This Cannabis Retailer Is Poised To Grow Top-Line Despite Tough Environment, Analyst Explains Why

Fire & Flower Holdings Corp. FAF FFLWF reported its financial and operational results for the fiscal year and fourth quarter ended January 29, 2022.

The company’s shares traded down 10% Tuesday following the earnings report's release, closing at $2.8001 per share.

The results were below FactSet consensus, with same-store sales down 30% YoY and retail gross margins down quarter-over-quarter to 26% from 30%.

The Analyst

Cantor Fitzgerald’s analyst Pablo Zuanic retained an overweight rating on the company’s stock after the quarterly numbers but lowered the price target to CA$9.5 ($7.44) from CA$10.4.

The Thesis

With the move, Zuanic addressed reduced estimates and an overall “tougher retail environment” in his recent note.

While the company reported opening 32 stores during the fiscal year, with 105 stores open and operating at the fiscal year-end, the increased number of stores in Canada has resulted in more competition among retailers. As a consequence, retail margins are suffering, the analyst explained.

“We expect the company’s profit margins to drop further  - direct peers pursuing a value/discount strategy are in the mid/high teens - as the company expands its own discount loyalty program,” said Zuanic who 

earlier noted that “the retail segment remains fragmented, in addition to a crowded market with decreasing margins.” He called it a situation that “will likely lead to consolidation (M&A, attrition).”

Zuanic initiated coverage of Fire & Flower in November. 

“We see an opportunity with Canada’s largest cannabis retail chains (operating in a market that we project will potentially double to $8 billion by 2024), as these stocks are undervalued vs. domestic producers (1-2x CY22E sales vs. 5-15x), in our view, and trade at a steep discount to U.S. retail staple peers on a growth-adjusted basis (operating in rather matured industries, those trade at 1x),” Zuanic said at the time.

Alimentation Couche-Tard Partnership

The analyst also stressed recently that the company’s partnership with Alimentation Couche-Tard Inc. ANCTF should lead to a meaningful footprint growth over time with minimal investment. Couche-Tard and FAF successfully launched a pilot program of Fire & Flower co-located cannabis stores adjacent to Circle-K stores in October.

Shortly after, the company secured $30 million in financing through a loan agreement with 2707031 Ontario Inc., an indirectly wholly-owned ACT's subsidiary.

Last week, ATC confirmed its intention to exercise warrants to acquire 8.29 million common shares of Fire & Flower. ACT  will convert its Series B warrants on Thursday, April 28, resulting in the ownership of common shares of Fire & Flower increasing by roughly 14.49% to approximately 35.32%.

The proceeds were meant to fund further development of the company’s consumer digital platform as well as for general corporate purposes. Zuanic expects ATC to also convert its Series C warrants by the second quarter of calendar 2023.

“By co-locating mini cannabis stores within Circle K stores, we expect the company to grow top-line,” he said, adding that Fire & Flower intends to open 20 stores in the 2023 fiscal year and “do so in an asset-light manner.”

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