The Hydropothecary Corporation is undervalued, Echelon Wealth says

Ramping up production from 3,600 kg of dried cannabis up to 108,000 kg by the end of the year is the name of the game for Gatineau, Quebec’s The Hydropothecary Corporation (The Hydropothecary Corporation Stock Quote, Chart, News: TSXV:THCX), and although its quarterly revenue came in lighter than expected, the company’s expansion plans remain on schedule, says Russell Stanley, analyst with Echelon Wealth Partners, who on Wednesday reiterated his “Speculative Buy” rating for THCX and one-year target price of $5.50.

The Hydropothecary Corp. delivered its three- and six-months ended January 31, 2018, financial results on Wednesday, reporting sales of medical cannabis up nine per cent over last quarter and up 45 per cent year-over-year. Its big news over the past month, however, was lining up to be the largest cannabis supplier to the province of Quebec’s retailer, the SQC, with negotiations still in progress on securing a definitive agreement.

“We have achieved excellent revenue visibility as we approach the legalization of recreational cannabis, with the 20,000 kg supply commitment under our letter of intent (LOI) with SAQ and our medical cannabis sales,” says Sébastien St-Louis, CEO and co-founder, in a press release.

“Predictable revenue streams from the recreational and medical markets, a debt-free balance sheet, two fully-funded expansion projects, and additional liquidity for corporate purposes, provide strong business certainty through Year 1 post-legalization and beyond. Without a doubt, this achievement is the most important milestone to date in our company’s history,’’ says St-Louis.

Hydropothecary reported revenue of $1.2 million for the quarter, which came in lower than Stanley’s $1.6 million estimate and the consensus $1.5 million, attributed to lower than forecasted volumes, says Stanley. But the analyst contends that having expansion plans still on schedule is the real takeaway.

“While revenue was below both our forecast and consensus expectations, we view the reiteration of expansion timelines as far more important at this stage,” Stanley says in a note to clients.

“With $265 million in cash and short-term investments and no debt at quarter end, not only are these projects fully funded, but we estimate that THCX has an additional $100 million in ‘excess cash’ to fund other organic growth and acquisition opportunities,” says Stanley.

And with the SAQ deal (covering almost 20 per cent of Hydropothecary’s full, planned capacity of 108,000 kg), the company will get industry-leading sales volume visibility, says Stanley.

The analyst uses a 15.5x EV/C2019E EBITDA multiple for his valuation, which he sees as in line with the adjusted average for the broad peer group of 15.2x. “We view this as a very conservative multiple, as the LOI with the SQC gives THCX a level of volume sales visibility that is amongst the highest (if not the highest) for producers,” the analyst says.

The analyst thinks THCX will produce revenue and adj. EBITDA of $10.3 million and negative $12.0 million, respectively, in 2018 and $97.1 million and $15.1 million, respectively, in 2019.

The analyst’s $5.50 target price represents a projected return of 38 per cent at the time of publication.