Analysts' Ideas of the Week › articles › research_reports › fundamental_research › … · Farmako to contribute meaningful company top-line revenue starting 2020. Weekly Cannabis

Analysts' Ideas of the Week Emerald, Ruby and Sapphire Assets With Near-Term Production

Potential

January 6, 2020

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PLEASE READ THE IMPORTANT DISCLOSURES AT THE BACK OF THIS REPORT

Mining / Exploration

Company Name: Ticker Symbol Current Share

Price:

FRC Fair Value

Estimate:

Date of PR:

Fura Gems Inc. TSXV: FURA $0.18 $1.17 December-31-

2019

PR Content

After multiple extensions, the company

finally completed a previously announced

acquisition of a sapphire mining project in

Queensland, Australia from Richland

Resources (AIM: RLD) for US$1.25 million

in cash. The project was in production from

2015 to 2017. According to RLD, the project

has an estimated 100 million carats of

sapphire (JORC 2004 resource estimate). Fura

intends to properly delineate the deposit, and

resume/ramp up operations. Fura had

completed the acquisition of a ruby

prospecting licence in Mozambique in

October, and is currently in the process of

completing the acquisition of three additional

licences/concessions in the area.

FRC Opinion

Positive – With the latest acquisition, the

company now holds emerald, ruby and sapphire

assets in Colombia, Mozambique and Australia,

respectively. The big three coloured gemstones

market (rubies, emeralds and sapphires) is

estimated to account for US$1.5 - US$2.5 billion

per year (Source: Natural Resource Governance

Institute). We will be publishing a detailed

update when management provides details on

their 2020 plans for all three projects. Note that

all three projects have near-term revenue

potential for Fura.

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Cannabis

Company Name: Ticker Symbol Current Share

Price:

FRC Fair Value

Estimate:

Date of PR:

AgraFlora

Organics

International

Inc.

CSE: AGRA $0.09 $0.38 January 3, 2020

PR Content

Closed the acquisition of Farmako GmbH

(“Farmako”), the parent company of The

Good Company GmbH (“The Good

Company”). Farmako has a German

distribution network that extends over 20,000

pharmacies and an aggregate patient

population of over 100,000 unique

individuals.

FRC Opinion

Positive – We are pleased to see AgraFlora

close the acquisition of a revenue generating

company (Farmako realized revenue of over

$2.75 million in their fiscal 2019). We expect

Farmako to contribute meaningful company top-

line revenue starting 2020.

Weekly Cannabis Commentary

Below is the performance of the Horizons Marijuana Life Sciences Index ETF (TSX: HMMJ /

“HMMJ”) as a proxy for sentiment of the cannabis market.

Horizons Marijuana Life Sciences Index ETF

Source: Google




The HMMJ is currently trading at $8.26, a week-over-week increase of 1.10%. Over a one-year

period, the HMMJ has lost 48% in value. Currently, the HMMJ is trading 1.35% above its 52-

week low of $8.34. Despite the roll-out of cannabis edibles and alternative cannabis products in

Canada, sentiment of cannabis stocks remains exceedingly weak. The coming weeks will be

crucial in gauging whether cannabis-infused products live up to investor expectations of

being able to drive greater value in the Canadian cannabis market. As we have previously

mentioned, cannabis-infused products could have a profit margin of up to 92% compared to

dried flower of 76% (Source: Grizzle).

From our interpretation of current supply and demand of cannabis-infused products in Canada,

we believe that supply is severely limited. To reinforce our belief, in Ontario, the projected

largest Canadian cannabis market, the Financial Post (“FP”) indicated that there is limited supply

of cannabis-infused products for purchase at retail stores. It was noted that “the Ontario

Cannabis Store (“OCS”) has received products from fewer than 10 licensed producers (“LPs”)

since such items became legal on Dec. 16 [2019] – the agency has supply agreements with 40

LPs across the country”. We believe this statement to be concerning, as it indicates that either (1)

LPs have failed to develop suitable cannabis-infused products in time for sale to consumers or (2)

regulatory approval by Health Canada for cannabis-infused products are highly stringent

(resulting in approval delays). We believe the latter point to be more probable. Although we

cannot draw conclusions as to the longer-term availability of cannabis-infused products, the

currently limited availability of cannabis-infused products is a potential red flag.

