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Ecofibre (ASX:EOF) Quarterly Report Update Q1 FY 2020

2019-10-14T06:04:14+00:00

When Ecofibre Ltd (ASX:EOF) released its 4C (quarterly cashflow report) for the three months to 30^th September early last week, there was no notable share price reaction. However, we do note straight out of the gates that it was rather early, and not amidst the muddy scrum of 4Cs lodged in the last couple of days before the deadline. I like this, because I think it demonstrates that the company has its sh!t together and management have a steady hand on the tiller. That's important in a fast moving industry such as hemp products.

Ecofibre Ltd Quarterly Cash Flows and the Quest for Controlled Growth

The company hitting the ASX in late March 2019 and initially traded at a share price of around $2. Despite the strong share price rise since then, we only have a limited amount of available historical financial information – but the financial metrics reported yesterday were directionally pleasing and the growth trend remains intact. (In contrast, fellow cannabis stablemate Elixinol, reported stalling growth in recent months – as covered in our recent EXL quarterly update).

Back to Ecofibre, you can see below that customer receipts of $13.6M and unaudited revenue of $14.4M represented increases from the June quarter of 10% and 17% respectively, and operating cash flow of $3.9M was a 22% increase from the previous quarter. That is all pleasing and positive.

While the growth trend in revenue remains intact, the chart below left illustrates that on a quarter-on-quarter (“QoQ”) basis, revenue growth has actually slowed since March. While we must recognise that a company won’t grow exponentially ad infinitum, and that we should expect proportional growth to decelerate as revenue increases, this will be something to keep a very close eye on in the coming quarters.

In our recent piece on Elixinol we dissected EXL’s March and June quarter cash flow reports and noted that the expected increase in competition in 2019YTD was having a negative impact on margins. Further, we noted that Elixinol had taken the strategic decision to materially increase its cost base in the form of greater sales & marketing activities and an expansion of the management team ahead of its launch into Europe.

In fact, that doubling of Elixinol’s annualised cost base, coupled with a slight decline in annualised revenue (following the decision to ratchet down private label manufacturing), drove the company’s ~$10M 1HFY19 NPAT loss and required a surprise $50M capital raising in June. As a result, Elixinol has become a considerably higher risk proposition in the past few months.

The good news for Ecofibre shareholders is that it doesn’t appear to be experiencing Elixinol’s problems at this point. For one thing, the Ecofibre management seem focused on taking a more deliberate and disciplined approach to managing growth and a comparatively more judicious approach to managing its capital. As profiled previously, the company operates only in the United States (via its Ananda Health nutraceutical, dietary supplement and skincare products business) and Australia (the Ananda Food hemp foods business), and is focused on executing in these markets, before expanding into new regions.

As such, Ecofibre has taken a more controlled approach to its cost base – as can be seen from the chart above right. Grower & production and administration & corporate costs have declined as a proportion of receipts, as one would hope. Meanwhile, staff costs have been stable over the past three quarters, though note this is on a cash (not accrual) basis and so ignores, among other things, any release of inventory build; not that there appears to have been a material inventory increase.

Operational and other developments

The 4C was very light on operational detail, but did note that the Ananda Health range was being distributed in more than 3,800 US retail pharmacies at the end of September, up from ~3,200 at June. With close to 22,000 independent pharmacies in the US, that suggests penetration of just 17% of this channel and significant further potential runway. The company also released 2 new products during the quarter (in response to consumer demand): a CBD roll-on deodorant and a pain relief lotion. The company continues to invest in developing its product portfolio and we expect further new products over the short to medium term.

As we noted in our previous quarterly report (for Q4 FY 2019) on Ecofibre in late July, the company is about to commence the commercialisation of the Hemp Black business – and to that end the $4.7M of investing cash flows in the 4C table above relates to the construction of the company’s new US headquarters (with significant space dedicated to Hemp Black). The company has remained highly secretive around potential future products for this division, but as we detailed in our previous EOF report, management has recently revealed that the Hemp Black business (in partnership with Thomas Jefferson University) will focus on the manufacturing of products such as (1) high-performance textiles; (2) hemp-based anti-inflammatory nano-film suitable for wound dressings; and (3) polymer fibres for industrial uses. FY20 is likely to see only minimal contribution from this division, but I am cautiously optimistic about the medium term prospects of the Hemp Black business.

The company also announced in yesterday’s 4C that Ecofibre’s shares will shortly be tradeable on the Over-The-Counter (“OTC”) market in the US. While this will potentially make the company more visible to US investors, from memory the US OTC market already has something like 150 Australian companies trading under American Depository Receipts (“ADR”) – and as such I don’t expect this to materially move the needle in the short term – particularly with cannabis stocks out of favour at the moment (in comparison with the recent cannabis boom).

