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Pyxus International: Better Growth Prospects And Cheaper Valuation Than Tilray And Canopy Growth

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By English Capital :

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In recent months, investors have become enthusiastic about the prospects of rapid growth in the emerging cannabis industry. The legalization of cannabis set to occur in Canada later this month has sparked an 1800s style gold run in cannabis stocks, some of which have experienced incredible price returns. Understandably, some investors feel like they missed out on these moves and are hesitant to buy stocks like Tilray ( TLRY ) and Canopy Growth ( CGC ) [TSX: WEED] at current levels.

Pyxus ( PYX ) is a new entrant to the cannabis business that already has significant sales and positive EBITDA. Despite having a valuation at a tiny fraction of its cannabis peer group, we believe Pyxus actually has better growth prospects and significantly more shots on goal than other cannabis companies, resulting in much higher upside potential for PYX stock compared to the peer group. This report will discuss the growth opportunities for PYX and relative valuation to peers. Based on our analysis of numbers provided by PYX management at the company's recent investor day, we believe PYX hasbetween 500% and 1,600% upside potential.

PYX is being mispriced by the market:

Here is our favorite slide from Pyxus's recent analyst day held September 12th in New York City:

Source:Investor Day Presentation

The chart shows the rapid expected increase in Global Specialty Product ("GSP") EBITDA from the current 3% of consolidated adjusted EBITDA to a number in fiscal 2023 safely north of 50%. I estimate tobacco adjusted EBITDA will represent approximately 35% or $182m, GSP represents approximately 62% or $322m, and value-added agricultural products represent approximately 3% or $16m of fiscal 2023 EBITDA. Pyxus has the potential to generated consolidate adjusted EBITDA of $520m in fiscal 2023.

Using these assumptions, we believe PYX is worth between $315 and $431 per share or upside potential of 1,167% to 1,630%.

Source: English Partners' estimates

Note: Due to working capital seasonality we are using fiscal year end (March)cash and total debt balances.

The market is focused on the hype around legal cannabis and therefore is largely ignoring the stability of the legacy leaf tobacco business (which generates positive free cash flow) and the fast-growing opportunities in industrial hemp/CBD and e-liquids. Companies like Tilray and Canopy Growth simply do not have this many "shots on goal."

How do we arrive at these results? Let's run through my assumptions. First, let's analyze Pyxus's legacy leaf merchant business.

Pyxus Legacy Leaf Tobacco Business:

Pyxus via its Alliance One subsidiary, operates a global footprint spanning more than 35 countries with shipments to approximately 90 countries. The company's 1,000+ field technicians support over 300,000 farmers on five continents. Pyxus has 35 owned or third-party processing facilities with +/- 375 customers each with unique requirements. Scale is critical, and Pyxus has 40-50% share of the US market, 30-35% of Brazil, 50-55% of Uganda, 30-40% of Malawi and 20-25% of Zimbabwe. In other words, there are very high barriers to entry.

Pyxus provided the following chart at its investor day, which will help us arrive at our adjusted EBITDA estimates above:

Source:Investor Day Presentation

A few points stand out from this chart. First, worldwide cigarette (stick) consumption is in a slow decline. The second point is Pyxus volumes have been essentially flat over the past four years which I believe implies market share gains.

We have augmented this chart with a few key assumptions to arrive at a range for Pyxus's adjusted EBITDA from its tobacco business in fiscal 2023. This can be viewed on the next chart:

Source: English Partners' estimates

Note: Due to working capital seasonality we are using fiscal year end (March)cash and total debt balances.

Here are the key assumptions from the above analysis. First, we're assuming 0.2% share gains from FY 2019 - FY 2023 in line with the average over the prior three years. Second, we're assuming ASPs average $4.50 per kg, in line with results over the past few years. Third, we're assuming processing and other revenues stay flat for FY 2018. Fourth, we're assuming adjusted EBITDA margins are within a range of 9-11%, which is in line with historical results and management guidance. Fifth, we're using a EV/EBITDA multiple range of 7.5-9.0x which is conservatively below the average TTM EV/EBITDA multiple for the Company since 1998 of 9.2x.

The end result is Pyxus' legacy leaf tobacco business is worth between $15.50 and $80 per share. This provides a significant margin of safety for the consolidated business that includes emerging opportunities in cannabis, industrial hemp ("CBD"), and e-liquids.

