Harvest Health & Harborside cut guidance, MORE Act passes congressional committee & more

By Mike Regan , Equity Research Analyst

The week was busy with earnings misses and beats, legislative progress, contract and deal adjustments as well as reduced expectations.

As Craig and I said in our recent webcast about the current cannabis investing environment, we do not believe the industry has yet bottomed out as the industry still needs to reset expectations and match business plans to capital – but the process is underway.

Harvest Health makes dramatic changes

Phoenix-based Harvest Health & Recreation (CSE: HARV) adjusted its strategy and guidance to the new reality this week – details of which we previously reported. What stands out in this action is that the company undertook several changes at the same time.

Though difficult, we see this as the best way to undertake these types of reset actions, like ripping off a Band-Aid, rather than in multiple events over long periods of time to fully remove the overhang on the equity.

More businesses in the industry need to take steps to dramatically change expectations before share prices start to recover.

The sooner management teams recognize new market realities and adapt their business models to effectively compete in the new landscape, the better opportunity those companies have to succeed at creating shareholder value.

Harborside misses and guides down

Harborside (CSE: HBOR), based in Oakland, California, reduced guidance for 2019 to $50 million-$52 million and “negative” EBITDA from “positive” for the year. This implies a sequential 6%-20% revenue decline in the fourth quarter of 2019 to $11 million to $13 million, compared with $14 million in the third quarter.

Interim CEO Peter Bilodeau noted that $2 million of the revenue reduction stemmed from a delay in opening California dispensaries in Desert Hot Springs and San Leandro, $1.5 million was due to the Lux acquisition not closing and $1.5 million because of disruption to three harvests.

Management expects to close Lux by the end of the year, and the other two dispensaries are scheduled to open in December, so arguably this miss is due to one-time factors.

It is a positive that management quantified the source of the changes, but like much of the cannabis sector, the firms will have to show some execution versus targets before calling the bottom.

Curaleaf reiterates 2020 guidance

In contrast to many in the cannabis sector, Curaleaf (CSE: CURA) reiterated its pro forma guidance for $1.0 billion to $1.2 billion in revenue and EBITDA margins above 30%.

Note that this pro forma revenue assumes Curaleaf’s Grassroots Cannabis acquisition closes Jan. 1, 2020, though it is expected to actually close sometime in the first quarter. This means the actual full-year 2020 revenue should be a little less with only 9-11 months of Grassroots.

The market widely expected a cut to the guidance, so the question remains whether this guidance is too aggressive or if Curaleaf guided conservatively when it first gave the targets in late August.

MORE Act passes judiciary committee; are higher multiples justified? 

The U.S. House Judiciary Committee passed the MORE Act – a positive milestone toward normalization of the marijuana industry but hardly a panacea to the industry.

This follows the entire House’s September passage of the SAFE Act, which focused more on improving banking regulations. However, it is generally expected that the SAFE Act has a greater chance of passing than the MORE Act in the near term.

The most quantifiable direct financial impact of any of the three acts would be to remove the excessively high tax that results from 280E.

As we will argue in more detail at our Investor Intelligence Conference in Las Vegas, we believe incremental signs of the end of 280E justify higher valuation multiples (revenue, EBITDA, NOPAT or earnings) for cannabis companies subject to 280E than normally taxed comps in CPG industries.

If you do not think 280E is going away in the next few years, however, you should pay normal multiples.

Canopy abandons volume commitment to Neptune – risk or opportunity?

Neptune Wellness (TSX: NEPTaltered its processing agreement with Canopy Growth (TSX: WEED), originally struck in June 2018, by waiving minimum volume commitments for Canopy. In addition, Neptune will be able to negotiate prices with Canopy and others starting in June 2020.

This can be a positive for Neptune if it can sell this capacity to the market at higher rates than the previous Canopy contract, but it also raises the risk that this capacity is not resold at all.

It seems Canopy is reducing its volume outlook and using its own capacity – or believes it can secure capacity elsewhere at lower prices.

Any kind of chemical processing business such as Neptune Wellness is a high-fixed-cost business with volatile margins, depending upon the capacity utilization and pricing.

Neptune also has contracts for large volumes with The Green Organic Dutchman (minimum of 230,000 kilograms over three years) and Tilray (minimum of 125,000 kilograms over three years) that could be at risk of renegotiation.

Terra Tech’s cash deal under renegotiation; equity deals fare better

Deals with a larger (or all-) equity component have a better chance of closing amid big stock moves, despite the change in the headline values, as both the buyer and seller participate in industry valuation changes.

Cash deals are generally at greater risk of renegotiation with big changes in equity values.

An example: Terra Tech’s (OTC: TRTC) planned sale of a dispensary, originally announced May 9 with expectations to close within 90 days, failed as the company blamed the Nevada regulator for failing to approve the transfer of the license within 180 days.

The seller and purchaser are “currently renegotiating the terms of the transfer,” which is not surprising given the change in valuations since May 9 and the fact the deal used $9.3 million in cash and $4.2 million in debt – so it did not see a similar drop in valuations.

There will be no Weekly Wrapup during the Thanksgiving holiday in the United States. Have a wonderful holiday in the U.S. and a great Thursday elsewhere.