Marking the start of a new year, we outline trends that shaped the global cannabis market in 2019,

and outline the plausibility of such trends extending into 2020.

Trends That Shaped 2019

1. The Rush to Establishing Commercial Operations;

2. Loosening Regulations on Cannabis; and

3. The Emergence of CBD products.

The Rush to Establishing Commercial Operations

The legalization of cannabis in one of the largest advanced economies in the world (Canada)

created a rush of new cannabis companies in hopes of becoming first-movers and differentiators.

The total capital raised from January 2019 through to October 2019, was US$10.33 billion

compared to US$7.46 billion over the same period last year (a 38% year-over-year increase).




Taken From: Marijuana Business Daily, Source: Viridian Capital Advisors

However, against the back-drop of a poor-performing Canadian cannabis market, small

and medium-sized companies that have rushed to establish operations in 2019 are now

facing the risk of bankruptcy. We believe investors are shifting away from being speculators

and becoming more cautious in picking companies that are able to achieve economies of scale

and profitability. As such, we believe this trend is not expected to take form for 2020. We expect

further consolidation in the global cannabis market as unprofitable cannabis companies shed

their operations.

Loosening Regulations on Cannabis

In addition to Canada having a legal framework for adult-use and medical-use cannabis, a

number of other countries have legalized cannabis for medical purposes. To date, more than 50

countries are regulating cannabis for medical purposes (Source: New Frontier Data).




Legality of Cannabis

Source: New Frontier Data

Currently, only Canada, Uruguay and some U.S. states have legalized cannabis for adult-use.

Loosening regulations on cannabis in 2019 is expected to extend into 2020 as the domino-

effect for cannabis legalization continues. Namely, readers should look to Mexico and

Luxembourg as countries that are expected to fully legalize cannabis in 2020.

The Emergence of CBD Products

With the legalization of cannabis comes the emergence of cannabidiol (“CBD”) products. As we

have previously touched upon, there has been many alleged benefits of using CBD products. To

capitalize on such alleged benefits, 2019 marked the start of a number of companies creating

products infused with CBD. To date, cannabis products in the form of CBD are currently readily

available online and in the stores of Wal-Mart (NYSE: WMT), Tesco PLC (LON: TSCO), etc.

With that said, given that CBD products have only recently started gaining traction, there are

numerous uncertainties regarding the benefits of using CBD products over an extended period.

For example, the Food and Drug Administration (“FDA”) noted that CBD products have the

potential to cause harm. Until more definitive research is published, we believe the

popularity of CBD products will extend into 2020. The following is an excerpt taken from the

FDA outlining the uncertainty regarding CBD products.




Source: FDA

Conclusion

Overall, the start of 2019 created a highly optimistic outlook on the cannabis market. However,

against the back-drop of a less-than-ideal Canadian cannabis market situation, this optimism was

short-lived and shareholder value was severely destroyed for the remainder of 2019. As we have

noted, the HMMJ lost 48% over a one-year period. We believe that investors will be cautious on

the outlook of the global cannabis market headed into 2020, and will be severely stringent in

their cannabis investment criteria. We expect further consolidation and only a handful of big-

name cannabis companies to emerge victorious. The continual legalization of cannabis in

countries around the world is expected to provide the cannabis market with a base-line for

growth. Lastly, we expect 2020 to be an essential year in gauging whether the hype regarding

CBD products are warranted.




Performance of Select Canadian LPs

The following shows the performance of select Canadian LPs on a 1-month, 6-months, YTD and

1-year basis.

Name YTD 1-Month 6-Months 1-Year

Aphria Inc. NM -6.88% -29.52% -27.05%

Aurora Cannabis Inc. NM -28.61% -74.56% -64.66%

Canopy Growth Corp. NM -7.60% -49.59% -32.06%

Cronos Group Inc. NM -4.34% -55.32% -46.55%

Tilray Inc. NM -19.30% -65.90% -78.40%

Hexo Corp. NM -35.81% -71.06% -69.38%

CannTrust Holdings Inc. NM 28.57% -69.40% -78.87%

Organigram Holdings Inc. NM -21.35% -69.70% -50.44%

The Supreme Cannabis Co., Inc. NM -8.96% -59.33% -63.03%

AVERAGE NM -11.59% -60.49% -56.72%

Source: Google

The average 1-month, 6-months and 1-year returns were -11.59%, -60.49% and -56.72%,

respectively.

