Contributor Since 2015
(Please see important disclosures on our research report including that this is company-sponsored research, available on Refinitiv (Thompson Reuters), Factset, directly from the company, and at Cascend's coverage)
Halo is a cannabis extraction company that develops and manufactures medical- and edibles-quality cannabis oils and concentrates to be sold wholesale as well as through Halo’s brands. Halo also cultivates its own cannabis for some of its manufacturing, in order to ensure quality and reduce risk in its supply chain. Halo has expertise in all major cannabis manufacturing processes, leveraging proprietary processes and products, and has produced over 3.5M grams of oils and concentrates since inception. Halo operates in California, Oregon and Nevada, and has begun operations in Lesotho Africa through a strategic partnership.
Halo Labs participates in an emerging sector which largely didn’t exist in the public markets five years ago. The industry as a whole is reacting to the changing regulatory environment to expand capacity and address new and increasing market sizes. However, although enormous opportunities exist, valuations vary significantly.
As most companies in the space are currently unprofitable, we expected to use Price to Sales as a valuation metric. This assumes that most companies within a subsector will achieve a similar range of operating margins for a given revenue run-rate, and thus accumulation of revenues is one of the clearest measure of early success.
Based on this metric, Halo Labs has virtually the lowest valuation on Price-to-Sales in the entire Medical-Quality Cannabis Extraction group
Described another way: investors are paying huge multiples per revenue dollar to participate in this market. However, Halo Labs has more revenues than 50% of competitors but only 5% of the valuation – seems like there is substantial value there which may be unlocked as more investors see this story.
Please note that this data doesn’t yet include the most recent report by Halo of March Q revenues which roughly equal all of CY18’s revenues – CY19 appears likely to top $30m in annual revenues, more than tripling Halo’s revenues (and divide Halo’s valuation by 3 – it’s even more attractive).
Viewed in a scatter plot, it may be observed that there is no strong correlation between CY18 Price-to-Sales and Market Cap.
What is obvious is that Halo Labs valuation is much lower than all the companies on this chart – both companies with more revenues and companies with less revenues.
Seen in another chart, the relation between Revenues and Market Cap is clear: companies with lower Market Cap for each revenue dollar should show up above the diagonal dotted line, and companies which cost more per revenue dollar should show up much below the dotted line. Again, Halo is seen to be less expensive than the majority of its comparables.
To be clear: this is the wrong sector to participate in as an investor if you seek long-term operating histories, high profitability, and consistently increasing dividends. This sector is a emerging sector which generally has very high growth potential coupled with unprofitable companies (unprofitable because they raise capital to quickly ramp capacity and market share) and valuations which do not fit into a traditional Value portfolio – it looks more like venture capital, but in with public companies. This is a similar situation in Streaming Music with Spotify (SPOT:BUY) and its competitors, and the RideShare market with Uber and Lyft (LYFT) – there is a huge and growing market, and companies who plan to be winners in the space must grow capabilities and market share quickly.
Halo Labs generated more than $10m of revenues in CY18 – more revenues than 50% of its competitors:
And Halo is already on track to triple this in CY19 from our forecasts.
Halo Labs also has less cash available per share. In fact, Halo has among the lowest cash available per share in the group – 1% of shares are liquid cash versus an average of 10% for the group. Most have between 2-10%, and several have roughly 20-25%, with one outlier at 50% (company specific issue).
We see low available cash as both a weakness and a strength: Halo has raised less capital than its competitors, which means there is less available for expansion and acquisitions – this may be a weakness in building market share as quickly as possible, just like in Streaming Media and RideShare.
However, this had made the company (relatively) lean as they had to run efficiently. And it doesn’t seem to have impacted their capacity build-out -- roughly 25% of Halo’s market cap is in its capacity (measured by its property, plant and equipment). Roughly half of Halo’s competitors have much lower PP&E per market cap dollar – in the 0-10% range.
There’s a similar story when looking at Price-to-Tangible Book: Halo is trading at 9.7x, above its competitors’ average of 6.0x, indicating that for every dollar of market cap Halo created higher than average tangible book – roughly 60% higher than average. There appears to be one group running at roughly 7-15% Price-to-Tangible Book, and another group trending in the lower range of 1-5%. The large caps in the group average 7.2% Price-to-Tangible Book.
It is well-known that the market for legal cannabis and cannabis products has expanded rapidly over the past five years, driven by recreational use as well as edibles, and medical/health products. However, it is our belief that the medical cannabis sector has vastly outgrown the recreational portion of the sector – there is real science behind much of this newfound popular interest, and as more clinical trials are completed we should see acceptance across a broader portion of the population. To directly measure this transition and the possible beneficiaries of such growth, Cascend Securities measured consumer demand of cannabis by consumers / patients through its online prevalence.
