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Botanical Holdings: Initiation of coverage

Botanical Holdings: Initiation of coverage
A medicinal cannabis company with multiple product verticals and a highly competitive cost structure

Botanical Holdings is an investment company focussed on selective investments across all verticals of the legal cannabis industry. The company is working towards a public market listing on the Aquis exchange during the fourth quarter of 2020. Through its current portfolio of wholly and majority-owned subsidiaries, the company addresses three market segments.

Medical cannabis:

A major focus for the group is the cultivation and processing of cannabis for the medical market. Medical cannabis is now legal in 45 countries including 15 EU member states and has become the fastest-growing segment of the legal cannabis market. See p3-4 for the dynamics of the medical cannabis industry.

Botanical Holdings has two major cultivation and processing projects.

In Portugal Botanical Holdings’ subsidiary company owns a 31-hectare site in the district of Santarem. At full-rate production, we estimate that there is the capacity for 7600 kilograms (kg) per year of dried flower from the current footprint, with headroom to expand. Early-stage development of the site is underway, and we expect the site to be completed in 2021 and first harvest from Portugal in 2022.

In Lesotho Botanical Holdings’ subsidiary company operates a 16-hectare site located 40 kilometres (km) from Maseru. At full-rate production, we estimate that there is the capacity for 2,600kg per year of dried flower from the current footprint, with headroom to expand. Development of the site is well advanced and we expect significant production from Lesotho in 2021.

CBD businesses – two business lines

Cannabidiol (CBD) is a non-intoxicating extract of cannabis that is used in a wide range of products for consumer healthcare and wellbeing. Botanical Holdings addresses the CBD market through two distinct business lines:

  • Southern African Hemp, a company that will cultivate hemp for CBD production from a 600-hectare site in Zimbabwe.
  • Unearthed Brands, a consumer products business that has developed and will market tinctures, skincare products and other consumer goods, under the brands “Unearthed” and “Le’Sutu”.
Financial dynamics and shareholder value

Botanical Holdings' businesses are capable of ramping up production and revenues over a short timeframe, and we are forecasting strong profitability from 2021 onward. The operations are configured to a low operating cost base and modest capital requirements. The low-cost base will help Botanical Holdings to remain profitable through future variation in the wholesale legal cannabis price, and we argue that this is an important feature of the investment case. We provide a sensitivity analysis on p10 calibrating Botanical Holdings' future profitability against various wholesale price scenarios. Furthermore, we examine valuation scenarios with a central valuation range €40-100mln on 2023e multiples based on the current assets.

Year end Dec 31 Current 2022 2023 2024
         
Revenue, € - 000s 4,265 18,080 46,020 59,250
EBITDA, € - 000s 1,415 10,410 33,350 42,955
         
 
Business overview
 
Source: Proactive Research

 

Medical cannabis is now the fastest growing segment in the legal cannabis space

 

The biggest revenue driver for Botanical Holdings in the coming years, in our view, will be the medical cannabis business. The market for medical cannabis currently stands at over US$6bln (2019) and we expect this to grow to US$30bln by 2024. The biggest driver of this growth is increasing legalisation of medical cannabis. For example, Germany legalised medical cannabis in 2017 and has already become the largest market outside of North America. We examine the medical cannabis market on p3-4.

In addressing this fast-growing market, Botanical Holdings has a number of strategic advantages, including:

  • A highly competitive cost base
  • Access to the EU market
  • Operation in Lesotho to be completed in the third quarter (Q3) of 2020
  • Operation in Portugal to commence construction in Q4 2020
  • Offtake arrangements in place for both operations
  • One licence in the northern and one in the southern hemisphere to allow low-cost year-round growing

We are forecasting a rapid ramp-up of revenue in the period 2021-2024e, led by the medical cannabis business. The following chart shows our revenue forecast by business line.

