Is Village Farms International a Buy?

To the dismay of investors, the cannabis sector as a whole has seen a significant decline. Industry benchmarks such as the Horizon Marijuana Life Sciences ETF and the ETFMG Alternative Harvest ETF are down 60.8% and 42.1%, respectively, over the past six months. While the raw excitement surrounding marijuana stocks seems to have died down in light of these declines, there are a handful of companies that have become excellent value investments because of this.

One of these is a small cannabis producer called Village Farms International (NASDAQ: VFF). With a market cap of only $614.5 million, shares of the company have fallen by 36% over the past six months but still beat the industry benchmarks. While losing over a third of its stock price might not seem promising at first glance, there are a number of reasons why Village Farms International is poised for growth and why this drop is a good buying opportunity.

CBD oil surrounded by cannabis plants

Image source: Getty Images.

From vegetable producer to cannabis grower

Village Farms International started off as a vertically integrated produce grower. With more than 30 years of experience growing vegetables, the company is known as a low-cost producer of cucumbers, peppers, tomatoes, and other produce. However, while Village Farms International has a respectable agriculture business, the vegetable market has historically had low margins and little growth potential. As such, investors have largely ignored the company.

However, things changed significantly over the past couple of years as Village Farms International made a strategic shift to diversify into a higher-margin, high-growth cannabis business. Entering into a joint partnership known as Pure Sunfarms with Emerald Health Therapeutics (OTC: EMHTF), Village Farms provided its experienced growing staff and sophisticated greenhouse equipment to the venture, while Emerald Health contributed $20 million in cash, cannabis industry expertise, and licensing assistance. 

Since then, Village Farms International has continued to expand its marijuana operations as its legacy produce business becomes smaller. Back in April, the companies agreed to expand Pure Sunfarms' greenhouse, doubling its annual growing capacity from 75,000 kilograms per year to 150,000 kilograms per year. At the same time, Pure Sunfarms has an option to expand another major greenhouse to add a further 180,000 kilograms per year of production should it wish to do so, which it likely will if things continue to go well.

Pot plus produce looks promising

Village Farms recently reported its Q2 financial figures, and they were quite promising. For the most part, the company revolves around its two major segments: its legacy produce business and its 50% stake in Pure Sunfarms. For its produce business, Village Farms posted $41 million in total sales while its cost of sales came in at $44 million. These results are nothing short of disastrous, and if Village Farms hadn't chosen to diversify into the cannabis business, its stock wouldn't really be worth mentioning at all.

However, Village Farms' cannabis business is the main attraction for investors. The company reported that its all-in growing costs were only $0.49 per gram with an EBITDA margin of 78%. Considering that Village Farms has posted an average selling price of around $3 per gram, this is quite an impressive margin. While its average selling price might be lower than some other producers, this is due to the fact that the company sells mainly to other licensed producers rather than supply Canadian provinces directly, something that comes with lower selling prices. However, this is also supposed to change in the months to come as Village Farms transitions to selling more of its cannabis directly to the provinces.

With such an impressive margin, Village Farms' cannabis venture with Emerald Health has been a major success so far. Currently, its shares are trading around a forward P/E ratio of 13.7 compared to other major producers such as Aphria and Hexo, which have forward P/E ratios of 23.6 and 68.6 respectively. As Village Farms continues to migrate away from the produce business altogether, the company is expected to become even more attractive to investors from a financial perspective.

Future prospects

With the Pure Sunfarms joint venture expected to reach full production in the near future and new greenhouse expansions on the horizon, Village Farms has exceptional growth potential. It's also worth mentioning that while the Canadian cannabis market is promising, there are also growth opportunities in the U.S. hemp market as well.

The 2018 farm bill, which legalized industrial hemp cultivation, has opened up new opportunities for cannabidiol (CBD) extraction in the U.S. that otherwise weren't available to producers. Village Farms is looking to test the waters in this regard, initially growing and selling hemp biomass, as well as CBD oil on the wholesale market to boost its near-term cash flow. To do this, the company also has a separate hemp-based joint venture which includes over 920 acres across four states. Village Farms also expects to eventually sell CBD products directly to major retailers sometime in 2020. While there isn't too much to say about this hemp joint venture considering the lack of significant financial results, it will be interesting to see just how successful its initial hemp/CBD efforts will be.

Overall, Village Farms International is a unique company in the cannabis sector with strong growth prospects. While major cannabis companies have fallen from grace amid shifting investor sentiment, there are still plenty of opportunities for smaller, less well-known producers to outperform the market. In my opinion, Village Farms International is one of them, and is an excellent investment if you're looking for a small cannabis company.

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Mark Prvulovic has no position in any of the stocks mentioned. The Motley Fool recommends HEXO. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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