January 18, 2018 Initiating Coverage Village Farms International, Inc. VFF-T BUY – Price Target C$11.00 Current Stock Price: C$7.67 Potential Return: 43% 43% It Takes A Village To Raise A Crop Vahan an Ajami mian an Analyst - 416.643.3879 vajamian@beaconsecurities.ca Beacon Securities Limited
Why We Like Village Farms Management knows how to grow high quality production at scale and low cost. The industry is seeing many players announce large scale greenhouse expansions and applying substantial valuations to their shares. Some of these players have not yet sold a gram of production grown in a greenhouse. Accordingly, we suspect some will be hit with challenges in scaling production while also switching building types from indoor to greenhouse. While it will take Village Farms some time to adjust to the specifics of growing cannabis as well, we believe that its team, which has been growing a variety of crops together in the same facility for over a decade promises investors lower execution risk relative to peers – especially since it can leverage the knowledge of its JV partner, Emerald Health Therapeutics Inc. (EMH-V, not covered), which was originally licensed by Health Canada almost four years ago. Management’s under-promising leaves room to over-deliver. Management is projecting yields of 75,000 kg in a 1.1MM sq. ft. greenhouse (Delta 3 – D3). This rate is meaningfully lower than most of the company’s peers are projecting. While we see compelling value in Village Farms’ shares even at a run rate of 65,000 kg for Pure Sunfarms, there is clearly the potential for the company to significantly surpass these figures . There is an underlying business that ‘pays the bills’ . Despite the Mexican competition, which has driven the company’s EBITDA margins over the past decade from ~10% to ~5% currently, management has found a way to control costs and still generate positive free cash flow after debt repayments. Furthermore, in what will be critical when selling cannabis to provincial governments, the team already knows how to sell to large demanding customers as it has sold to Walmart, Costco, Loblaws etc. for years (i.e., has experience with on time delivery, logistics, IT integration, dealing with sometimes finnicky customers, etc.). Good shareholder base and a tight cap structure. Village Farms has only 42.0MM shares outstanding, and 44.6MM on a fully diluted basis. Insiders own 26% of the company. We believe institutional investors hold a much larger percentage of its shares than is the case for most of its peers. Incredible optionality. Pure Sunfarms has the option to acquire Delta 2 (D2 – 1.1MM sq. ft.) and/or Delta 1 (D1 – 2.6MM sq. ft., the largest greenhouse in North America). The values at which these greenhouses would be acquired by the JV have already been set at undisclosed amounts, which we believe are higher than the C$20MM paid for D3. Critically, Village Farms can maintain its 50% share in the JV simply by ‘throwing greenhouses’ at it as opposed to being forced to fund it with cash and diluting investors. While the company has no plans to cultivate cannabis in the U.S. until it becomes federally legal, the potential to one day convert its 5.7MM sq. ft. of greenhouses in Texas represents a free call option for investors. Beacon Securities Limited 2
Intro To Village Farms Established in 1987, Village Farms is one of the largest and longest-running greenhouse growers in North America . It produces and distributes premium quality tomatoes, bell peppers, and cucumbers to national grocers, primarily retail supermarkets and fresh food distribution companies, in the U.S. and Canada. The company owns and operates seven large- scale greenhouse facilities in BC and Texas, and has partnered with greenhouses in BC, ON, and Mexico, enabling it to service its customers with fresh produce 365 days a year reliably. Products are grown hydroponically, using coconut fibre and rockwool, in a glass- enclosed structure with proprietary technology that regulates climate conditions and yields consistent, high-quality produce that fetches a premium price . With crop growing practices that are environmentally sustainable and resource-efficient, the company leads the greenhouse vegetable industry in North America in terms of sales, distribution, and marketing . This is achieved through the business’ focus on building and maintaining strong customer relationships, and upholding the highest standards of food safety. Seeing margins on produce decline over (US$, 000's) FY 2009 FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 FY 2015 FY 2016 LTM Revenue $130,524 $144,768 $164,448 $133,942 $137,635 $136,615 $141,934 $155,502 $158,850 the past few years due to competition Gross Margin $14,765 $21,136 $23,821 $7,977 $18,272 $13,885 $13,756 $14,724 $14,434 from Mexican producers, the company EBITDA $8,740 $15,272 $15,759 $1,529 $12,965 $8,778 $10,193 $9,385 $8,272 has proactively decided to branch out Gross Margin % 11% 15% 14% 6% 13% 10% 10% 9% 9% into cannabis. EBITDA Margin % 7% 11% 10% 1% 9% 6% 7% 6% 5% Source: Company reports, Beacon Securities. Beacon Securities Limited 3
