. In the medicinal market, they operate under a very different model. 

Instead of selling direct to the retailers and/or the Provinces, they sell their premium 7Acres (medicinal) wholesale to the other licensed producers, and 7ACRES (recreational) to provincial wholesalers in 8 of the provinces, for the recreational market.

It's a pretty smart business model, as it allows the company to scale without the added cost of patient acquisition, retention, and fulfilment (which most of its competitors spend heavily on).

Supreme Cannabis

Supreme's 7ACRES products are at the premium end of the market, fetching between $10-14 per gram (with prices varying by province). Although their primary focus to date has been on the cultivation of premium dry flower, with the upcoming legalisation of edibles and extracts, they are primed to play a significant role in the premium oils market.

We aim to produce a unique, plant-based cannabis oil that carries the award-winning qualities of our flower into an oil product for consumers looking for a premium cannabis oil experience.

Supreme is currently in the final stages of completing their 440,000 sq. ft. cultivation facility in Ontario, which is currently licensed for 230,000 sq. ft., allowing for an annual production capacity of 33,500 kg. Once the facility is fully completed, the company projects annual production capacity of 50,000 kg.

In June of this year, Supreme announced that they had been chosen as one of four LP's to partner with PAX, the former parent company to Juul, and the makers of the PAX Era vape, one of the highest-rated and selling vaporisers. Following the legalisation of edibles and extracts in late October, the 7Acres premium vaporiser oil will be sold exclusively through the PAX-compatible pods.

Growth through acquisition

Supreme has grown aggressively through a few select and accretive transactions over the past 12 months. 

In May of this year, Supreme announced the acquisition of BlissCo – a medicinal cannabis producer – for $48 million in an all-stock deal. For the issue of 23 million Supreme shares, they received a 12,000 sq. ft., CO2 extraction facility in British Columbia, and one of the industry's most premium medicinal flower brands. This sale cemented a relationship between the two companies that had been in place since early 2018 (via a supply agreement).

Supreme Cannabis

And a short while later in July, the company acquired Truverra, a global leader in the development, production, and marketing of hemp and cannabis-derived medicinal products, in an all-stock transaction valued at approximately $20 million. Through the acquisition, Supreme gained a 5,000 sq. ft. facility in Ontario, which will be used to produce cannabis extracts, as the company gears up for Legalisation 2.0 in Canada later this year.

Acquisitions weren't only limited to Canada, with Supreme taking an investment in MediGrow in Lesotho, and obtaining a cultivation license in Malta. Although these transactions are not immediately revenue accretive, they do position Supreme as an international player, diversifying the risk of being hindered by a slow-to-start Canadian recreational market.

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Financials – Fiscal Year 2019 Q4

Supreme recently delivered a supreeeeme set of quarterly financials for the period ending June 30, 2019. Revenue of $19 million was a staggering 92% increase over Q3, and with a 59% gross margin, Supreme finds itself on a podium finish in terms of industry margins.

The company also produced their first adjusted EBITDA profit of $3.2 million driven by superb gross margins and better operating leverage. 

As mentioned above, the company is ramping up its production capacity, as it continues to increase its focus on supplying the ever-increasing recreational market. Their current model is a B2B wholesale model, which is not sustainable given the inevitable build-up of production capacity and associated supply. 

Supreme Cannabis

Supreme went on to give guidance of $150 to $180 million of revenue for the coming 12 months but stopped short of providing an adjusted EBITDA target in its 2020 guidance. Rather, they simply stated that it would be positive.

Operationally, the company is still burning cash, with free cash flow falling to $21.6 million in deficit for the quarter, albeit on higher capital expenditure. In total the company spent $76.9 million for the year, including nearly $15 million on the 7Acres cultivation facility.  This site is expected to be completed this calendar year, which will reduce the company's capital expenditures moving forward.

Supreme ended the quarter with $55 million in cash but also carries $79 million in convertible debt on their balance sheet. This convertible note is the $100 million of senior unsecured debt that arose from am offering in October last year and carries a 6% interest rate. The debt matures in October 2021 and converts to shares at a price of CAD$2.45/share (which are currently trading at CAD$0.96 at the time of writing). 

Risks

The biggest risk facing any cannabis company right now is how much runway they have left (gas in the tank if you prefer). The current conditions for raising capital for cannabis stocks is horrific, and investor sentiment means that share prices continue to fall. Raising capital in an environment of falling share prices on diminishing volumes is never a good place to be. For the moment though, this is not a risk for Supreme as they have enough cash in the bank. Definitely something for investors to keep a close eye on.

Their wholesale model is both an advantage and a risk

On the plus side, it removes the need to spend heavily on patient acquisition and retention. However, the risk is that as LP production capability and capacity ramps up, their reliance on Supreme's wholesale cannabis will significantly lessen. 

The Bottom Line

For Supreme, the future will depend on their ability to evolve 7Acres from a B2B wholesale brand, and into a recreationally-facing premium consumer brand. The company has given guidance that this transition will be completed by the end of March 2020, including the development of in-house packaging for its range of premium flower.

On a forward basis, Supreme trades at about 3.5x forward sales, which is significantly cheaper than some of the larger Canadian LP's like Canopy Growth, Tilray and Cronos. However, this is in line with smaller Canadian producers like Aphria,  Hexo, and OrganiGram.

Supreme had a very strong quarter with solid revenue growth, underpinned by one of the highest gross margins in the industry. Although this is their first EBITDA-profitable quarter, on their current revenue and margin guidance, we believe that Supreme will be able to deliver positive cash flow in the coming quarters as revenues (hopefully) continues to rise. 

We believe that the current share price offers investors either a great entry point to start a position or to dollar average down an existing position. We are buying Supreme Cannabis.

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Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

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