Quick thoughts on Valuation and closing thoughts

Ecofibre’s share price has held up pretty well amidst the recent carnage in global cannabis stocks, and at today’s closing price of $3.16 is only 15% below the $3.70 high reached after the company released its full year FY19 results in late July. As such, Ecofibre has materially outperformed ASX cannabis peers Elixinol (down 65% from its 52-week high) and Cann Group (down 53%), and international majors such as Canopy Growth (-64%) and Aurora (-70%), a major shareholder in Cann Group.

Ecofibre has a market capitalisation of ~$920M currently. In our previous note on Ecofibre, we noted that the company provided no formal FY20F guidance and so we pondered a number of potential different earnings outcomes which might justify its (then $1.1B) market valuation – see repeated table below:

We noted that EBITDA of $20-30M for FY20E could potentially deliver NPAT of $13-21M – which at Ecofibre’s current share price would represent an FY20E forward P/E of 47x – 73x. Clearly still not a Deep Value stock but growing nicely, but one could argue it is cheaper than other momentum darlings like ProMedicus and Nanosonics, even without ascribing any value to Hemp Black. As stated previously, I believe Hemp Black will be a meaningful generator of revenue and earnings from FY21/22F onwards, though it is also arguable that the market remains skeptical.

Sentiment towards the cannabis sector has soured from the recent frothy enthusiasm of early 2019 as the market has developed slower than many thought, and the regulatory regime has not opened up as quickly as the optimists hoped. If we were to frame cannabis in the context of the Gartner Hype Cycle, I would say that cannabis is currently in the Trough of Disillusionment which follows the Peak of Inflated Expectations. The Gartner Hype Cycle is of course imprecise as we can’t know how long technologies or new products spend in each part of the cycle, but it is still a useful tool for trying to understand the trajectory of the life cycle from inception to widespread adoption.

I continue to be optimistic about the cannabis thematic broadly (see our background industry report here) and about Ecofibre specifically, as my preferred ASX cannabis stock. While the company’s share price has held up much better than most of its peers, I wouldn’t be at all surprised to see some volatility over the short term if sentiment towards cannabis continues to remain subdued. And personally I would welcome that if it yielded an opportunity to add to my Ecofibre holding between $2.50 and $3.00.

Disclosure: Both I (@Fabregasto ) and Claude Walker hold shares in Ecofibre and will not sell for at least 2 days after the publication of this article. Fabregasto also holds positions in Elixinol and Cann Group.

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Fun Times With Ecofibre (ASX:EOF): FY 2019 Results Analysis And Valuation Meditation

2019-07-30T08:23:00+00:00

Ecofibre (ASX:EOF) Full Year 2019 Results Analysis And Valuation Meditation

Ecofibre (ASX:EOF) today reported its maiden set of full year results as a public company. The company’s share price has been something of a rollercoaster ride over the 4 months since listing: a 70% first day stag profit on its $1.00 IPO price, then essentially 3 months in a sideways range between $1.90 and $2.20 before soaring to $3.60 in early July in advance of its June quarter 4C (quarterly cashflow report). Since the release of its 4C, the stock traded down below $3.00 – no doubt a mix of profit taking; general recent choppy market trading over the past few weeks during which time the broader market has arguably gone “Risk Off” in advance of reporting season; and raised eyebrows at “valuation” (presumed historical P/E multiple of ~300x at a market capitalisation of ~$1 billion). And then yesterday the share price soared 25% to $3.69 (a record close) in response to the FY19 results, before retracing to #3.39, today.

Strong operating momentum

As will be surprising to exactly zero readers, there is strong momentum in the business – as evidenced by FY19 annual revenue growth of more than 500% (spoiler alert: unlikely to continue ad infinitum). The FY19 results and accompanying investor presentation didn’t contain a lot of new operational metrics – the US independent pharmacy channel bar chart at right was included in the June quarter 4C. The key takeaway is still that the Ecofibre pharmacy network of 3,200 stores represents just ~15% of the total US independent pharmacy market and that there is significant further penetration growth available.

It was curious to note that selective bulk white label contract manufacturing for certain “strategic” customers has increased from 10% at 1H19 to 16% for the full year – implying that 2H19 white label and bulk sales comprised 20% of total 2H19 sales. I’ve previously assumed that these sales are typically lower margin than Ananda Professional volumes to distributors and Ananda Hemp sales to consumers via the company’s website – and yet gross margin increased materially from 65% in 1H19 to 76% for FY19.

