WFCF: A Superior Pick-And-Shovel Play On A $20 Billion Industry

About: Where Food Comes From, Inc. (WFCF)
by: Easterly Winds

WFCF is one of the best ways to gain exposure to the nascent North American hemp-derived CBD market.

The company has a history of strong revenue growth, supported by a healthy, albeit, flatlined free cash flow.

A forward revenue valuation model highlights the potential for significant capital returns over the next five years.

Many readers would be acquainted with Fama and French's efficient market theory which posits that stock prices are a mirror-like reflection of all currently available information, hence, no one posses any significant capacity to gain and sustain alpha on a long-term basis. While the theory broadly holds true with quantitative comparisons of the performance of active and passive funds, the actuality of a stock like Where Food Comes From, Inc. (OTCQB:WFCF) gives a reason to pause.

In my previous article on WFCF, I describe the company as a boring stock, noting how the combination of a unique niche and stable financials has laid the foundations for capital appreciation over the medium to long term. While I think sentiment expressed in the article was broadly right, the long call has proved to be wrong.

A Superior Pick-And-Shovel CBD Play

WFCF's businesses up until 2018 focused on providing certification and verification services to the food industry. The company's long-term revenue growth was primarily being driven by the growing desire of consumers to discover the story behind their food as well as to support a more sustainable food ecosystem. This positive macro backdrop saw revenue increase from $2.7 million in 2009 to $17.8 million in 2018, a 23.31% compound annual growth rate.

WFCF Investor Presentation August 2019

However, the investment case evolved when in 2018, it announced that it had been selected as the exclusive Program Administrator for the new U.S. Hemp Authority Certified verification standard. The long-term implications of this are material as it exposes the company to a market that could grow to $20 billion by 2024. Essentially, hemp growers and processors who display the U.S. Hemp Authority Certified seal in their product labelling, advertising and marketing distinguish themselves as high-quality in what is fast becoming a sea of options for North American CBD consumers.

In March 2019, the seal was awarded to 13 CBD companies; (1) Charlotte's Web (OTCQX:CWBHF); (2) CV Sciences (OTCQB:CVSI); (3) HempMeds; (4) Medterra CBD; (5) Balanced Health Botanicals; (6) HD Distribution; (7) Bluebird Botanicals; (8) MetaCan; (9) GenCanna; (10) Shell Farms; (11) Nature's Hemp Oil; (12) HempWorx; and (13) Barlean's.

US Hemp Authority Charlotte The North American hemp-derived CBD industry, still in a very nascent stage, will encompass a broad range of consumer products like tinctures, pills, beverages, food, as well as topicals (creams, balms, salves). Further, large national retail chains like Kroger (NYSE:KR) and Walmart (NYSE:WMT) have already started openly stocking CBD items in their stores. This sector is growing quickly and will likely never be smaller tomorrow.

By being the exclusive program administrator for the industry WFCF has created a strong foundation for continued material improvements to its business model.

I estimate quarterly revenues growing at a CAGR range of 9.5% over the next five years to $7.73. This could see the company realise annual revenue of $31 million come 2024. Assuming the company's current P/S ratio of just over 2.26 remains constant until 2024, the market capitalisation of the company should grow from $42.14 million to $70 million, a 13% annual rate of return. This is in excess of the historical returns of the broader market indices.

The Bear Argument

While the CBD narrative will lend some credence to healthy revenue growth over next half-decade, the extent to which this will translate to free cash flow should be questioned. WFCF has failed to translate revenue growth into free cash flow growth for most of the last few years, a flaw that has effectively flatlined the stock.

Chart Data by YCharts

Hence, while I expect the CBD business to boost top-line growth over the next few years, if the company mirrors its historical incapacity to translate growing revenues into growing FCF, then the appreciation of its stock price will be muted.

Where Gains Come From?

WFCF has a lot to gain as the fledgeling North American CBD market becomes more mature. The company, currently trading on a TTM EV/Rev of 2.11, has a bright future ahead of it as consumers requiring more information on where their food comes from and their increasing appetite for a more sustainable food chain intersect with the growing North American hemp-derived CBD market. If the bullish thesis comes to reflect reality, then WFCF might as well change its ticker to WGCF.

Disclosure: I am/we are long WFCF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.