4Front Ventures (OTCQX:FFNTF) has a stated thesis of low-cost production and distribution of cannabis. The thesis is paying off and the company reported EBITDA profits. The riots of the summer brought the company’s revenues downward as it had to board up shops. Since then, the company is expecting to rebound strongly. The recent sale/lease-back of its facility put money in its coffers setting it up healthily. The company is opening new facilities in new markets, including California, the biggest market in the US. It claims the #1 position for one of its products in one of the nation’s biggest markets, Washington State. The cannabis market itself is continuously expanding and growing and 4Front is amongst its leaders.
Given that, is 4Front Ventures a good buy for your portfolio, or is it too late?
4Front itself is currently in five separate states: California, Illinois, Michigan, Massachusetts, and its original state: Washington. However, its corporate office is in Arizona. I bring that up because Arizona is a medical-only cannabis legal state; that is, until the very last election. The company’s idea is that its business thesis has been proven effective in multiple markets. All it is doing now is opening up new markets and replicating the very same thesis. The newly launched California market should prove to be a huge boon for 4Front should it get the very same success it’s seen in the other markets. That being said, with Arizona now legal for recreational cannabis, I also wonder if this will be another market it enters?
At the same time, there is one thing that I am hesitant about upfront, although it does appear to be unwarranted. 4Front’s thesis is for “low-cost production” cannabis, something that makes me curious. I am reading far too many cannabis company financial statements lately. The trend I am noticing is for a transitional shift towards premium branding. The Canadian cannabis companies started to get involved heavily in the low-cost market and that nearly tanked the entire industry as there was far too much supply of lower quality cannabis. Now, these companies are switching gears away from this type of product. That is Canada, however. For now, I have found more than one US company that is doing low-cost white label production and labeling and turning a profit so, perhaps 4Front can pull this off.
Cannabis in the United States
I always like to set up the stage when I analyze a company. Here is a look at the cannabis industry’s expected revenue totals for the next four years:
(Chart Source: Marijuana Business Daily)
There is only one problem with this chart: It is outdated simply because of the election having turned four more states legal for recreational cannabis: Arizona, Montana, New Jersey, and South Dakota. That is a total of 18.7M new additional customers for cannabis companies.
Before that, with all of the states that had already legalized recreational cannabis, 80M individuals were living in these states. That 18.7M is 23%. If there were a linear percentage and you could correlate the numbers, the 2024 projection would be $37B-$45B.
That is a significant potential increase.
Revenues
4Front saw a rebound in its quarterly numbers the past quarter and it attributes this to the reopening of dispensaries closed to the riots as well as other issues, COVID notwithstanding:
(Data Source: 4Front Ventures – Author’s Chart)
Revenues have been a bit sporadic because of the issues present in the United States with the lockdown from COVID and then the riots. When you think of 4Front Ventures, remember, it is a Washington-based company and you will also remember the concern over the summer of the “CHAZ,” the autonomous zone in Seattle.
Because of that, some of the dispensaries in the Washington area were shut and this disruption manifested in the revenues for the previous quarter along with COVID. Washington is not only the home market for 4Front Ventures, but it is also its most important market, as stated in the latest quarterly earnings release:
Our facilities are the number one edibles manufacturer and the number two flower producer with an overall number two market share in Washington, outperforming over 600 license holders in one of the most competitive cannabis markets in the world.
I thought this quote was important. The reason is simple: It is the #1 and #2 edible and flower producers in Washington, respectively. The company is about to open up operations in the biggest market in the country: California.
To be #1, you are producing a product that people enjoy and come back to purchase over and over again. If it were to achieve the same success, that is a massive market to be at the top. The state of Washington has a population that is only 18% of the size of California. If 4Front were to achieve the same status in California, its revenues would increase by several multiples.
And this is by no means pie-in-the-sky prophecy. 4Front is already moving into new markets, and as it exclaims, it is seeing significant orders already and is biting into the competition at the dispensaries it is entering already.
At the beginning of this, I quoted the theory of the company: Duplicate exactly what it is doing in its home state in these new markets. That philosophy is paying off very well.