 

Main revenue driver in the medium term: medical cannabis cultivation in Lesotho and Portugal

 

Revenue forecast
 
Source: Proactive Research

Aside from medical cannabis, the other major revenue contributor in our forecast is Southern African Hemp, which will cultivate hemp and produce hemp extracts. Hemp is essentially cannabis without the psychoactive ingredient THC (tetrahydrocannabinol). It is often used to produce the non-psychoactive compound CBD (cannabidiol) that is used in consumer healthcare and skincare products. Southern African Hemp will provide Botanical Holdings with a revenue diversifier as well as a significant additional revenue and profit stream.

The consumer CBD business is a relatively small revenue contributor in the coming years according to our forecast; however, this business has the benefit of providing Botanical Holdings with a business-to-consumer (B2C) channel, which could be expanded upon in future.

 

A compelling investment case based on strategic and economic differentiators

 

 

Summary

 

Botanical Holdings offers investors broad-based exposure to the fast-growing legal cannabis market. Furthermore, the company’s operations are configured at the low end of the industry’s cost curve, providing protection against future erosion in wholesale prices.

Key investment characteristics of Botanical Holdings include:

  • Exposure to high growth end markets, encompassing both medical cannabis and CBD
  • A competitive cost base
  • A rapid transition to revenue generation, profitability, and ongoing growth

The medical cannabis market

The global market for legal cannabis has evolved rapidly in recent years. There are three main categories of legal cannabis:

  • Pharmaceutical cannabis. This is cannabis used to produce pharmaceutical drugs such as Sativex and Epidiolex. These address a few specific medical conditions, and as such pharmaceutical manufacturing makes up a small proportion of the wholesale cannabis market.
  • Medical cannabis. This addresses a wider market for conditions that can be hard to treat, including some types of muscle spasms, eating disorders, and persistent pain. In jurisdictions that allow medical cannabis, patients can access cannabis in edible, combustible or other formats, under the direction of a qualified practitioner. This market gained critical mass when California passed the Compassionate Use Act in 1996, and there are now 14 countries worldwide that allow medical use of whole-plant cannabis, including Australia, Germany, Portugal and Italy.
  • Recreational cannabis. Recreational markets include Canada and Uruguay. There are significant regulatory barriers for involvement in this industry, and Botanical Holdings does not target the recreational market.

A focus on medicinal markets, not recreational

The target market for Botanical Holdings is medical cannabis. This is the fastest-growing segment of the legal cannabis market, driven by regulatory liberalisation, particular in Europe. The following charts illustrate the growth dynamics.

Global legal cannabis market
 
Source: Proactive Research

 

EU leading global growth in medical cannabis

 

We expect continued growth in the medical cannabis market globally, and particularly in the EU. Important developments in recent years have included:

  • The legalisation of medical cannabis in Germany in 2017
  • Medical cannabis legalised in Portugal, Italy, Greece, Poland
  • Further European jurisdictions bringing forward legislation

Botanical Holdings will have widespread access to the European market via its position in Portugal. Furthermore, once this is fully operational we expect the company to leverage its position as an EU cultivator to also sell product from Lesotho into the EU

By developing an EU based customer market for its medical cannabis, Botanical Holdings will access a market of 750 million people, with potentially 30-40 million medical cannabis users. We estimate that this would represent a market of more than €10bn per year.

Botanical Holdings' medical cannabis business

Botanical Holdings’ medical cannabis businesses operate through a wholly-owned subsidiary called Eurocan and are focussed on cultivation and processing of high-quality cannabis for the medical market. Through Eurocan, Botanical Holdings is developing two projects:

  • In Lesotho, the company holds a licence to cultivate and manufacture medical cannabis through an 80% holding in Botanical Oils (PTY) Limited. The venture operates a 16-hectare site located 40km from Maseru and adjacent to a tarred road. Development of the site is at an advanced stage (see below) and will accommodate 10,000 square metres of greenhouse once fully ramped up. We believe that this initial growing footprint is sufficient for 2,600kg of dried flower per year. First production is due in 2021.
  • Portugal has been a leader in the EU in developing a regulatory framework for the cultivation of medical cannabis, and we believe that the country will become a hub for the European legal cannabis industry. In July 2020 Botanical Holdings completed the acquisition of a 31-hectare site in the district of Santarem, two hours from Lisbon. The company has received pre-licence approval for cultivation at the site and has engaged contractors for pre-construction work at the site. The full licence will be granted when the site has completed construction (expected in 2021) with the first crop expected in 2022.

