Despite being a relatively ‘old’ name in cannabis retailing, Nova Cannabis ($NOVA) is relatively ‘new’.

Nova Cannabis – as a retail chain – existed as a subsidiary within Alcanna – a liquor retailer that Aurora ($ACB) ultimately paid $138MM for a 23% ownership stake. $ACB quickly followed with a licensing deal to (presumeably) unlock margin vis a vis some level of verticality and self-branding. Alas, cannabis regulations didn’t roll out – nor did the State Monopolies behave – the way the business plans were written.

Barely 2 years after their entry, $ACB sold what they owned in Acanna for $27MM…….taking a smack on the ass on the way out the door.

It’s emblematic of the premium that attaches to otherwise pedestrian assets…….whenever the word ‘cannabis’ is able to be bolted on. We’ve seen so many examples of this in both Canada and the US over the past 5 years. It remains persistent across some regions.

Last January – Alcanna made the move to spin-out the Nova Cannabis assets, putting in motion a reverse takeover of struggling retailer YSS Corp ($YSS), who I’d pretty much given up on.

A successful secondary raise was timed well with sector effervescence in the early part of this year, and more activity followed as Alcanna was acquired by Sundial ($SNDL) in an all paper transaction in October. The price $SNDL paid was at a 40%(!) premium to market. Such is the cost of paper, right?

A Master Service Agreement (MSA) and debt financing arrangement continues to exist between Nova and Alcanna, and a close level of interaction between the two remains. The CEO of Alcanna is also the Chair of Nova, although Nova’s C-suite is based in Toronto (Alcanna has always been ‘Edmonton’).

High Tide’s ($HITI) CEO Raj Grover announced his company’s corporate wide rebrand (to a ‘discount club’) back in October. Yet it’s easy to forget that Nova’s combination with $YSS was predicated upon the notion of building a high-volume-thin-margin shop. Hey – that’s what Alcanna has been doing all along in booze anyway. Given the timing of Raj’s brand pivot, it’s not a stretch to suggest that Nova’s actions might be a large driver behind $HITI’s decision.

Nova’s put out a couple of financial statements, and it’s probably time to have a look at how they’re doing, what their disclosure and capital structure looks like, and see if there’s anything for the investor here. Their share price was lifted (along with Alcanna’s) in early September – as a potential takeout rumours swirled:

As we’ve recently noted, the ‘discount/value’ angle is capturing the attention of the news cycle. The media is happily chasing clicks over the perpetual worries of fretful hand-wringers (Ontario retail saturation anyone?), or eliciting emotion bandying about the phrase ‘illicit market’.

At any rate, To the financials!