I was interested to see mentioned in the investor presentation that the company has created a CBD 360 online education portal for the pharmacists and practitioners in its independent pharmacy network – a sensible investment in my view – both in ensuring a well-informed pharmacy sales channel capable of driving sales to consumers, as well as building trust with pharmacists.

FY19 results: US business the growth engine

In the June quarter 4C (see here for our previous article), the company guided towards full year FY19 revenue of $35.6M and profit before tax of $4.5M – both of which were higher than our back-of-the-envelope estimates from our April initiation report (see here). Ecofibre’s full-year FY19 results are summarised below left. Note that FY19 NPAT is inflated by the first time recognition of Deferred Tax Assets ($2.0M), otherwise NPAT would have been closer to $4.0M.

It’s clear that the company’s current stellar growth trajectory is being driven almost entirely by its US business – which posted growth of 646% to $34M in FY19, demonstrating that Ecofibre’s strategic decision to grow market share through the independent pharmacy channel is working. The investor presentation included a quote from US market research firm Information Resources Inc which suggested Ananda is the “clear market share leader of CBD products across all US retail pharmacies (as measured by sales)” – however I wasn’t able to track down this report, and I imagine the market is extremely fragmented at such a nascent stage. Hopefully the company will share further information from this type of market research in the future.

The Australian business still increased revenue by 24% in FY19 – albeit off a very small base of ~$1M. Ecofibre’s investor presentation did disclose that the Australian business will commence supplying to Woolworths’ private label Macro Foods brand from August 2019 onwards – which I expect to materially increase the volumes of this business going forward and hopefully tip it into profitability in its own right.

As previously noted, the Hemp Black business (in partnership with Thomas Jefferson University, a top 20 shareholder in the company) is pre-revenue. FY20 will prove a pivotal year for this division with early commercialisation activities about to commence. The company has previously been highly secretive around potential future products for Hemp Black, alluding to confidentiality required by patent law – but the investor presentation for the first time referred to 5 “core” Hemp Black products:

Hemp Black: “carbon infused high-performance fibre and intelligence textile” – this could be the performance apparel (with anti-odour properties and thermal regulation) described in Ecofibre’s prospectus;
Hemp Black Nano: Ananda full spectrum extract nano-film – described in the prospectus as being suitable for wound dressings and textiles with anti-inflammatory properties;
Hemp Black Hide: Ananda full spectrum extract vegan leather and Hemp Black Element: Ananda full spectrum extract infused polymer fibre – both presumably for industrial uses such as fabrics for motor vehicles and offices etc; and
Hemp Black Ink: “carbon infused conductive water based ink” [I don’t know what this is either].

CEO Eric Wang has previously stated his belief that Hemp Black will eventually become the largest revenue generator for the company. I am also cautiously optimistic on this given the thousands of years of human history of utilising hemp fibre for industrial uses such as clothing and building materials. It’s going to be another 12 months at least before we’re able to more accurately gauge the revenue potential of this division in any event.

FY20E – *Illustrative Speculation*

The company provided no hard numerical FY20 guidance – not surprising given how fast revenue is growing and the number of moving parts in such a nascent hyper-growth market (as we’ve noted previously). Note that Ecofibre did not provide any formal FY19 forecast guidance in its prospectus, waiting instead until the release of its March quarter 4C in mid-April to provide revenue, gross profit and opex ranges for the forecast year to 30 June.

Clearly the lack of formal guidance is unhelpful for any Deep Value investors chewing through their fingernails with extreme frustration/puzzlement while watching from the sidelines. As Wise Monkey Matt Joass has noted in his seminal piece on Inflection Points however, traditional value metrics (both historical and 1-year forward) appear ludicrous for companies which have just become profitable (as Ecofibre has for the first time in the year just passed).

So what range of FY20E potential outcomes might be acceptable in the context of Ecofibre’s current $1.1 billion market valuation (at today’s $3.69 share price)? The following bewildering – even to me – table ponders a number of different scenarios:

Four scenarios in relation to revenue growth – ranging from 25% to 200% (all arguably conservative in the context of the 519% top line growth achieved in FY19, however we must expect that revenue growth WILL start to slow); then
Five Gross Margin % scenarios – ranging from 60% to 80% (compared with 72.4% generated in FY19). I personally expect gross margin % to improve as the business scales, but this would allow for potential lower-margin-but-higher-revenue-generating white label agreements in future. The combination of parts 1 and 2 therefore gives 20 (5 rows of 4) scenarios which feed into part 3;
Three (being 3A, 3B and 3C) scenarios in relation to growth in operating costs – under which, respectively, opex increases by 53%, 104% and 155% from FY19A to FY20E (and thereby respectively represents 30%, 40% and 50% of FY20E revenue (down from 58.7% in FY19 as Ecofibre should generate operating efficiencies as revenue increases)).