Gross Margins and Operating Efficiencies
On the cost front, 4Front has the trend in its favor, but more needs to be accomplished to achieve profitability:
(Data Source: 4Front Ventures – Author’s Chart)
Achieving 67.3% gross margins in the latest quarter is remarkable. YoY, the company achieved 24% more in 2020 than it did in 2019 for the same quarter. I’ve looked at many companies in the industry; these margins may be the highest I have seen.
However, for operating efficiencies, the only way a company can be profitable is to have efficiencies well below gross margins. They are not:
(Data Source: 4Front Ventures – Author’s Chart)
Operating efficiencies are the total operating costs over revenues. These are costs for labor and other expenses such as SG&A. This is where 4Front still needs to put in the work necessary to achieve its goals.
With new facilities coming online, this is likely where it will be focusing on cost structures. It is a huge success in Washington and is merely replicating that success in new markets. It will take some time to get the new facilities up to full capacity and reach economies of scale. This is where the cost savings are going to show up. As an investor or a potential new one, this is where you would want to keep a keen eye peeled towards. With increasing revenues from the new facility and increased economies-of-scale reached in these facilities, achieving higher levels of profits will be next.
Net Income
Net revenues were negative, but the next quarter will already be a positive simply because of a recent sale 4Front Ventures can put into the books. Here is a chart on the net revenues:
(Data Source: 4Front Ventures – Author’s Chart)
4Front Ventures sold a facility to Innovative Industrial Properties (NYSE:IIPR) and then did a lease-back to itself. The proceeds were $30M which it can then pay off debt and sit on some cash. The cash holdings will be $16M while it will have $43M in long-term debt and an impressive $300M in assets.
So, for the next quarter, there will be a big pop upwards in the net revenue due to the earnings it received from the sale of the facility. That will be an outlier. The company needs to bring its operational costs down and achieve overall profitability.
Book Value
When a company is not profitable, you do not have the ability to use forward earnings projections to value a stock. Since 4Front has yet to reach sustainable profitability, I look towards book value to see where the company’s assets should place the stock. The stock is trading at $0.82 per share. Book value is slightly above that providing a small margin of safety with investing in the company:
(Data Source: 4Front Ventures Data – Author’s Chart)
My preference is to invest in a company that has a stock price below the book level. In this case, the two are in line with each other. I have found many stocks that are below value with their book/price ratio. The industry has sold off for several months but is now starting to turn a corner.
I expect that this stock will pick up the pace and move higher. What I would like to see from management is an increasing book rate given that management’s job is to increase investor value. While the stock is below the book price, the downward trend is something I would like to see turn along with the stock price.
FFNTF Stock
Along with all of the cannabis stocks, FFNTF went higher at the beginning of 2019 only to come right back down throughout the rest of the year and into 2020. Now, and along with a lot of the cannabis stocks, FFNTF is heading back upwards:
(Chart Source: Trading View)
I have far too many stocks I am sifting through right now. That is too bad because having had the ability to pick this stock up at about $0.60 per share just a few weeks ago would have made getting into this stock a whole lot more comfortable. An investor could have bought into this stock at a price that afforded far more margin of safety from the perspective of book value.
Still, the stock price is not too high and may even slide down somewhat as the world waits for the Senate election to take place in January.
Nonetheless, I think this stock will be heading higher over the long term simply because of the product quality and the potential for 4Front to gain significant market share in California and other markets it has just entered.
Is 4Front Ventures a Good Buy?
Do the math: 4Front produces the #1 edible product in the state of Washington. If that is the case, then entering into the biggest market in the country should reap rewards should it be able to replicate the same success. I doubt that its products are regional in the sense that only Washingtonians would like that particular product and therefore it would not do well in other markets. The proof of that is that in Massachusetts, it is seeing rapidly increasing sales growth after recently entering into that market. It should, therefore, replicate that success in California. The company is ready to go in that state and revenues will begin showing up shortly. Given that, the fact that it could become the #1 edible product in California as well as the other markets it is now in, that is a very big opportunity.
Economies of scale need to be achieved to get to profitability from a cost perspective, but that is a goal the company has stated and I feel as if it will achieve that, increasing margins and eventually, net earnings.
For these reasons, I am very bullish on 4Front Ventures.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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