From this data we determined CBD (red in chart below) has been the outstanding cannabis product, with the highest growth over the past five years -- it’s now the second largest search/commentary term with respect to online activity, behind “pot” but above the ubiquitous “weed” – this is impressive, as a decade ago few people knew the term at all.
Halo Labs is entering the CBD business directly as well: In April 2019 Halo agreed to lease a purpose-built hemp processing facility in Talent, Oregon to expand the Company’s production capabilities into manufacturing CBD isolate and distillate.
CBD demand has grown from close to 5% of total demand to over 30% in more than five years. And this demand has accelerated from 15% Y/Y growth in 2014, steadily increasing to 100% Y/Y in 2018, and finally slowing a bit to 80% in April 2019.
Our interpretation is that demand for CBD and CBD-based products shows the transition from a mostly recreational cannabis market to equal balance for medical/health focused cannabis products. This is why we believe that medically-driven cannabis extracts and treatments are among the best segments long-term -- we think this is real consumer/patient interest in medical uses of cannabis which is still in early innings – with more research and clinical trials we will likely see more demand
This demand for CBD likely mirrors the demand for extracts: pure compounds must be extracted from cannabis to be utilized in edibles and for health and beauty products. Demand will continue growing for medical-quality extracts, as we discuss later in this report. The recent passage of the US Farm Bill that excludes hemp from the Controlled Substances Act, permits CBD derived from hemp products to be imported and exported across U.S. state lines, although demand was growing strongly well before this.
Drug chain retailers are also entering the CBD, including CVS and Walgreens with CBD roll-outs to 800 and 1500 stores respectively.
There is the risk of the term “CBD” getting saturated in the market: it is getting hyped? We see almost zero online activity in “cannabidiol” suggesting health/medical-conscious consumers are being led to CBD by media instead of directly from scientific reports (or maybe consumers simply can’t spell it?) as most scientific literature reference the full name. Also, THC for health usage may be the long-term value play here for brand/offering differentiation: it’s barely growing (green below) and from a small base, and CBD is taking all the attention in online, but clinical/scientific research on THC and other derivatives (extracted and synthetics) are much more equal in prevalence
Our measurements (reasonably) show that pot and weed (blue and orange in chart above) combined are the largest category of online activity. Usage of the term “pot” is growing solidly off a very large existing base – not as strong as CBD, but still seeing growth. However, the term “weed” has been basically flat over five years: the term is still used commonly, but it is slowly being more-and-more eclipsed by “pot”. Virtually no-one uses the term “cannabis” except industry and medical professionals, and the occasional analyst, and “marijuana” continues to decline in use as well.
There’s a clear seasonality for consumer demand in the holiday season – gifts? solace from family?. We can also see investor-driven interest at key points which is much smaller than general holiday consumer demand.
Given the enormous – and continuing – growth potential of CBD and extracts in general, we expect revenues and market capitalization should increase at roughly the same rate. The chart below show Halo Labs’ stock price versus the scaled consumer demand for CBD. As can be seen, the stock has steadily risen from CY2016 of roughly $0.15 per share to the recent peak of $0.58 per share (and has pulled back a bit). Please remember small cap stock market capitalizations may be driven near-term by trading spreads and volumes and capital raising activity, but we believe the fundamental performance of extracts in general and the company specifically coincides with the increase in valuation.
The next chart shows the same chart but with the year-to-year growth of CBD demand. As may be seen, growth has accelerated over the past five years, growing faster and faster, culminating in a 100% Y/Y growth throughout most of CY2018. We don’t expect this growth rate to continue, not because demand is slowing, but because the market is getting to be of a significant size and high growth is difficult in large markets.
Even before a company embarks on the FDA approval clinical trial process, they must demonstrate that they are able to consistently manufacture a high-quality drug product. This is an essential part of drug development and presents special challenges when the drug is derived from a botanical source, including cannabis. The Pharma industry worries about issues with mixed consistency of product, and variability in these unpurified products, whether they come from a single plant source or from a combination of different plants. To support development of drugs derived from botanical sources, CDER established the Botanical Review Team in 2003, and in 2015 revised and published a draft Guidance for Industry: Botanical Drug Development.
This is important for medical cannabis: Tetra Bio-Pharma just suspended its European Phase 3 clinical program in February 2019 due to impurities found in its PPP001 investigational drug. The study found the presence of three mycotoxins in the lot used for clinical trials. The drug was extracted from raw plant-based material and not synthetically created. This delays the trial by six months while Tetra Bio_Pharma reassesses its extraction/preparation process.
This is also important for edibles and health applications: cost of materials are far lower than the cost of bad publicity from a product with unwanted side effects: consider Chipotle’s ongoing disasters with impurities: risk avoidance is of paramount importance for consumer products companies. And quality / purity is a significant marketing point for companies, and is one of the key reasons a customer will stay with a brand over the decades.