Phew! There are therefore 60 different FY20E EBITDA possibilities in the “analysis” below – ranging from, at the lowest end, EBITDA of $4.5M (25% revenue growth @ 60% gross margin with 155% growth in opex – orange shading) to FY20E EBITDA of $53.4M (200% revenue growth @ 80% gross margins with 53% growth in opex – blue shading).

But… 60 scenarios is too many!! So, the table at the very bottom then estimates what FY20E NPAT *might* look like for EBITDA of $10M, $20M, $30M, $40M and $50M (all within the EBITDA possibilities presented) making certain assumptions re below-EBITDA items (see fine print below table):

The above is clearly the by-product of the combination of several assumptions regarding (fast) moving parts – a meaningful variation in any one of which (even including effective tax rate) could significantly move the needle from an FY20E EPS perspective.

I think FY20E EBITDA of $20-30M is certainly possible however (noting that EBITDA increased by ~$14M in FY19). For illustrative purposes (see green shaded cells), a combination of:

Revenue growth of *only* 100% in FY20E (a significant slowdown from 519% in FY19 but of course revenue growth is very likely to slow from here); plus
Growth margin of 75% (a slight improvement from FY19 only despite the doubling of revenue); plus
Opex growth of 104% from FY19A (growing faster than sales – perhaps reflecting increased investment in Sales & Marketing – such that Opex represents 40% of revenue for FY20E)

……would deliver EBITDA of $24.9M For FY20E, and NPAT of ~$17M (per fine print assumptions re below-EBITDA items above) – being the mid-point between $20M and $30M EBITDA in the bottom table. Ecofibre would then be trading on a ~65x forward P/E at its current share price of $3.69 – but then would have almost tripled NPAT in FY20E (or more than quadrupled if you removed the one-off tax-benefit). I don’t think it’s extremely far-fetched that the company could generate EBITDA of $30M-$40M in FY20E (cc: @AussieBaggies) – at which point the current forward P/E is probably closer to 45x. Note however that as the business scales, it will require significant focus from management to rein in costs and pull the right levers to protect profitability in this high-growth environment.

Please note that this section on FY20E is merely some “thought bubbles” round what potential revenue growth and margin assumptions could be encapsulated by the company’s current market valuation. This of course ignores any value attribution to Hemp Black – which is unlikely to generate any revenue until FY21E – and about which I am personally very optimistic.

Closing thoughts

I continue to be optimistic about Ecofibre. I added a little more to my position in early June around $2.00 (though not as much as my gut was telling me to – for which I am now kicking myself).

At a current historical FY19A P/E multiple of ~168x (including the benefit of the one-off tax gain), the company is clearly not going to be a Deep Value staple any time soon – but readers will know that we are focused on relative growth profiles of companies which look forward more than one year (often a few years out) to try to determine if we are buying Growth at a Reasonable Price (“GARP”). Fast-growing companies are simply not available to buy at mid-teen P/E multiples and so we must be prepared to pay a higher multiple for this growth.

**If** Ecofibre can continue to grow its top line at 100% (or more) for the next 2-3 years as the CBD market expands, I would expect the share price to be considerably higher than it is today despite the frothy FY20E forward multiple. Sceptics may opine that the current share price projects a continuation of FY19’s impressive growth rates into FY20 – but actually it doesn’t: a 500% revenue increase in FY20 (to revenue of >$200M) would probably generate NPAT of ~$50M using the spaghetti of assumptions above – at which point the company would be trading on a P/E of ~23x currently. **For the avoidance of doubt, I absolutely do not believe the company can continue to grow revenue at 500% in FY20**.

The company has pledged to give shareholders increased clarity on FY20E forecasts as the year unfolds – but I’d be surprised if we got any meaningful FY20E guidance until after the release of 1HFY20 results in February (mid-February at that given how refreshingly punctual (read: non-tardy) management have been in releasing 4Cs and results so far. For the meantime I will continue to hold my $EOF shareholding – although I expect the share price to continue to bounce around a lot (I expect some profit taking shortly with buyers in June having generated returns in less than 2 months of 70-80%).

Accordingly, we continue to hold Ecofibre, but only as an appropriately sized very high risk investment, especially given the current optimism in the share price.

Disclosure: Both I (@Fabregasto ) and Claude Walker hold shares in Ecofibre and will not sell for at least 2 days after the publication of this article.

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This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

Ecofibre (ASX:EOF) Quarterly Report Update Q4 FY 2019

2019-07-16T23:26:29+00:00

Ecofibre (ASX:EOF) has performed strongly over the past few months since we initiated on the company in April (see here) – In that time the share price is up 52% and it’s up a total of 222% for investors fortunate enough to get into the March IPO.