As you can see from the above analysis, we're assuming the legacy leaf tobacco business generates between $162m and $200m of adjusted EBITDA in FY 2023. The trailing-twelve month adjusted EBITDA for Pyxus is $179m with 97% from the legacy leaf tobacco business. As such, we believe our fiscal 2023 estimate is fair. Since PYX is currently trading at $24.89 per share, we believe the market is mispricing the legacy leaf tobacco business, and we haven't even started to value the emerging growth opportunities of cannabis, industrial hemp/CBD and e-liquids.

As a point of reference, the legacy leaf tobacco business average 10-year free cash flow ("FCF") from fiscal 2008 to fiscal 2017 was ~ $17m or ~ $1.94 per share, and the average 5-year FCF from fiscal 2013 to fiscal 2017 was ~ $43m or ~ $4.89 per share. In other words, PYX trades with a ~7.8% FCF yield to its average 10-year FCF and a ~19.7% FCF yield to its average 5-year FCF.

Pyxus Fiscal 2023 Investor Day Targets:

The midpoint of our fiscal 2023 adjusted EBITDA number for the legacy leaf tobacco business is $182m, and we think looking at the pie chart above that it represents approximately 35% of the total. Now, we can back into the estimate for GSP by taking $182m/0.35 = $520m for the total pie. That means at approximately 62% of total, GSP adjusted EBITDA will be an estimated $322m in fiscal 2023.

Pyxus's Fiscal 2023 Intrinsic Value:

Based on this analysis, the consolidated fiscal 2023 EBITDA will be approximately $520m. What follows is a scenario analysis for different multiples of the $520m in adjusted EBITDA:

Source: English Partners' estimates

Note: Due to working capital seasonality we are using fiscal year end (March)cash and total debt balances

We know these values look crazy, but we are using as a starting point management's guidance for future EBITDA from its legacy leaf tobacco business and its new emerging opportunities in high-growth areas of legal cannabis (Canada), industrial hemp (legal in 40 US States), and e-liquids (potentially the future for nicotine consumption). Keep in mind, the EBITDA numbers here were provided by management in their investor deck and based on commentary from the investor day. We believe the numbers have merit.

As you might imagine, investors asked Pyxus's CFO, Joel Thomas, about the pie chart and potential for fiscal 2023 adjusted EBITDA. Here's the exchange:

Robert Bryan Jacoboski,Abingdon Capital Management LLCEarly in the presentation, there was a pie chart that showed adjusted EBITDA in 2023. Just visually, it looked like about a doubling. Is that right, that it would be $330 million, $340 million in adjusted EBITDA in 2023?Joel L. Thomas , Executive VP & CFO Bryan, due to the new businesses and not having an historical basis for providing forward-looking information, we tried to give a better understanding of what we think the future can look like. And so I think the way to think about it is that, if we look at the last 3 years of the tobacco business, it's been very consistent. And we see consistency as we look out and some opportunities as well to continue to grow that business. We've taken market share, clearly, on the tobacco side. And so as we look to the future, there are pockets of growth around the world for tobacco. We're going to continue to go after those. We've got a great customer base with almost 400 customers around the planet. Pretty much anywhere that you look where you see a white-wrapped cigarette, it's highly likely that our product is inside there. So there are a lot of opportunities, as we look forward, for the tobacco business. And then as we think about the future and the layering on of each one of these startup businesses that are all on different stages of startup, you're going to see that start to get layered on. And by the time we get out to 2023, we think that there should be substantial increases in the absolute dollars value of EBITDA and improvement in the percentage of EBITDA versus revenue. So there are a lot of good things to come, and we tried to graphically sort of represent what we think is going to happen.

Source: Investor Day Presentation Transcript

Pyxus's CFO clearly feels confident the legacy tobacco leaf business will continue to generate +/- $170m in adjusted EBITDA and, in fact, sees opportunities to grow over the next five years. If we understand his words correctly, our overall estimates for the consolidated adjusted EBITDA are in-line with management's thinking.