The following summarises the two operations:

 

Lesotho development nearing completion. Portugal making rapid progress

 

Growing operations
 
Source: Proactive Research

When both sites are operational at full capacity, we estimate that Botanical Holdings will produce 10,000 kg of dried flower, giving rise to revenues of over €40mln (our 2023 forecast). This still leaves headroom for further capacity to be added at the two sites, as well as future potential to add further land. Details of our assumptions are on p8.

 

Industry moving beyond the high cost indoor growing model

 

Economics

The first wave of large commercial producers of legal cannabis came into existence ahead of the legalisation of recreational cannabis in Canada in 2018. Big names include the likes of Canopy Growth, Aurora, and Tilray. These first-generation cannabis companies had an initial focus on indoor growing, in an artificial environment. This allowed them to achieve speed to market in a rapidly emerging industry; however, an artificial growing environment is expensive and capital intensive.

Botanical Holdings is focussed on building a cultivation footprint that is positioned at the low end of the industry cost curve – greenhouse based and in relatively low-cost locations. This makes for a business model that is capital-light and has the ability to remain highly profitable even as wholesale price erosion takes effect, which we expect to be the case over the next five-10 years.

The following charts illustrate the cultivation economics for Botanical Holdings compared with some existing names in the industry (at their current cost base). Our Botanical Holdings estimates are based on full-rate production, which we expect in 2022.

Comparison with peers - cost and capital intensiveness
 
Source: Proactive Research

Clearly we do not expect Botanical Holdings to be the only player to target lower cost cultivation. Indeed, the existing players in the industry are already taking steps to obtain cultivation capacity at a lower cost base.

The following table summarises some of the mergers & acquisitions (M&A) that have taken place around lower cost cannabis cultivation in recent years. Metrics for the growing footprints come from news releases from the companies but may overstate the active available growing space, meaning the prices paid per square metre are in reality higher than the price implied by the stated figures.

 

Lesotho cultivation facilities in demand

 

 
 
 

We expect more cannabis producers to migrate to lower-cost production over time, meaning greenhouse growing and lower-cost geographies. We believe that Botanical Holdings is ahead of the curve in this regard.

The CBD businesses

Cannabidiol (CBD) is being increasingly widely used as a consumer wellbeing product as individuals become more aware of the beneficial effects of CBD. CBD oil is often derived from hemp, which is a type of cannabis that does not contain the intoxicating THC (tetrahydrocannabinol) compound.

The market for hemp-derived products has grown strongly since the US government passed the Farm Bill in December 2018, which legalised the cultivation, processing and sale of hemp. For these purposes, hemp must contain less than 0.3% concentration of tetrahydrocannabinol (THC) which is the psychoactive ingredient in cannabis and which remains illegal in the USA and many other jurisdictions.

The range of health benefits that consumers seek to derive from CBD continues to grow as the market becomes increasingly established. The following diagram highlights some of the applications.

 

CBD is being used for a wide range of health benefits

 

Benefits of CBD
 
Source: Proactive Research

The market for CBD products has been growing strongly in recent years, as more jurisdictions have made regulatory accommodation for this non-intoxicating plant extract. The following chart shows the growth in demand for CBD globally.

Growth in demand for CBD products
 
Source: Brightfield Group, Yahoo Finance

Botanical Holdings has two business lines that address the CBD market.

