It’s been awhile since our last Structure on High Tide ($HITI), when we looked at them back in their Q4 F2020. We noted CEO Raj Grover’s moves a few months earlier to expand digital and online sales.

As GoBlue points out within his latest ‘Quarter in Pictures on $HITI’ – concerns about the sales velocity and profitability are shared by both of the ‘large scale’ cannabis retailers in Canada (the other being Fire & Flower ($FAF), whom we have covered both recently, and extensively).

I’m certainly not writing a eulogy on retail here. Many a eulogy has been written over the past couple of decades on many different outfits, but others always soon emerge. Consumption patterns and consumer preferences are dependent on time, and as fashions and trends change, some companies (even supertankers) adapt well to regional/national tastes.

Put specifically in the context of Canadian cannabis sector retail though: I agree with GoBlue that there are worrisome signs for business attempting to scale. Increasing competition crimps rates of returns, and store caps by province creates an ultimate ‘speed limit’ of capital a retailer can deploy.

And enter the quintessential and foremost of all Canadian fetishes of commerce in Canada: the oligopoly. As retail profits diminish, independent retailers in a marginal location (or lacking in customer dedication) will be stressed. And I think examples from other sectors (groceries, clothing, electronics) will ultimately be applicable, be it in specific strategies of offering retail the choice between ‘Bulk Buy Value Warehouse Save A-Lot’ in an industrial park……….or a store called ‘Beauregard’s Finest Premium Sativa Compendium’ in an upscale neighbourhood.

Indeed, Raj has tilted towards the former, recently announcing splitting $HITI’s retail into 2 separate ‘divisions’: the already ‘no frills’ discount ‘Canna Cabana’ will be soon be joined by an even harder tilt to the ‘discount’ end of the spectrum (‘warehouse vibe’ as $HITI describes it).

In no uncertain terms, $HITI is definitely signalling the ‘vibe’ its’ getting from watching OPEX increase and incremental margins decline – and moving to lever volume as the core of the business. One can see this as targeting the largest consumers of gear – the extract segment – who are known as being an extremely price sensitive demographic. <We see this in the extract segment, where monthly cost for a 4 gram/month shatter consumer is ~=$250 and up>.

$HITI made an application for, and moved to the NASDAQ. Their share price demonstrated the same volatility back in February, and same sector declines since. The shareholder though is packing similar volatility and at a larger relative dollar value per share:

Let’s have a look at their share structure since they’ve effected that reverse-split, and see if there’s any moving parts.

To the financials!

_________________________________________________________________

• Goodwill and Intangibles (G&I) last three quarters (latest to oldest): $126MM; $93MM; $78MM. A function of Raj’s shopping spree. 18 months ago, it was $18MM. More below.
• Derivative liability down $5MM QoQ (from $15MM to current $10MM).
• ‘Share Capital’ up $43MM QoQ

Ok. Good disclosure in the financials overall. Not many moving parts in the capital structure…….but for 3 items.

Regarding G&I, it’s simple. The total amount isn’t important per se: the amount attributed to it though needs to bring in a rate of return on it that’s greater than a company’s cost of capital. If that takes years to crystallize – or if returns are uneven or looking improbable – the valuation of it will fall, and lead to write-downs.

And G&I is agnostic to how it came about: whether through strikes of optionality; cash; or equity issuance. Reductions inevitably flow through the equity box.

As $HITI’s acquisitions (and incremental cashflow) comes online, profit in excess of amortization and SBC are the gage. ‘Investing’ at the retail level is hyper-focused on cashflow, often to the detriment of whether or not a company is actually profitable for a shareholder. This is one of the cruxes of capital structure analysis.

That ‘Derivative Liability’ stems from a combination of warrants, debentures, and acquisition, although FAB Nutrition makes up the bulk of the total (Note 17). It’s attributable to a put option that $HITI issued that’s nested in the deal. Essentially, $HITI needs to hit certain ‘gates’ of some measure (perhaps EBITDA or revenue or share price) – or the sellers can force the remaining 20% onto $HITI at a fixed strike. It reveals the sellers are sophisticated (to whatever degree), and that they retained some leverage during negotiation. Ostensibly, it acts as a floor price for the assets, $HITI’s call acts as the ceiling. Either party might have suggested its’ insertion:

With respect to ‘Share Capital’ – between the Meta Growth Acquisition, the convertible debenture conversion, and a well timed equity issue in February – share count has proliferated – going from 33MM at the beginning of this fiscal year to its’ current 146MM.

The upside in doing raises at a high value is one gets ‘more’ cash. The downside? Equity has grown dollar wise, and like the example of G&I above – earnings need to be able to support capital structure. A high(er) relative equity value to earnings raises at an implicitly higher cost of capital. Earnings expansion needs to match capital expansion.

For different reasons…..but in agreement with GoBlue……I find these financials worrisome. $HITI is expanding in the US – it’s now a question of whether that growth can meet or exceed the growth in equity.

Share price is the mechanism with how this is measured, and by recent share price movement, the market didn’t see as much expansion as expected. Whether that expansion is measured by the equity box or in EBITDA.

The company is diversifying revenue streams and heading into a world where none have really ventured in the sector (selling weed, online accessories, broad based multi-national sales). Raj is heading into riskier waters than simply opening new stores.

I’d like to be more profound, but it boils down to $HITI is packing an expanded capital base, and they need to grow sales. If $HITI’s ‘new’ capital isn’t fed enough earnings/revenue growth regularly, share price will lose weight.

They need a progress quarter, relatively soon.

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 no position in $HITI