Nearly all of that share price run since April has occurred in the past couple of weeks – immediately prior to a bullish market update released on 4^th July – which confirmed the predictive abilities [cough] of those who bought into the stock over 2^nd and 3^rd July (during which time the share price jumped 25%). That market update included a quick update on the growing number of independent US pharmacies stocking Ecofibre’s Ananda Professional product range, and foreshadowed the release of the company’s maiden quarterly cashflow report (4C) for the June quarter on 11^th July.

To quickly re-cap, Ecofibre comprises three businesses, two of which are generating revenue:

A US-based vertically integrated manufacturer and distributor of zero-or-low THC hemp-based nutraceutical, dietary supplement and skincare products. This division sells Ananda Hemp branded products through its website to wholesalers and retail customers, and sells Ananda Professional branded products through independent pharmacy chains; (Ananda Health);
An Australian-based manufacturer and marketer of hemp foods (Ananda Food); and
A pre-revenue business focused on commercialising the production of hemp-based textiles and composite materials, in partnership with Thomas Jefferson University, a top 20 shareholder in the company (Hemp Black).

The US business generated ~90% of sales for 1HFY19 (to December 2018) and is the key growth driver for the company given the strong growth in that market following the signing of the US Farm Bill into law late last year. The chart below illustrates Ecofibre’s increasing penetration of the US independent pharmacy channel to date after formally launched the Ananda Professional brand less than a year ago.

The number of pharmacies retailing Ecofibre products has more than doubled between December and June to 3,200 – which per the company has underpinned the very strong growth in revenue for FY19 (discussed shortly). The prospectus detailed that there are ~22,000 independent pharmacies in the US – suggesting a penetration rate of ~15% as at June and a long potential growth runway.

Preliminary FY19 results

In our Ecofibre initiation piece, we tried to estimate FY19 results based on some high level guidance provided by the company in the March quarter 4C released in April. Our back-of-the-envelope calculations suggested revenue of at least $31.5M and profit before tax somewhere in the region of $0.5M.

Pleasingly, based on the preliminary unaudited FY19 data points shared in the June quarter 4C this week, the company has outperformed the previous guidance and our rough estimates – with unaudited FY19 revenue of $35.6M (up 519% from FY18A) and a maiden profit before tax of $4.5M. The June quarter 4C also detailed that Ecofibre generated operating cash flow of $3.2M during the period. We will provide further detail on finalised FY19 results once release in August.

Closing thoughts

As we’ve discussed previously in pieces on ASX stablemate Elixinol (ASX: EXL) and our broader cannabis industry pieces, the hemp-based nutraceutical, dietary supplement and cosmetics market is in a hyper-growth phase which has seen a flood of new competitors enter the market in the past year. It is too early to gauge which operators will be the long-term dominant players in the market; the near and medium term focus for all players will be to establish a market position and try to defend it –against both existing rivals and future new entrants attracted into the sector by the strong growth potential).

The next few years represent a substantial land grab opportunity in both individual regional markets and the global marketplace as a whole. To this end, Elixinol recently completed a $50M capital raising to accelerate its US growth ambitions, and we would not be surprised to see Ecofibre undertake a similar strategic move – although we note the company boasted a ~$26M cash balance at the end of June (an increase of~ $1M during the quarter post some investment and debt pay-down).

As I mentioned in our Ecofibre initiation piece, I am very intrigued by the Hemp Black division and feel that it could eventually be the largest generator of sales for the company – and this echoes comments from CEO Eric Wang. Hemp Black will likely require further capital at some point as it moves towards commercialisation – however that is probably a year or two away at this point, and won’t necessarily require the company to consider a capital raising. The company has also left ajar the potential for the company to enter the medicinal marijuana space (which management have shied away from until the regulatory picture is clearer) – which would also likely require more capital – but there is no visibility as to whether Ecofibre will even go down that path.

In the meantime, EOF – like EXL – will continue to trade on premium (read: eye-watering) multiple from a traditional historical multiple viewpoint. At its current market capitalisation of ~$1 billion, Ecofibre is trading on a historical P/E multiple of close to 300x (assuming final FY19 NPAT of $3.0-3.5M). Frothy stuff indeed, but readers will appreciate that the company has only just recently reached its profitability inflection point – which of course means that traditional backwards-looking valuation multiples (which do not factor in future growth or relative growth profiles versus in comparison with other companies) will look extreme. As a result, we expect that Ecofibre’s share price will continue to be volatile – and reiterate out caution that the company is suitable only for those Ethical Equities readers with an appetite for risk.