Valuation of Select Canadian LPs

The following shows the average Enterprise Value to Revenue (“EV/R”) that cannabis

companies are currently trading at. The change in average valuations due to notable news are

also presented below. The companies used in the chart below are outlined further.




Source: FRC

Source: FRC, S&P Capital IQ

The average EV/R, as of January 6, 2020, was 12.5x – a slight decrease from an average EV/R of

12.7x on December 23, 2019. As a number of companies are not EBITDA positive, we have

refrained from tracking the average Enterprise Value to EBITDA (“EV/EBITDA”).

In the following, we provide commentary on Canadian retail cannabis pricing.




Canadian Retail Cannabis Pricing

Source: Online Provincial Cannabis Store, FRC

The average retail price per gram increased nominally from $11.62 to $11.63 – a week-over-

week increase of 0.10%. The largest retail price per gram increases were witnessed in the

provinces/territories of British Columbia (of 0.91%) and Nova Scotia (of 0.69%). This was

slightly offset by a retail price per gram decrease in Quebec (of 0.93%) and Manitoba (of 0.50%).

The other provinces/territories witnessed a nominal week-over-week increase/decrease in their

retail price per gram. Over the long-term, to combat the black market for cannabis, we expect

retail price per gram to decline nationwide.

Having discussed the restricted supply of cannabis-infused products in Canada, we provide a

discussion on the pricing and dosage of such products. Our discussions will be primarily on

cannabis edibles.

Using the Ontario cannabis market as a proxy for edible cannabis prices, the retail prices per

package of cannabis edibles range from $7 to $14. Products available include mints, chocolate

bars and gummies. Readers should note that the legal limit on THC per package is 10 mg. When

THC regulations on edibles were announced, many Canadian consumers outlined dissatisfaction

and stated that the THC limit was not enough to provide an adequate high. With that said, the

high generated from THC depends entirely on the tolerance of an individual.




Source: latimes.com

Shown above (outlined in red), those who have low to very low tolerance will find legal cannabis

edibles to provide a suitable high. On the other end, those with greater tolerance will likely find

such products to have a weak high. For comparative purposes, the following outlines the

estimated amount of THC inhaled through a 0.5g joint (using a THC content of 11%).




THC Inhaled From a 0.5g Joint

Source: latimes.com

Using the average price per gram from our model above, a 0.5 gram joint would cost

approximately $5.82 and yield a THC content of 20 mg. This amount of THC would provide a

“typical desired” high for beginners, those with some experience, and those that are

experienced. To achieve the same THC content in edibles (assuming an average retail price of

$10.50), a consumer would have to pay approximately $21. Adjusting for the duration of the

high (assuming high from dried cannabis flower to last two hours and from edibles to last six

hours), the cost of having a 20 mg THC high for six hours would be approximately $18 for

dried cannabis flower and $21 for edibles. We have provided a visual illustration below (each

green rectangle represents the number of respective products required to be consumed).

Costs to a Consumer for a “Typical Desired” High Effect for Six Hours

Source: FRC

The cost from using dried cannabis flower to cannabis edibles to achieve a similar high

seems to be 14% lower. As such, price-sensitive consumers who are strictly looking to achieve

a high (neglecting the convenience of edibles), would likely opt to continue using dried cannabis

flower as opposed to cannabis edibles. With that said, given the convenience of using edibles to

smoking dried cannabis flower, we believe that the pricing discrepancy to be very reasonable.




There was no notable cannabis news across Canada this week.

The below chart shows Canadian retail cannabis pricing since we began price coverage.

Source: FRC, Online Provincial Cannabis Store




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not independently verified with respect to truth or correctness. There is no guarantee that our forecasts will materialize. Actual results will likely

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Analysts' Ideas of the Week › articles › research_reports › fundamental_research › … · Farmako to contribute meaningful company top-line revenue starting 2020. Weekly Cannabis