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Ecofibre: Growing Hemp Producer With Diversified Revenue Streams

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About: ECOFIBRE LTD. (EOFBF)
by: Yunus Yenikalayci
Yunus Yenikalayci
Value, foreign companies
Summary

The hemp producer has diversified revenue streams and could reach scale in the long-term.

Strong sell-off in the common equity brought the growth stock to attractive entry points.

Kentucy headquarter construction ongoing as costs did not require debt financing.

Profit margins and top line improved comparing the last quarter to the prior.

Investor Takeaway

Ecofibre Limited (OTCPK:EOFBF) is an international hemp producer that is active in the industrial use of the material, cannabinoid oil, and derivatives, along with plant-based protein products. The common stock is trading at a premium compared to the pharmaceutical industry and has recently experienced a considerable sell-off. This has brought a buy a dip situation to the growth stock and investors have the opportunity to pick up the diversified hemp producer at a bargain. With no debt and a healthy balance sheet, the company has turned profitable in mid-2019 and has growth prospects in the relatively young cannabis industry. We believe that the common equity could achieve scale in the segment in the future given its diversified revenue streams.

Company Background

Ecofibre Limited is engaged in growing, processing, and distributing hemp products within Australia along with the United States. The product offerings of the company range from hemp seed oil, hemp-based protein powders, tinctures, nutraceutical product lines for both human and pet consumption, and topical creams. Being founded in 2009, the enterprise is fairly young and is headquartered in Sydney, Australia. The main operating segments that I would like to highlight are the industrial use, plant-based protein, and the CBD business.

Consolidated Financials

Trading at 61.9x earnings, Ecofibre is a growth name in the developed market. The common stock trades at a premium compared to the pharmaceutical industry average of 20.1x. The company finally turned a profit in the quarter ending in the second quarter of the 2019 business year. Return on equity in the last reported quarter is 35.7% and is considered high as the pharmaceutical industry average stands at 10.9%. Profit margins improved to 26.3% in the last quarter of 2019 from 22.4% in the quarter prior. The enterprise holds no debt on its books and is debt-free. Important to note the business year starts in July. The company reported revenues jumped 42% in the quarter ending on March 30th, 2020 compared to the quarter prior. The company is building its headquarters in the U.S and directed cash flow to investing activities constituted mostly the construction process. The remainder of the cost to build will be paid by June 30th, the fourth quarter of the 2020 business year for the company. Funding for the building will not utilize debt, operating cash flow and cash on hand will be used to pay construction costs. Consolidated financials can be found here and here.

Catalysts

The company has gained itself ground in Kentucky, a state that use to grow a substantial amount of hemp back in the 1940s. They have political support in the state as tobacco jobs that used to offer employment in the state are declining in numbers. Hemp brings the state jobs and this assures political support. The company is active in selling CBD products to pharmacies around the United States. The CBD business is still young and barriers of entries are low, however, over time the segment will become more saturated and entry barriers will be higher. Regulatory frameworks in the United States are more straightforward and that is why the company is active in Kentucky. While we would prefer equity exposure in the industry, pure plays do not fit our investor profile. Rather, we prefer a company that also has several other revenue streams besides selling CBD. The U.S based business division utilizes a distributor-led model to sell products to pharmacies and practitioners in the United States. Which makes Ecofibre the perfect candidate, the industrial use department utilizes hemp in textile as the material is more sustainable compared to alternatives in the industry. Moreover, vegan consumer habits show that there is a market demand for plant-based protein. This doesn't imply that the demand for meat-based proteins is going to decline, rather that there is room for growth for plant-based proteins.

The U.S distribution division of the company sealed an exclusive deal with CVS Pharmacy to distribute its products at select CVS stores around the U.S. Bear in mind, CVS has over 9,900 stores around the United States. The CBD products that will be sold in CVS stores will be produced in the new headquarters in Kentucky. This only adds to the long term prospects of the business.

The thing we expect is companies that are profitable in the cannabis and derivatives segment, the revenue is already there all segment participants are selling at some amount of volume. Right now in the industry, net income positive companies are the ones that are ahead, and if they have some size, they are our candidates of interest which can achieve some rate of considerable scale in the long term. Trading this segment is oxymoronic, investors need to consider the longer investment horizons. Ecofibre in this space is an attractive candidate for the long term, the several revenue streams of the enterprise could allow the international company to grow further on. Hence, I think the premium the market has priced in on the equity is justified.

Technicals

ChartData by YCharts

There was a steep sell-off that occurred in the equity this morning session on the 18th of May. Price per share fell off to $1.1 from 1.682, the equity trades well below its 20 and 50-day simple moving averages. This in return has brought a discount to the growing hemp producer, meaning investors can take this opportunity to buy the dip and pick up shares at a bargain. My main outlook is that the major sell-off has brought the common equity to reasonable entry levels around $1.10.

Downside Risk

Governmental regulation is one of the main issues that could affect sales in the future. Especially in the U.S where the federal government still considers sales of CBD related products illegal, however, the states do not seem to care that much and we could see future legislation in favoring state's rights in cannabis medical and commercial sales. The majority of the states have legalized the medical usage of CBD and related products, while some still have not taken legislative action to do so. Implying that demand for the product has not peeked. How long will this take is the question in the mind of investors. The pandemic could push the legislative agenda indefinitely. Meaning that the post-pandemic environment will be bullish for Ecofibre. The next U.S election will be critical for cannabis legislation. The democratic candidate, Joe Biden has expressed his anti-cannabis stance numerous times before. Trump has a similar stance hence compared to his rival and this serves as a significant risk factor for investors contemplating exposure into the sector.

Conclusion

The growth prospects of the enterprise are attractive for growth-orientated investors that are seeking growth at a reasonable price. The healthy balance sheet along with improved margins supports our bullish conviction. Recent sell-off in the shares of the company have brought the equity to justified bargain levels, considering the scale the company could reach in the future. The company is signing deals with large scale pharmacies, while some legislative questions will arise after the 2020 elections. Exposure to Ecofibre makes sense for those who are seeking exposure to the cannabis industry with a company with diversified revenue streams.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.