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• Cash at $15MM, down $10MM QoQ. We’ll have a look to see where it’s been going. Inventory is flat at $6MM.
• $HITI’s inventory is $15MM, but packs an additional 30 stores, and carries proprietary glass/accessories. I went to look up inventory as a comparison on a per store basis (I’d assumed they would split out cannabis v non-cannabis), but note that neither company presents an inventory note nor breakdown in financials.
• PP&E at $29MM, $23MM in leasehold improvements, another $48MM in Right of Use assets. Of the entire outfit, with 63 stores….. .there’s a total of $6MM in tactile PP&E (fixtures & computers). Lean indeed.
• $19MM in Goodwill, arising solely from the $YSS acquisition. The $22MM purchase price for $YSS brought with it only $3MM in net identifiable assets (only $500k in cash and A/R). Notably, since the close of the deal on March 22nd, revenue from $YSS was $14.5MM, while it booked a net loss of $2.3MM.
• As to revenue, Nova booked $38.6MM this quarter and sported a gross margin of 17% ($6.5MM). Welcome to the world of “low prices everyday!”
• That comment from the analyst about $HITI never seeing 30% margins again doesn’t seem so prescient when such a clear example is already presented in $NOVA.
• Aggregate SG&A of $7.5MM, up $2MM QoQ. Thus, they report a loss of $1MM on operations. Depreciation and amortization is at $2.7MM.
• An additional $1.2MM was essentially written off. In July, $NOVA made a move on two stores in Ontario, paying $2MM for the licenses and such, but one of the stores wasn’t even built out/operationalized. As it is, they could only identify $750k in net assets between the two and took the punch.
• That $10MM in cash burn was comprised of additions to equipment and signage, although $NOVA notes a $4MM discrepancy between capitalization of this and the timing of payment.
• Most of that spend ($6.5MM) was in rebranding to the ‘Value Buds’ concept. $NOVA takes pains to point out that MoM revenue on a per store basis is climbing post conversion.
• Which brings up their disclosure: its’ tight. These folks have been around public markets for awhile, and it shows.
• Those ‘folks’ though aren’t $NOVA per se. They’re Alcanna people. Alcanna also owns about 60% of $NOVA as the apple never fell far from the tree. That MSA I referenced above costs about $200k per month for services from DaddyCo (IT/accounting/inventory mgmt. etc). Looks like they lever pretty hard off of the retail backbone, which, makes sense.
• 57MM shares outstanding. Existing warrants and options are essentially worthless (for most but the book-runners). More below.
• An example of exactly how lean this thing is run is within Note 15 – Administrative Expenses by Nature and Note 14 (Selling & Distribution Expenses). As far as I can impute, $NOVA’s spending about ~=$40k/mo/store on a per store basis.
• This quarter shows a real bulge in that number, up from $28k Q prior. Look for a return to lower per store expenses next time.

Ok. The disclosure……… and the way the financials are put together is good.

About inventory levels, it’s somewhat of a blind spot. Probably attributable to competitive concerns, both $NOVA and $HITI appear to run lean on a per store basis. $NOVA does refer to inventory in the MD&A on a YoY basis….mentioning that a $4MM YoY increase is due to increased store count, as well as “strategic investments in inventory levels at the stores re-branded to the Value Buds discount banner to accommodate the higher sales volume inherent in a discount retail model.” $HITI says nothing at all.

The $YSS folks didn’t exactly make out on the deal. They were issued 1.7MM warrants in a swap to consolidate their own (existing optionality). They’re at a strike of $6.51 – which – has never (nor will) come near the money – because they expire in 10 days. A real ‘hurry up’ there, and reveals who was pitching and who was catching. Contrast this with the financing Alcanna did in February to finance the combination, which was at $3. The warrants attached are not only in-the-money, they’ve another 18 months until expiry. The $YSS people pretty much got what they brought to the table, which wasn’t much.

The (only) jewell in $YSS’s crown – Sweet Tree – did cost Alcanna/$NOVA about $3MM as a standalone vis a vis contingent consideration. My takeaway is that Sweet Tree’s owner(s) had a good lawyer, and kept themselves separate from $YSS enough that they weren’t included in the larger deal by default. It’s an example of a good business management unto its’ own.

Well, I’ll have another look next time. There’s more, but the financials are pretty clean, and we’re in a place where the ‘discount’ model is in its’ infancy. Whether ‘17%’ margin is the floor, or whether we might end up with single digits in sight is an open question. With Raj and $HITI chasing the same consumer, it will probably become more difficult for independents that don’t have a solid location, or those who haven’t built loyalty into their existing customer base. It will likely become more difficult…… even if they already have those features.

If there is ‘synergies’ or a strategic vision within $SNDL’s purchase of Alcanna – it isn’t a leap to believe that Inner Spirit ($ISH) will be folded into this thing at the first moment it makes sense. As we’ve seen in other sectors (as well as cannabis), provincial ownership limits can be fluid over time.

Maybe that idea itself is what prompted Raj to act.

Either or, Retail 2.0 has begun.

The preceding is in the opinion of the author, and is not intended to be a recommendation to buy or sell any security or derivative. The author holds no position in $NOVA, $HITI, or $SNDL.