Bottoms-up Analysis:

So far, we built a bottoms-up analysis for the legacy leaf tobacco business, a mature, high barriers to entry, free cash flow positive business with a long history of data to reference. This bottoms-up analysis yielded a fiscal 2023 adjusted EBITDA range of $162-200m and valued the entire company in a range of $15.50-80 per share. Even before looking at the new emerging opportunities that Pyxus is pursuing, we valued the company with tremendous upside and little downside.

Industrial Hemp/CBD:

Pyxus's management provided this nice chart at their investor day:

Source:Investor Day Presentation

We have taken this information and come up with a valuation range for the Pyxus's industrial hemp/CBD business in fiscal 2023:

We assume Pyxus will increase its interest of Criticality from the current 40% to 50% after 2020. Pyxus assumes the price per acre will increase over the time period, but we have left that flat for conservatism. We have already adjusted for outstanding cash and debt in our valuation of the legacy leaf tobacco business, so there's no need to double-count that here. The result: Pyxus industrial hemp business has a valuation range of $17-$65 per share.

In case you think this is crazy, take a look at this fact sheet and investor presentation for Charlotte's Web (CNSX: "CWEB"). The gross margins have been consistently above 70% since the beginning of 2017 with EBITDA margins of 35%. And US hemp production is set to soar and US cannabidiol ( CBD ) consumer sales are set to rapidly increase .

E-liquids:

You might have heard of Juul ? If you have, then you know vaping is growing rapidly . Well, Pyxus is participating in this fast-growing market too. Check out the reviews on popular Humble Juice Co. e-liquids or another Pyxus brand, Bantam .

Here is the admittedly basic graph Pyxus management provided at their investor day. Although sales are low, the EBITDA margins are already incredible at approximately 46%. And as the link above illustrates the market is developing rapidly.

Source:Investor Day Presentation

According to Research and Markets , the vapor products market is expected to reach worldwide sales of $43 billion in 2023 with 30% in the UK and US. We have made the assumption that the US will account for $8.5 billion in sales or approximately 20% of the global market.

As our valuation analysis indicates, we come up with a per share value range to Pyxus of $21-$108 under different market share and margin assumptions. It may turn out that e-liquids becomes Pyxus's best business in terms of the size of the market and the economics to Pyxus.

Legal Canadian Cannabis:

We're going to assume that this part of the presentation does not need any introduction. We're going to assume our readers are aware of the cannabis trade occurring in the market right now. Canada is set to legalize recreational marijuana starting October 17, 2018. For Pyxus, we believe this is a significant opportunity. Importantly, Pyxus International's 80% owned Goldleaf Pharm (aka: FiGR North) received its cultivation license form Health Canada on September 28, 2018.

The Canadian cannabis market is projected to reach CAD $9.2 billion sales by 2025 . The stock market in Canada and the US has taken notice. Here are a few key players and their current EV/Sales multiples:

Canopy Growth Corp. [TSX: WEED] is trading at 10.7x 2020 sales of $1.05 billion

Cronos Group [TSX: CRON] is trading at 12.3x 2020 sales of $160m

Aurora Cannabis ( ACBFF ) [TSX: ACB] is trading at 8.6x 2021 sales of $1.1 billion.

Aphria ( APHQF ) [TSX: APH] is trading at 9.4x 2021 sales of $360m

Tilray is trading at 43.8x 2020 sales of $350m

Now, let's compare that to Pyxus, which is trading at 0.8x fiscal 2018 sales of approximately $1.8 billion. It simply doesn't make sense that Pyxus would trade at such a big discount to the group because it not only has two Canadian cannabis licenses with its FIGR East and FIGR North operations, but also has an emerging industrial hemp/CBD business, a growth e-liquids business and let's not forget a legacy ~ $175m EBITDA tobacco leaf business selling in over 90 countries and a farmer base of over 300,000.

Pyxus's management provided the following slide at their investor day:

Source:Investor Day Presentation

This slide with some additional assumptions helped us frame out the opportunity for Pyxus as follows:

We're assuming the price to retail falls anywhere between 50% to 80% from the $6.56 provided by management at the investor day. I'm also assuming the adjusted EBITDA margins are below the range provided for all of the GSP also provided at the investor day and presented here:

Source:Investor Day Presentation

As you can see, the range of value to PYX shareholders is $14-$99 per share. And that's just for the cannabis opportunity. I ask, why would you buy Canopy Growth at an $11 billion market value or Tilray at a $15 billion market value when you can buy Pyxus at a $260m market value and get a legacy, free-cash-flowing leaf tobacco business and access to three other large and growing markets: cannabis, e-liquids and industrial hemp/CBD?