Halo Labs is a cannabis extraction company which produces and sells quality cannabis oils and concentrates -- the fastest growing segment in the cannabis industry. Halo has expertise in all major cannabis manufacturing/extraction processes, leveraging proprietary processes and products, and has produced over 3 million grams of oils and concentrates since inception. The Company operates in California and Oregon as well as Nevada with its partner (Just Quality). The Company has also begun operations in Lesotho Africa through a strategic partnership with Bophelo Bioscience. Halo markets branded and private label products across multiple product categories.
Halo Labs was formed as a corporation under the laws of British Columbia on May 25, 1987 as "Apogee Minerals Ltd.". On September 28, 2018, Apogee amended its articles to create a class of convertible class B restricted voting shares ("Class B Shares") and changed its name to "Halo Labs Inc.".
Production (Manufacture & Extraction)
Halo Labs core competency is the manufacture and extraction of cannabis oil and concentrates for sale to retail businesses and wholesale distributers as finished consumer-packaged goods. The Corporation's three co-founders have been involved in the manufacturing business since 2013, and Halo Labs has manufactured and sold over 3 million grams of cannabis oil and concentrates since April 2016.
The Corporation's philosophy with respect to the extraction and manufacturing of cannabis oils and concentrates is to be platform- and technology-agnostic, given the rapid evolution of technology and consumer preferences. The Corporation operates numerous extraction utilizing:
The Company produces and sells over 50 products in the following categories: concentrates – shatter, sauce, resin and diamonds (THC-A crystals); oils – both in raw and distillated form in a variety of strains and flavors, as well as THC, CBD and blends. These oils are primarily packaged and sold in glass cartridges, but also in plastic cartridges and in syringes for consumption as dabs. Halo also manufactures and sells made-to-order distillates to edible manufactures.
In October 2018 Halo launched three edible products in the state of Oregon:
Halo Labs operates a manufacturing facility is in Medford, Oregon of 12,000 square feet of indoor manufacturing space. Within the facility, approximately 1,400 square feet is a segregated Class 1, Division 1 explosive-proof room for volatile extraction.
In April 2019 Halo agreed to lease a purpose-built hemp processing facility in Talent, Oregon to expand the Company’s production capabilities into manufacturing CBD isolate and distillate. The facility will initially be 7,500 square feet but expandable to 10,000 square feet in total. Production at the facility is expected to start in 3Q19. At full capacity, Halo will be able to process approximately 10,000 kilograms of hemp per month, which the Company expects will yield 700 to 900 kg of high-grade distillate or isolate and is projected to result in monthly revenue in excess of US$3.5 million at current wholesale prices. Talent, Oregon is in the Emerald triangle, just 20 miles from the California state line and 10 miles from Halo’s existing Oregon THC-focused extraction facility -- the site allow Halo to buy hemp biomass from both Oregon and California as well as building critical mass between the two nearby Oregon facilities.
Halo is working with Just Quality on the operation of a manufacturing facility located near the Las Vegas international airport. Halo works with Just Quality in 2,000 square feet of this facility , and Clark County has permitted Just Quality to build out a 1,000 square foot non-volatile extraction lab that can utilize ethanol or carbon dioxide.
Upon closing of the purchase agreement with Just Quality, Halo intends to manufacture using both volatile extraction methods (e.g., butane and propane) in a Class 1, Division 1, explosive-proof room, as well as non-volatile extraction processes (e.g., carbon dioxide and ethanol). This facility is currently being primarily used to assemble vaporizer cartridges and DabTabs™, however, Halo intends to produce its entire suite of cannabis oils and concentrates in this Las Vegas facility following the acquisition by the Corporation of the Production License, (which should occur within 180 days pending the processing and approval of the transfer request by the NV DOT).
Halo entered the California extraction market in November 2018 and operates two facilities in California:
Halo Labs cultivates cannabis in Oregon under OLCC cultivation licenses and intends to begin cultivating cannabis in Nevada, pending the closing of the Corporation's acquisition of certain Nevada cannabis licenses and related assets from Just Quality and the proposed transfer of the cultivation license to a 20-acre site in unincorporated Clark County, Nevada. Halo Labs only plans cannabis cultivation it is necessary to ensure adequate and cost-effective supply of raw cannabis materials for its production of cannabis oil and concentrates. Cannabis cultivation in California is not part of its current strategy.
In Oregon, Halo Labs holds OLCC cannabis production licenses for outdoor cannabis cultivation on approximately four acres of farmland. The Corporation also manages outdoor cannabis cultivation on two additional adjacent acres under third party production licenses, with the raw material produced contracted to the Corporation.