We will provide a further update on the company post the release of its maiden full year results next month – which hopefully will contain some initial guidance on the new FY20 trading year.

Disclosure: Both I (@Fabregasto ) and Claude Walker hold shares in Ecofibre and will not sell for at least 2 days after the publication of this article.

For early access to our content, join the Ethical Equities Newsletter.

If you don't yet use Sharesight, please consider signing up for a free trial on this link, and we will get a small contribution if you do decide to use the service (which in turn should save you money with your accountant, or time if you do your own tax.) Better yet, you can get 2 months free added to an annual subscription.

This article does not take into account your individual circumstances and contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.

We Decided To Buy Ecofibre Ltd (ASX:EOF): Analyst Initiation Report On A Cannabis Stock

2019-04-17T00:26:45+00:00

The Mysterious Fabregasto's Initiation Coverage Of Ecofibre (ASX:EOF)

Ecofibre (ASX:EOF) listed in late March and has been a strong performer – closing its first day at a share price of $1.70 (a tidy 70% gain on the $1.00 IPO price for those who participated in the float).

The stock fell back to below $1.50 in the following week, with a number of (probably retail) shareholders happy to lock in a handy stag profit, but it has subsequently powered to a recent high of $2.64 (with the most recent close being $2.12).

The enthusiasm for the stock since listing is likely to be at least partly attributable to the stellar run of Elixinol Global (ASX:EXL). (You can read our coverage of Elixinol's FY 2018 Results). In truth, there are some striking similarities between the two. But (“Gah!” said grammar nerds, starting a sentence with “But”!) there are also a couple of key differences.

Like EXL, Ecofibre comprises three operating businesses, two of which operate in the same space, have been trading for some time, and are generating revenue. They are:

A US-based manufacturer and distributor of hemp-based nutraceutical, dietary supplement and skincare products; (Ananda Health) and
An Australian-based manufacturer and marketer of hemp foods (Ananda Food)

Ecofibre’s third arm is pre-revenue, and focused on commercialising the production of hemp-based textiles and composite materials (Hemp Black). Unlike many listed players, EOF has deliberately decided not to focus on the emerging medicinal cannabis space at this time (with the current regulatory framework making this market difficult, in management’s view).

For more background on the cannabis sector, please refer to our broader sector piece on Cannabis Stocks, The Industry Opportunity.

Because it is a freshly listed company yet to attract broker coverage, there is a limited amount of publicly available information on Ecofibre, apart from its prospectus, its website, and its maiden quarterly cashflow report. The IPO was not underwritten and the prospectus was prepared by the company itself – and as such is a little on the “skinny side” in terms of detailed descriptions and elaboration – but we will make do with what we have.

Ananda Health

This business launched in early 2017 and at this stage generates the majority of Ecofibre’s revenue and earnings (just as Elixinol’s US business does for it). Ananda Health is focused primarily on the manufacture and sale of zero-or-low-THC hemp-based nutraceutical products under the Ananda Hemp and Ananda Professional brands – predominantly in the US market. This division also selectively undertakes bulk white label contract manufacturing for certain “strategic” customers – presumably in order to absorb latent production capacity as well as generate additional revenue and margin. This contract manufacturing comprised ~10% of 1H19 sales per the prospectus.

Ananda Hemp sells CBD-oil and hemp-oil derived products (predominantly dietary supplements) via its website to wholesalers, distributors and directly to retail customers. The product range is marketed towards the health and wellbeing customer segment, in particular consumers seeking anti-inflammatory and anxiety relief or assistance with sleeping. Key Ananda Hemp products include CBD oil herbal extracts for humans (in a variety of strengths) and also pets, hemp extract gel capsules, hemp flower extract topical cream, and also a cannabis infused Ananda Bliss oil for “your inner sexpot” (Hello Sailor! [Ed: Keep it PG, Mr “Gentleman”]).

Ananda Professional is a brand distributed exclusively throughout independent pharmacy chains – with differentiated branding and packaging, but essentially mimicking the Ananda Hemp range above (excluding the racier Ananda Bliss oil).

Ecofibre signed its first pharmacy customer in 1H18 and formally launched this brand in 2H18. This brand was sold in ~1,500 independent US pharmacies as of late February 2019 (out of a total of ~22,000 nationally per the prospectus) – suggesting a store penetration rate of just 7% and ample opportunities for growth. As consumer awareness of CBD-based products increases following the signing of the US Farm Bill into law in December 2018 (discussed in our $EXL coverage), we think demand will increase. Management aim to accelerate new product development in line with the significant market opportunity in the US – although competition is likely to increase too, as newer players enter the market with their own expanding product ranges.