Bottoms-up Valuation:

Our first valuation exercise looked at PYX from the top-down using the pie chart provided by management at their investor day. That analysis indicated a valuation range of $315-$431 per share. Next, we looked at a bottoms-up analysis of each segment of Pyxus's business. After rolling-up the individual parts, the analysis indicates the following:

The results from the bottoms-up analysis elicit a lower overall range of values at $154-$358 per share, but we think we can agree these values remain much, much higher than today's current PYX's price of $24.86 per share leaving a substantial margin of safety.

Risks/Downside:

Like any investment, there are potential risks with our thesis. In no particular order, here are a few things to consider:

Worldwide cigarette trends have been in a slow decline for years. We have assumed this trend continues, but regulatory changes in the US or abroad could accelerate the decline curve.

Reduced risk products (RRP) such as vaping and heat-not-burn may grow faster than expected accelerating traditional cigarette consumption declines (although since PYX participates in the e-liquids space it could offset the negative effects to its legacy leaf tobacco business).

The legal cannabis market in Canada may not develop as expected. For instance, cannabis is a commodity, agricultural product. Wholesale and retail pricing will depend on supply and demand dynamics and brand building.

PYX is moving closer to the customer developing its own brands for cannabis ("FIGR") and CBD oils (Humble, Bantam). The Company has historically not been involved in brand building and may not be successful.

The market for industrial hemp/CBD in the US may not develop into the market we expect and/or it may become more competitive than we expect and our estimates for growth, market share and margins could prove too optimistic.

The last point we'd like to make is the PYX has a levered balance sheet, but we think it's more than manageable. PYX has significant net working capital. Its inventory lasts for ten years. In fact, the net working capital per share is ~ $72 as of June 30, 2018. Even if we remove the cash, PYX net working capital minus cash is ~$49 per share. This provides a healthy margin of safety from the Company's financial leverage.

PYX's tangible book value per share as of June 30, 2018 was ~ $19. And as we discussed earlier in this report, we believe the legacy leaf tobacco business is worth between $15.50 - $80 per share. This is a high barrier to entry business with operations on five continents. The operation manages 300,000+ farmers. Importantly, this business is FCF positive. Thus, we think the downside here is in the range of $15-20 per share. PYX has one of the most asymmetric risk/reward tradeoffs we have come across in a long time. The market thinks PYX is a cannabis play. Sure, this is a component of the story, but PYX is also a leaf tobacco merchant, an emerging play on industrial hemp/CBD (legal in 40 US states) and an emerging e-liquids business.

Conclusion:

Pyxus is worth anywhere between $154 and $431 per share yet trades currently at $24.86 per share. In comparison to story stocks like Canopy Growth and Tilray, which trade at close to 11x and 44x sales, respectively, Pyxus trades at approximately 0.8x EV/Sales. And with, Pyxus you have many shots on goal - a legacy, profitable leaf tobacco business and emerging growth opportunities in cannabis, e-liquids, and industrial hemp/CBD. The market is totally missing the extreme upside in Pyxus's stock price over the next months and years.

Disclaimer:

This post is for informational purposes only and should not be construed as investment advice. It is not a recommendation of, or an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Our research for this post is based on current public information that we consider reliable, but we do not represent that the research or the report is accurate or complete, and it should not be relied on as such. Information regarding a company or security may be obsolete by the time it is published on Seeking Alpha and investors must therefore independently verify updated information regarding a company or investment. Our views and opinions expressed in this report are current as of the date of this report and are subject to change. Investing is inherently risky and comes with the potential for principal loss. Past performance is not indicative of future results.

Disclosure:

I am/we are long PYX. We have no plans to buy or sell the stock within the next 72 hours. We are not receiving compensation for this post (other than from Seeking Alpha).

See also Really Mean That, Just Because The U.S. 10-Year Treasury Has A 'P/E' Of Less Than 30x, I Should Not Buy The New Safe Haven At Under 20x? on seekingalpha.com

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


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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