High Tide: 'Continued Progress, But More Operational Leverage Needed,' Analyst Says

The Analyst

Pablo Zuanic from Cantor Fitzgerald remained ‘Neutral' on High Tide Inc. HITI and lowered the stock 12-month price target to C$4.45 from C$7 “given overall sectoral derating.”

The Thesis
Zuanic noted High Tide, a leading retail-focused cannabis company with bricks-and-mortar as well as global e-commerce assets, is making progress with its discount loyalty program, garnering same-store sales growth above 20% while delivering increased retail $ gross profit growth.

However, High Tide needs greater operating leverage, “given the current negative EBIT and FCF pace,” Zuanic said. “In the current stock market context and the challenging Canadian retail sector, we prefer to remain Neutral, although recognize there could be value here if management can successfully deliver on its strategy over the next two years – especially with the stock trading at 0.6x EV/Sales on our CY23 estimates).”

Highlights From April Quarter

• Total sales rose 12% sequentially to $81 million, or +10%. High Tide's Canadian retail business grew 23% sequentially to $57 million from 126 stores.
• The loyalty program now has 550,000 members, of which the company considers 60-70% as active, with an average basket size north of $50.
• The US business (mostly CBD and accessories) fell 9% sequentially to $15.9 million, partly due to seasonality and consumer spending pressures. The international market dropped to $1.6 million from $2.3 million in the January quarter.
• Reported gross margins were 28% vs. 32% in the Jan quarter (Canada 22%; US 55%).
• Canadian retail revenues were 16%; the latter is in line with management’s expectations and plans (it sees margins stabilizing here).
• Adjusted EBITDA fell to $2.4 million sequentially (op cash flow was -$2.2 million) from $3 million (adj EBITDA per share fell 29% sequentially), and negative free cash flow worsened to ($4.7 million) from ($3.9 million) in Jan.

“Still, net debt is manageable, in our opinion, at 0.1x sales,” Zuanic wrote.

Management Perspective

Zuanic said management is pleased with the company’s performance. As the retail network continues to gain Canadian cannabis retail market share and has generated sequential same-store sales growth above 20% in two quarters in a row.

“If we judge the Canadian retail piece based on $ gross profits, we see this increased sequentially by $2 million to $13.9 million (...) on the other hand, negative EBIT for the Canadian piece remains north of -$8 million (...) with gross margins stabilizing, increased operating leverage is key for the Canadian unit to become EBIT positive and reduce cash burn,” Zuanic noted.

High Tide’s Outlook

Management plans to reach 150 stores by the end of 2022, via M&A and organic openings, including an entry into BC in the July quarter.

High Tide is negotiating $15 million of a $30Mn credit facility that will help pay the cash portion of its acquisitions (and also help with the convertible debt due late June).

“On the back of its pricing strategy and discount loyalty program, management expects to continue gaining retail share in Canada. It plans to roll out the recently acquired Fastendr kiosk technology across its retail network by the end of 2022.”

Regarding its private label program, management expects to account for 20-30% of cannabis retail sales over time. In addition, delivery will also be expanded selectively. “Management says this will account for mid-single digits of sales (4% now),” Zuanic said.

In terms of its international expansion, Zuanic mentioned plans to expand its CBD offerings and enter Germany after acquiring Blessed CBD in the UK. “In the US, it will start selling Delta-8 and Delta-9 products where states allow it,” he added.

Valuation And Price Target

Zuanic calculates an enterprise value (EV) of C$244Mn. “On our estimates, this values the stock at 0.7x CY22 sales and 0.6x CY23, and 16x and 8x our CY22 and CY23 EBITDA estimates,” he explained. “We prefer to stay Neutral given the execution risk with the strategic pivot, M&A integration risks, and our own concerns about the medium-term outlook for the US CBD market.”

“That said, (...) the stock upside could be significant if management can execute on its strategy/vision. If we assume the company can reach 10% of the Canadian retail market by CY24, which we estimate at C$6.5Bn, that would mean sales of C$650 million; if we took 5% EBITDA margins for the retail cannabis business and valued that at 20x, the retail EV would be C$650 million (650 * 5% * 20x) by the end of CY23. If we add the CBD piece at acquisition value, this would bring the EV to C$750 million,” Zuanic concluded.

Sharon Mccutcheon On Unsplash.