This site produced approximately 5,521 pounds of usable dried cannabis material (including A bud, B bud and trim) in CY18 – it’s first year of operation -- at a cost of approximately $188 USD per pound (including amortization of CapEx). Halo Labs is continuing to cultivate here to help ensure consistent supply of high quality raw material, even though there is substantial existing oversupply overall in Oregon. Its cannabis cultivation operations in Oregon provide approximately 13 weeks of supply for its Oregon manufacturing needs.
On September 27, 2018 Halo Labs agreed to acquire Just Quality’s Cultivation License, Production License, and its rights for the Distributor License. Halo plans to cultivate cannabis at an unidentified site in Clark County using lowcost light-deprivation hoop houses to cultivate raw cannabis material primarily for use in its manufacturing of cannabis oils and concentrates. Current expectations are that this facility will be fully operational within 24 months of acquisition and that at full capacity it will produce 50,000 pounds of usable cannabis material (A bud, B bud and trim) annually at a cost of approximately US$175 per pound (including amortization of CapEx).
Management believes there is currently an undersupply of wholesale cannabis materials in Nevada. Halo is hedging its supply risk by becoming self-reliant in producing quality raw material at low cost, which likely will provide a sustainable competitive advantage in the Nevada market.
In California, the Corporation intends to leverage its relationships with cannabis cultivators from the “Emerald Triangle” (Humboldt, Mendocino and Trinity Counties) from its work in Southern Oregon to provide raw cannabis supply. The so-called Emerald Triangle is considered to be the largest cannabis-producing region in the U.S. It believes pesticide-free outdoor cannabis material from licensed producers in Northern California will cost $80 to $160 USD per pound (before cultivation taxes). Near-term, cannabis will likely be in abundant supply in California (as it is in Oregon and Washington). Because of this, Halo doesn’t plan cultivation facilities in California.
Halo formed a strategic partnership with Bophelo Bioscience in Lesotho Africa for a 20% royalty stake. They have an off-take agreement on 14 hectares.
Halo is in active talks for partnerships in Europe.
Halo Labs operates a licensed distribution (wholesale) business in Oregon and is in the process of acquiring rights to conditional approval of a distribution license in Nevada from partner Just Quality.
Halo’s distribution (wholesale) business in Oregon is focused almost exclusively on the wholesaling of the internally manufactured products. It employs salespeople who call on approximately 300 cannabis retailers in the state, and dedicated drivers to deliver products to these dispensary clients.
Just Quality began distributing the Company's branded products in Nevada in August of 2018: the Gilt, Black Hat, Mojave, and Hush branded product lines which are now available at 14 dispensary chains across 18 locations.
In California, Halo plans to utilize a small portion of its second 13,900 square foot facility to house its distribution business for Southern California. Specifically, Halo is using its distribution capabilities to prepare finished goods fully tested with a certificate of analysis to sell to established distributors in final form for them to sell onward to dispensaries and other smaller distributors.
The Corporation holds an OLCC processor license and an OLCC wholesaler license for its manufacturing and distribution facility in Medford, Oregon. The Corporation also holds four OLCC producer licenses for its outdoor cannabis cultivation operations in Rogue River, Oregon.
Coastal Harvest holds a Cannabis Business Local License for manufacturing issued by Cathedral City, and an Annual Type 7 Manufacturing License from the California Department of Public Health, for its manufacturing facility in Cathedral City, California.
ICL9 holds Cannabis Business Local Licenses for manufacturing and distribution issued by Cathedral City, a Temporary Type 7 Manufacturing License from the California Department of Public Health, and a Temporary Type 11 Distribution License from the Bureau of Cannabis Control for its manufacturing facility in Cathedral City, California.
The Corporation does not yet hold any licenses in Nevada, but entered into an asset purchase agreement on September 27, 2018 to acquire Nevada cannabis licenses from Just Quality:
Halo also plans to manage Just Quality's manufacturing facility pending the closing of the asset purchase agreement. Pending the issuance of a Marijuana Business Support License from Clark County, the Corporation is financing and advising Just Quality, and the Corporation and Just Quality have not implemented the terms of the Management Agreement.
White label sales account for roughly 35% of revenues.
NEVADA (through Just Quality)
Revenues are already stronger than Halo’s comparables, but they look ready to increase substantially. In the first three months of CY19 Halo reported three consecutive months of record revenue including $2.4 million in January, $2.6 million in February, and $2.8 million in March 2019, with over half of those figures coming from newly launched California operations. These revenues are already roughly 50% of CY18’s revenues.
In California Halo signed a monthly extraction contract with Industrial Court L11, LCC worth $2.1m USD per month, and a $2.0m USD monthly extraction contract with Cannus.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: (Please see important disclosures on our research report including for company sponsored research, available on Refinitiv (Thompson Reuters), Factset, directly from the company, and at Cascend's coverage)