Ananda Hemp sales to retail customers comprised just 5% of total 1H19 sales, with the remaining 85% (after including white label above) derived from Ananda Hemp wholesale and Ananda Professional.

Sales have grown quickly since inception of this business – as demonstrated by the financial information disclosed in the prospectus (compiled and presented below left). Note that Ananda Health sales for 1H19 are already 160% higher than sales for the whole of FY18. We are loathe to make lazy projections based on a limited number of data points, but if no further growth was achieved in 2H19 (i.e. vs. 1H19), full-year FY19 sales would be in the ballpark of $24M (422% revenue growth from FY18). This would be very impressive growth even though it will not continue ad infinitum. On top of that, gross margin has increased to 67% in 1H19 from 39% for FY18, suggesting a degree of scalability in this business.

The US operations are vertically integrated. Ananda Health processes high-CBD concentrated hemp sourced from contracted local farmers at its Kentucky production facility to produce “dried green material” which is used as the base feedstock from its hemp extract product range. Per the prospectus, this site has been extended twice since commissioning in 2016 in order to accommodate growth, and a bottle and packaging line was added in July 2018.

Ananda Food

This business was launched in late 2017 post the inclusion of low-THC hemp as a food in the Food Standards Australia New Zealand code (which effectively legalised hemp as a food in Australia). Currently Ananda Food is focused purely on the Australian market, but has plans to expand into Asia at a later stage.

The Ananda Food product range includes hemp protein powder, hemp flour, hemp seeds and hemp seed oil. The majority of these volumes go through the wholesale channel which includes health food stores, grocery stores, and distributors, but there are also some white label and bulk customer sales per the prospectus.

While still small, this business is growing quickly (like the US division above it achieved higher sales in 1H19 than for the whole of FY18), and appears on track to break even in FY20.

Ananda Food contracts the growing of cannabis crops to growers in Tasmania, New South Wales and Queensland – using genetic material supplied by the company in order to produce maximum quality crops, over which Ecofibre retains ownership at all times. In November 2018, a manufacturing facility was commissioned in Newcastle which will focus on de-hulled seed, hemp protein and fibre powders. As part of its vertical integration strategy (i.e. to mirror the US operations), Ecofibre is also seeking to bring in-house the pressing of hemp seed (into oil) which is currently outsourced.

Hemp Black

This division is focused on developing hemp-based textiles and composite materials in partnership with Thomas Jefferson University (“TJU”, which is a top 20 shareholder in the company).

Hemp farming is not a recent innovation from the hipster community, it dates back to the beginning of recorded human history. Cannabis originated on the Central Asian steppes and was being used as early as 8000BC as an industrial fibre in clothing, building materials, lighting fuel and medicine. For thousands of years hemp was the world’s largest agricultural crop and was farmed throughout Europe and East Asia. As such, there is a long history of humans using hemp in industrial applications.

Ecofibre’s prospectus quotes research from Grand View Research Inc’s Industrial Hemp Market 2019 report that expects:

The global hemp fibres market to grow from US$1.7B in 2018 to US$4.4B in 2025; and
The global hemp textiles market to increase from US$955M in 2018 to US$2.8B in 2025.

Given the ubiquity of hemp as an industrial fibre throughout human history, I personally feel that these 2025 market estimates are likely to be on the conservative side, but time will tell. It is also well worth noting that hemp uses less water than cotton, and it would therefore be a positive for parched river systems if we used more hemp.

Hemp Black commenced operations in mid-2017 (when Ecofibre and TJU formally started collaborating) and is still in the R&D phase and yet to launch its first product. The relationship between Ecofibre and TJU is governed by a Research and Share Subscription Agreement (“RSSA”) under which TJU provides research services to the company until December 2022 – for which Ecofibre will not pay more than US$5M in total (excluding licence fees).

All intellectual property will be owned by TJU but Ecofibre will have global exclusive rights in regard to the commercialisation of products using this IP. Interestingly, under the RSSA, TJU has the ability to take payment for its research services in EOF stock (issued at A$0.537 per share per the prospectus).

Should TJU take all of its R&D fees from 2019 to 2022 in scrip – as it should with the EOF share price currently hovering at 4x this level already – TJU’s ownership in the company will grow from 1% currently (obtained via the conversion of R&D services to date into shares) to 4%. In addition, the prospectus detailed that TJU has an option to subscribe for a further 12.2M shares (representing ~4% of the company) at the same A$0.537 share price – provided that TJU has elected to receive payment in EOF shares for all R&D services provided under the RSSA.

