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Sunniva - No Dice.

|Includes: Aurora Cannabis Inc. (ACB), CGC, SNNVF

Summary

Industry race to build the first Cannabis Gigafactory?

In contrast to popular opinion, Sunniva is not the Canopy of the South.

Recommend trading the momentum with stop losses.

Required reading - https://www.baystreet.ca/articles/research_reports/fundamental_research/Sunniva-Jan-2018.pdf.

Comments regarding Fundamental Research Corp's analysis on Sunniva.

THE GOOD STUFF

1 - Management is a team of all stars who know what they're doing

2 - Proposed Greenhouse design is quite detailed and can be considered relatively state of the art

3 - California market is ripe for a big manufacturer to step in

4 - Access to capital is relatively easy at industry average 8% cost 

5 - Expansion plans are feasible on paper

AREAS OF CONCERN

> Negative working capital of $12 Million and promissory note debt of $17 Million 

> Growth in intangible assets from $13.5 Million to $31.7 Million

> Goodwill of $12.9 Million probably related to purchase of NHS (overall this acquisition was accretive and beneficial as a launching pad)

> Current market cap is 10 times FY 2018 expected revenues of $35 Million

MY COMMENTARY

1 - Company sponsored analysis is generally bullish in nature and that's a good thing because every newly minted company wants high flying share prices to generate liquidity from. For a new growth stage company, their main objective should be to polish their story and promote it through all avenues (including sponsored research) to generate positive buzz which often leads to positive momentum in their share price.

Higher prices will enable them to raise capital at attractive valuations during a time when the company may not necessarily have any working capital and is burning through cash quickly. Since the management at Sunniva owns about 33% of the company, I see quite a lot of room for dilution as their massive expansion plans require funding. 

2 - At the time the report was published, the stock was valued far more reasonably than it is right now. The DCF analysis which supports the entire $47 "conservative" valuation hinges on the company executing to perfection at every step of the way until 2025 at which point in time the fair value of their shares will be $47. However, by then the company may have already issued another 10 million shares to its existing pile of ~26 million shares which could dilute the fair value estimate correspondingly to $29 per share. 

In my opinion, no fundamental analyst should recommend buying an overvalued company with negative FCF because its fair value as a company has the probability of increasing by 2025. By that standard, Tesla and Amazon would be fairly valued a decade from now so why not "get in today before the train leaves the station"? This is a dangerous way to think and invest.

3 - Other non-gaap metrics like price per square footage are completely bogus in terms of factual analysis. All else being equal, if I gathered investors and leased a 10 million square foot facility in Ontario, would that company be worth Billions of dollars just based on square footage? Square footage is only really valuable as a metric in real estate holding companies or REITs. 

4 - You may be wondering, what do I think these shares are fairly worth right now? I would say about a quarter of it's current price ($3.42) because that would still give it a market cap of ~3 times expected FY 2018 revenues, a high percentage of which are from the acquisition of NHS which itself was a profitable business at the time of acquisition (Feb, 2017). Net income for the enterprise would still be negative so any further fundamental analysis would be inaccurate and an exercise in futility.

As a side note, Sunniva is by no means an industry leader yet and therefore should not be valued with the high multiples that go along with being industry leaders. ACB currently enjoys a market cap 4.5x its FY 2018 expected revenues and they are arguably one of the top 5 global cannabis leaders. 

5 - I don't have an axe to grind with Sunniva or with Fundamental Research Corp. Indeed I think Sunniva's management is quite capable and have what it takes to execute their vision but I find it difficult to recommend purchasing their shares for any purpose other than swing trading (with tight stop loss triggers). Enamored as I am with their story, I think they have embarked on an uphill journey and the likes of canopy/aurora are not likely to just give up their leadership position to anybody.

As soon as cannabis is legalized on a Federal level in the US, Canadian companies are poised to flood their markets with high quality, cheap cannabis and derivatives which will likely negatively impact local US growers who will then be competing in a highly commiditized market. The price drop will be quite a bit more than a linear 5% per year and only the most well capitalized companies will make it through this initial boom phase in the cannabis industry. 

6 - What Fundamental Research Corp. has done right is assign a speculative rating to their thesis which I strongly support.

7 - What nobody is talking about yet is that well capitalized companies are in a race to create the first "Gigafactory" of cannabis that can produce 1 million kilos per year out of a single location. As soon as even one big player reaches a facility of that size, they will instantly change the game and overtake any competition based on economies of scale and far lower production/sales costs per gram. At this point, it's merely a thought experiment but as with all commodity driven businesses, the bottom line always wins. Just something to think about.

Thank-you for reading. This is my first post and I welcome all constructive comments.

Disclosure: I am/we are long ACBFF, TWMJF, HRVOF, RDDTF.