This company is one of the largest in retail revenues in Canada, and has targeted some 27 stores up and operating in 5 provinces (as of their 2nd quarter of their fiscal year). Give or take a couple here or there, their revenue totals show it, and they are definitely in full formation at the moment. They even claim global aspirations for the brand when and where available.
The share price has avoided as many of the bone jarring bumps others in the sector have seen, and even then, it’s seen a loss of almost half of its value since February (ranging from $1.72 – $0.94). Back to $1.34 now, the volatility in this sector makes for great trading if one can pick out who the market is ‘undervaluing’ at the moment relative to peers. I put air-quotes around value there because asset valuations and cashflows are unsettled, and certainty is far from certain.
Some outfits will be ready and execute – others won’t.
Retail has my attention at the moment, and given these guys are doing pretty whiz-bang in sales numbers, it’s time to add them to our retail section coverage, and get up to speed.
To the financials!
- Cash is good. They just completed a raise recently – and they’re gonna need it given the size of their shopping list.
- Asset to liability ratio is good, but the expansion is taking a toll on the accumulated deficit. They lost $17MM last quarter, on $9.5MM of revenues.
- G&A and SBC together is double their current operating margin of a respectable 35%. Ouch. Builds aren’t cheap.
- Marketing and promotion almost non-existent. ’Travel and Entertainment’ was 40% higher than marketing.
- They got stung with ownership requirements and forced into a reprice on some debentures. (Note 9. It’s a complex set of transactions, potential and actual, and not for the faint of heart). Net impact: loss of $8MM.
- Rather civilized income statement given they are in build, but for the debenture repricing.
- 35% margin across segments, I *heart* segmented reporting (Note 17)
- A little bit of ugly in commitments and contingencies (Note 16). Relatively sweetheart deals to the CEO and ED, with financial backstops in case anyone’s throw under a bus. That and related party transactions (Note 17)
- Goodwill is low. On-boarding of assets appears orderly as well. Perhaps a sign of right-pricing. More on that below.
- Private placement back in May wasn’t cheap. At all. 278 two year at-the-money warrants per $1000. This is where some serious potential future cost lays. But. It probably wouldn’t have nettted out too far from if they’d gone public with it (give or take).
- Dilution is given within the ‘Subsequent Events’ (Note 19) as purchases made with cash and shares combine with those stack of warrants. 2 years living under a cornice. Blech.
- And….boom. Not weeks after issuance, 2.5MM of the debentures were struck. Warrants remain live.
- 8MM options at $0.64 still rolling, with 2.4MM at $0.14 live. Lookout for the sound of SBC louder than a Rolling Stones concert soon.
- 39MM in warrants at $0.81. Blech times two.
- And….given the private placement and debenture execution, make that a new total of 36MM warrants at $0.77
- Doesn’t look like their apparel is selling. Immaterial.
Okay. If I’m down to hat selection, it likely means not much more to see there. Much to talk about though.
As a company, they own and operates an outfit with a wholesale arm/ licence, retail storefronts, and an accessory side. Verticality is the name of the margin game in retail. Disclosure is good in these financials. They’re well laid out, and largely fulsome. As I think about it, that’s one thing I’ve noticed in every retailer I’ve looked at so far. And it’s a very welcome thing.
Thumb-nailing their list of acquisitions, it looks like they’re paying around $4MM per incremental retail store. The consistency in which they’ve done this suggests they have a model and they’re sticking to it. It suggests planning, which has appeared somewhat haphazard in other links of the value chain. Leasehold improvements are running about 1:1 with each dollar of hard assets acquired. Intangibles are relatively civilized. Can’t say I like ‘customer lists’ being capitalized though. It’s only $800k ($3MM less than Namast’s), but still. Immaterial ultimately though.
Their lease obligations are high relative to PP&E – a function of renting versus owning. I’m a fan of owning the building (personally), but the nature of REIT’s and commercial real estate doesn’t lend itself to straying outside the system – at least if you want high traffic concentrations of retail. Not too notable, but, they are at the whim of owners – who tie increases and cost to a location’s profit. Something to look for going forward – it’s a direct hit to margin. I’m going to note exposure in other retailers as well, High Tide’s in the same boat largely. Might just be ‘the way that it is’ for most retailers.
Ontario has been as frustrating to these guys as everyone else. So far, they’ve gone in with 2 of the lottery winners to operate the brand, and appear to have secured ROFR’s on the license when it becomes transferable vis a vis purchase options. They have an analytic side (foundational for anyone delving into consumer consumption patterns and habits), as well as an online retail platform they operate in Saskatchewan.
Their sales growth looks good, as does expansion. Nothing too flashy, and nothing on their schema about creating day spas or a ‘Dolce Gabbana’ of dope. Good.
The bad? Capital structure.
To get to this point, they did the deals they could (presumeably). But. They have 100MM shares out as of balance sheet date, but what’s not mentioned explicitly is that there is another 74MM shares in debentures and warrants and options at the ready. This thing could up its’ share count by 75% in a sneeze.
I mentioned the share price in the header above, which normally I don’t do. The thing is, if or when Fire & Flower share price begins to accrete, the urge to strike optionality would be expected to rangebound the stock price – much as we’ve seen with FIRE and TGIF.
Most things operationally look good in this outfit. But relative to peers, the optionality looks much more like some of the LP’s in early formation. Given scale, that might be somewhat manageable as incremental cash flow comes online (if it were an LP). Instead – it’s somewhat governed by retail margins, external costs in leases, and the sluggishness of the overall storefront rollout.
A caveat is that their reported revenues probably don’t capture the most recent openings, and that only partial periods are caught. This is somewhat problematic for the investor (much like their peers), inasmuch as they’re like a car accelerating, but we don’t know it’s top speed. A function of an industry in formation. The branding is simple, formulaic, and consistent: a sign of experience. Regulatory hurdles remain an irritant. They are looking to Banff, Fernie, Vancouver, and Revelstoke in near term expansion – all known quantities when it comes to cannabis. Incursions into smaller towns – where limited competition would be expected in terms of number of stores – is good.
These guys look to be firing on all cylinders, even if single store revenues aren’t as good as peers. Given the brief period of initial ops, that’ll likely get better through time, and will eventually speak to brand and location quality. At $0.05/store – the current share price is around peer-set, but as mentioned, their capital structure is that of an LP. They need to keep opening stores, and keep increasing revenues. As it stands, they’re in a tractor pull.
There is nothing special or cheap about this at the moment, and I think the market knows that as well. This one might have been a reasonable price at sub $1, but it appears most don’t see much share price differentiation between retailers at the moment.
The next few quarters will give us far better insights. I wish I could say more. The capital structure in this one is worrisome to me.
The preceding is in the opinion of the author, and is not a recommendation to buy or sell any security or derivative. The author holds no position in Fire & Flower.