High Tide CEO Raj Grover recently took out a competitor. When/if the deal closes, he’s going to rename all of their properties under the ‘Canna Cabana’ banner, have 63 stores in-system, and become (at least for a while) the largest retailer in Canadian legal cannabis.

It’s a bold move, but as we’ve chronicled, retail in cannabis has been a rough go. Constrained margins, slow permitting in B.C. and Ontario, and Quebec’s exclusionary State Monopoly have set up impenetrable barriers to entry. I expect margins are going to remain somewhat thin as the product is heavily regulated. I also expect Ontario and B.C’s limitations will alleviate over time and that Quebec will remain a state-monopolistic ghetto. An extended time frame to get assets into position costs money. A lot of money.

As we talked about on our latest podcast (not yet released, it’s still in post production), cannabis retail chains in Canada have followed an ‘inverted’ approach to growth. That is: a retail concept typically begins growing in a local or regional context, adds financial heft through sales over time, refines and polishes the operation, then takes that framework and expands nationally.

For public companies in retail, expectations of them having national exposure are somewhat of a given. The sluggishness of growth in legal cannabis retail had put a high premium on capital as well, so that the costs alluded to above not only contains limited margins supporting a ‘national’ business – it also has incremental capital coming in at 20%+. In this context, perhaps Raj’s move wasn’t as bold as it was necessity. $META was in the same boat, albeit a smaller one. And that smaller one (despite a good sized store count) wasn’t proving out as an operator.

$META’s sales were declining, and in an environ where market share is a critical metric, that’s a weakness. And despite having a decent sized bank account, the quality of store sales and brand weren’t going to let it remain decent for long.

Thus, a deal was born.

Let’s have a look at the last financials of $HITI’s initial stores, and see how performance was under the second quarter of COVID.

To the financials!

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• Cash flat at $7MM. Inventory at $6.4MM. Lean both ways.
• With $10.5MM in payables, and $14MM in convertibles coming into current as well….that acquisition – ostensibly paper for cash – is looking like it was the path forward for them.
• Describing this a ‘fighting for survival’ situation might be a little histrionic, it’s probably more accurate to say dilution was preferable to attempting a capital raise.
• Sales up again to $22MM, up $3MM. That’s a million a month in sales with only a single incremental store opened during the quarter. That’s good.
• 40% gross margin reported, up 2% over previous quarter (which was the first positive adjusted EBITDA reported).
• They attribute growth coming from GrassCity (their online accessory portal). More below.
• $HITI took a lump on $HALO’s $12MM acquisition of the Kush Bar properties. $HITI received $3.5MM as a non-refundable cash deposit, and the remaining value in shares. Those shares have tanked, and despite $HITI selling 25% of them, they’ve reported a loss of some $1.6MM on the sale so far. That deal was repriced, yet it doesn’t look like it’ll get done without additional write downs.
• Up to 236MM shares (ugh), 132MM warrants (59MM near the money), 9.5MM options at $0.50. This is going to change dramatically with the $META pickup. Those 59MM came from a pricy raise/facility created back in January.
• They’ve been shooting out $0.30 warrants to a business development consultant (almost 5MM of them out now). Cash conservation is a great idea, dilution…not so much absent hard growth in underliers.
• They rolled $2MM in debt by a year. It cost them repricing 1.6MM warrants from $0.85 to $0.30, likely to retain cash.
• FX loss of $4k in the quarter. Hallelujah. A company that can path $5MM in USD denominated sales, and have forex held steady. Hella, that’s taken 3 years for me to see in the cannabis sector. For anyone out there wondering if this is good or bad: this is what ‘normal’ looks like for companies with foreign exchange exposure. Revenue should come from core operations, not currency flux. Given the growth in US sales, it’s a little too ‘good’, and I doubt it was planned.
• If $HITI isn’t managing currency exposure yet, they will need to if non-native currencies become a larger portion of their income statement. I’ve got a question into them about it, whether it was an accident, or, is actively managed.

Ok. I’ve said it before and it’s worth saying again: their disclosure is very good.

As Canadian cannabis sales expand across the country, we’ve seen some retailer’s sales remain flat or even decline. $HITI bucks this trend with sales, and that $1MM/month growth is cause for some optimism. It implies they are capturing and retaining customers, as well as acquiring new ones. Given their heavy concentration in Alberta (34 of 37 stores are there….in a market of 500+) – is where optimism can be seen. Sales have increased in core cannabis by about a million. Replicating that in other regions will be a challenge over the mid-term.

In a nicely theoretical world, one assumes stock prices are a reflection of underlying assets. Is that the case in Canadian legal cannabis? Yeah, ummm, no.

To me, a large factor in valuation right now across the value chain is perceived survival rates. That is, who can be expected to survive the capacity rationalization and ‘normalization’ of the sector over the near-term. From this, valuations could be seen not as much of a function of the underlying assets as they are relative to peers. Fire & Flower’s ($FAF) value can be tied to Couche-Tard’s ($ACT) ‘investment’…. a capital deep and experienced retailer….such that $FAF has a backstop of cash and knowledge to be drawn from. The intimacy of the deal is one thing ($ACT gets 2 seats on $FAF’s board and specific ‘share registration rights’ as well). If the options are struck, $FAF becomes a subsidiary of $ACT. Any investor in $FAF needs to understand this. The removal of control from $FAF if $ACT acts – means the exposure an investor holds can change from being 100% legal cannabis, to soda pop and potato chips becoming almost all of the investment’s exposure. Not a bad thing if you’re looking for it, but one needs to be aware that’s what will happen.

The reader will note I include $FAF in most posts about $HITI – because I see valuations/performance as being relative, and the closest comparison(s) in retail (at scale) are between those two companies. With $HITI’s $META acquisition, it’s even closer.

We’ve kept an eye on US and international sales, and they appear to be tracking positively:

They attribute sales outside of Canada to ‘GrassCity’ (a detailed look at this subsidiary can be found here) and changes in purchasing habits. Wholesale is up as well – from $1.2MM to $2.6MM – and reported a 34% margin. That bump in US/international sales is from online accessory purchases – and is welcomed as the previous 5 quarters were largely flat.

Whether COVID (and the Amazon effect) changes purchasing habits structurally is yet to be seen, but will bode well for $HITI if so. We remarked that these business lines represent diversification and potential for margin uplift. We are now seeing some of that potential, and we’ll be looking for continuance/expansion of it.

I asked Raj what he expected the $META acquisition to add to his accessory sales – and he said $4-5MM per year. He also mentioned that every $META store will brought under the Canna Cabana banner.

And that’s the core of the acquisition: the $META properties underperform relative to Canna Cabana’s. $HITI’s conversion of these needs to uplift sales of $META’s properties to Canna Cabana averages. If Raj can do that, he’ll get the most value out of the buy. Look to the next couple of quarters to be somewhat muted (on a per store average ) in terms of profitability as the $META properties come into system. If $HITI improves those stores’ performance markedly, they’ll be in a good position, and more importantly, demonstrate capability. Expect disappointment in average sales per store initially…….as $META’s mutts will have to go through the dog wash.

Also look for continued momentum in US sales. They comprise 25% of $HITI’s revenue now – and if traction continues – it’ll bode well.

There’s a few negatives, a big one being the share printers $HITI’s got going overtime. They’ll need to be bulldogged at some point. But until financial performance gets to where capital becomes more readily available….they’ll keep right on printing.

The preceding is the opinion of the author, and is in no way intended to be a recommendation to buy or sell any security or derivative. The author holds a position in $HITI