 

Initial capacity is being developed for 30 hectares of hemp cultivation

 

 

Southern African Hemp

 

Southern African Hemp, as a subsidiary of Botanical Holdings, will operate a 600-hectare farm site in Zimbabwe. During Q4 2020 the company expects to develop 30 hectares of this site for cultivation. The company holds a licence for medical cannabis at the site and will focus on hemp cultivation for the CBD market.

We expect strong growth in revenue and a significant profit contribution from Southern African Hemp during the next few years. Some details are on p8.

Some key aspects of the Southern African Hemp business include:

  • Access to all necessary resources for hemp cultivation, including irrigation which is a significant obstacle to large scale hemp growing in some locations due to the plants’ high requirement for water
  • Access to the South African and global end markets
  • Full licensing in place

 

The "Unearthed" and "Le'Sutu" brands address tinctures, skincare, and other products

 

CBD consumer products

The other CBD investment in the Botanical Holdings’ portfolio is a consumer products business named Unearthed Brands. This will produce, market, and distribute consumer products containing CBD under the Unearthed and Le’Sutu brands, with other brands to follow. The Unearthed brand will offer therapeutic tinctures, while Le’Sutu will offer skincare products and other consumer healthcare goods.

We are forecasting a small revenue contribution from these businesses in the 2021-2024 timeframe. The strategic advantage of owning these businesses is that they give Botanical Holdings a B2C platform, which could be expanded upon at some point in future.

Financials

We believe that Botanical Holdings offers investors exposure to a rapidly growing revenue and profit stream over our forecast period 2021-2024e. We are forecasting €4.2mln of revenue in 2021, rising to €49.5mln by 2024. The following table summarises our assumptions.

Sales model breakdown
 
Source: Proactive Research

The following chart illustrates our revenue growth forecast.

 

Strong revenue growth outlook

 

Revenue forecast
 
Source: Proactive Research estimates

In terms of profitability, Botanical Holdings benefits from a low-cost cultivation base as described on p6. Furthermore, we expect the company will maintain a lean operating expense base, outlined on p11. The following chart shows how this translates into earnings before interest, tax, depreciation and amortisation (EBITDA) growth.

 

A fast transition to profitability, at strong margins

 

EBITDA forecasts
 
Source: Proactive Research estimates

In order to realise this revenue and profit trajectory, the company will make investments in completing development of its facilities. The following table summarises our forecasts for capital expenditure (capex).

Capex forecasts
 
Source: Proactive Research estimates

Modest capex requirements relative to the revenue opportunity

We argue that this represents a modest capital requirement relative to the revenue and profit potential. This capital-light business model is one of the major attractions from an investor perspective, viewed in absolute RoE (return on equity) terms or relative to the cannabis peer group.

Valuation and sensitivity

We have argued that Botanical Holdings is well-placed to absorb future wholesale cannabis price erosion. The level of sensitivity to cannabis price movements is an important factor in assessing the investment case. The following table shows our estimate for Botanical Holdings’ sensitivity to different wholesale medical cannabis prices.

Valuation sensitivity - output in € - 000s
 
Source: Proactive Research

 

Expect conservative valuation multiples at this early stage. Further upside in future valuation

 

The spot prices we use as the base for future pricing are August 2020 prices:

  • Medical cannabis flower - €5 per gram
  • CBD flower - €0.83 per gram
  • Medical cannabis oil - €50 per 40 ml container

We have highlighted as a central set of scenarios with wholesale prices down 30% - 50% by 2023e, and applying 2-3x EBITDA valuation multiples. We note that 2.5x EBITDA is a very low multiple for any stock listed in the UK, in any sector; however, at the current time we would expect the market to apply a steep discount to future earnings because the company is still at a pre-revenue stage. We would expect the multiple to increase going forward as site developments are completed and then crop harvests realised, at which point the 2023 profit expectation would become materially de-risked, and we could expect a higher valuation multiple.

 


Appendix: Forecasts

 

P&L forecasts
 
Source: Proactive Research

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