Pure Sunfarms: Village Farm ’s Cannabis Initiative On June 6, 2017, Village Farms announced that it had entered into a JV with an existing LP, Emerald, to form Pure Sunfarms Corp. for the pursuit of cannabis production in Canada. Management will not conduct any cannabis growing operations in the U.S. until it is federally legal. With Village Farms’ expertise in low-cost greenhouse growing and Emerald’s cannabis compliance/licensing as well as intellectual property, the resulting new corporation is expected to develop and sell high-quality, low-cost cannabis at a large scale . To initiate the JV, Village Farms has contributed a 1.1MM sq. ft. greenhouse facility in BC (the “Delta 3 ” greenhouse, or D3), determined to have a fair value of C$20MM. Emerald has agreed to match this amount in cash to fund the conversion of the facility, resulting in a 50% interest for each (in the form of common shares) . Pure Sunfarms has commenced conversion of one quarter (Q1, ~250,000 sq. ft.) of its Delta 3 facility for the cultivation of cannabis – the license for which is under review by Health Canada. The company expects to complete the conversion of Q1 this quarter and, subject to the receipt of cultivation and sales licenses from Health Canada, begin selling dried cannabis . The company expects all four quadrants of Delta 3 to start commercial production in Q4/FY19, and be able to reach an annual production rate of 75,000 kg in 2020 . Management estimates that the greenhouse would be a more efficient use for cannabis cultivation, potentially generating revenue 10-15x that of current produce, with an EBITDA margin >50% . Source: Company reports. Beacon Securities Limited 4
Cannabis Competitive Advantage With a dedicated focus to greenhouse growing, Village Farms has built deep agricultural experience (a combined 750 years from multiple growing regions around the world), and has become an expert in agricultural safety , holding biological control/pesticide registrations, adopting Good Agricultural Practices (GAP), and undergoing comprehensive food safety audits by Primus Labs. Management sees cannabis no different than any other agricultural product , although it will have its own unique ramp up challenges to master. There has been little turnover at the company. The team has largely been cultivating with established management and labour forces through the course of its 30 years of operating history. This, coupled with the point above, means that the company should be time-efficient in launching its cannabis business. Village Farms has advanced proprietary technological expertise for greenhouse crop-growing , with its Applied Research Division continuously developing improvements for its production technology to stay at the forefront of the industry. Greenhouse systems provide control to achieve the best desired agricultural climate , including the ability to efficiently harness all available natural sunlight, resulting in lower energy needs and therefore lower cost of production . That said, part of the retrofitting of D3 will be to add supplemental lighting to boost yields (tomatoes don’t have the margins to justify the capex, but marijuana does). Besides the greenhouse facilities, Village Farms also has the infrastructure in place to begin selling cannabis to sophisticated institutional wholesale buyers such as LCBO, Shoppers Drug Mart, etc . It has the IT systems, has mastered the logistics of maintaining a regular and stable supply chain, and has the know-how to deal with potentially temperamental clients. It’s worth noting that it costs less to convert a greenhouse (C$55MM for 1.1MM sq. ft. or ~C$50/sq. ft.) than to build one from scratch (rule of thumb is C$~150/sq. ft.). Additionally, the large scale of operations provides Village Farms with cost efficiencies from economies of scale . Beacon Securities Limited 5
Existing Greenhouse Facilities – D3, D2, D1 Source: Company reports. Beacon Securities Limited 6
Pictures Of Facilities & Produce Source: Company reports. Beacon Securities Limited 7
Pictures Of The Delta Greenhouses – December 2017 Source: Beacon Securities. Beacon Securities Limited 8
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