The prospectus outlines two potential paths for commercialising the Hemp Black technology:

Hemp Black bi-component fibres: via the pyrolysis (heating) and then spinning of fibres into different patterns and concentrations which per the prospectus may have anti-odour and anti-microbial properties, moisture management, thermal regulation and low friction. Potential commercial applications include multi-filament yarns, performance and athleisure apparel, 3D printing filament, and fabrics used in motor vehicle seats and office furniture, amongst other uses.
Hemp Black Nano: the use of hemp flower extract to create CBD-rich fibre mats with potential anti-inflammatory benefits which could be incorporated into wound dressing and textiles, and in drug delivery and filtration technologies.

Last year TJU filed six provisional patent applications – however the IP and potential products themselves remain confidential at this stage under patent law. Management currently anticipate that the first prototypes of these products will be introduced to the market in mid-FY20.

Ecofibre has commissioned the equipment needed to produce the feedstock required for this first generation of products, and has commenced the establishment of a dedicated Hemp Black commercial facility at a new site in Kentucky which is expected to be completed in the June 2020 quarter. In addition, the company has commenced establishing its supply chain for Hemp Black operations, and has identified a commercial partner to spin Ecofibre’s pyrolised bi-component hemp fibre at commercial scale – with this partner injecting $3M of equity into the company in December 2018.

The company does not expect Hemp Black to become a manufacturer of the products described above – but envisages that this business will be a supplier of the technology (presumably under licence and including royalties), Hemp Black feedstock and CBD extracts.

Financials & “Valuation”

Consolidated historical financials for Ecofibre appear below including the Ananda Health and Ananda Food business, and also Hemp Black (which incurred $1.3M of costs in FY18 and also for 1H19). The company is clearly growing very quickly, and if there was no growth in 2H19 from 1H19, Ecofibre would achieve 364% top line growth versus FY18 – impressive albeit impossible to sustain indefinitely.

The prospectus contained no official forecasts – perhaps unsurprising given the growth trajectory and potential difficulty in nailing down accurate forecasts in this environment.

My read of the prospectus suggested to me that the company is on track to break even in 2H19 – this view was supported by the company yesterday, with the release of its 4C quarterly cashflow report for the March quarter. The commentary included in the 4C noted that Ecofibre achieved unaudited revenue of $10.1M for 3QFY19 – more than 75% of revenue generated in the December half and suggested that growth has accelerated further in early 2019 (annualised $40M of revenue ignoring seasonality).

Pleasingly, the 4C also included the company’s first guidance for FY19E with respect to year-on-year growth for revenue, gross margin and opex (included in the table above), as well as confirmation that management believe Ecofibre is on target to record a small profit for the current financial year – that’s better than breaking even exactly and capturing the Infinity P/E Multiple, a very rare Pokémon indeed.

The table above extrapolates an estimated small profit based on this guidance (and holding several other things constant from FY18 (as broadly suggested by 1H19 actuals). Note however that if March quarter revenue was $10M and there is no discernible seasonality in the business, we would expect FY19E revenue to be closer to 6x FY18 levels (~$34M) – which would require June quarter revenue of $11M, not at all absurd given the apparent acceleration in revenue in 3QFY19 vs 1H19.

Ecofibre listed with a market capitalisation (at the $1.00 IPO offer price) of $309M (excluding the option held by TJU) – which has swelled to $656M at yesterday’s close. The current market capitalisation is a rich valuation indeed for a company just breaking even, however its growth trajectory is impressive and clearly the market is less bothered with traditional valuation measures and more focused on medium term growth potential – as it is with peer Elixinol:

At current respective share prices, Ecofibre is trading on a 19-21x multiple of FY19E (June year-end) revenue. That is actually higher than Elixinol, although the limited financial information we have does suggest that EOF is growing faster than EXL at this point in time (EXL only grew revenue by 125% in the year to December 2018). Note that the revenue figure above is EXL’s latest FY18 (December year-end) comparable, and that annualised revenue for Elixinol to June 2019 is likely to be closer to $50M given its growth trajectory – which would put EXL on a 12x revenue multiple – more than a third lower than Ecofibre. Of course, if EOF can continue its growth trajectory in FY20 (which will commence in only several weeks), then the forward revenue multiple will decrease significantly. Note that even a doubling of revenue in FY20 from FY19 would represent a considerable slowdown from the 450% increase flagged by Ecofibre management for FY19E.

The takeaway of course is that it is EOF and EXL trade on comparatively eye-watering multiples because these companies are enjoying this spectacular growth in a rapidly expanding market which is benefiting from regulatory tailwinds. Both companies have also just recently reached their inflection points from a cashflow and profitability break-even point of view – and as such traditional valuation measures such as P/E multiples make these companies look very expensive indeed. We have previously discussed on Ethical Equities the PEG (P/E multiple divided by medium term % Growth rate) ratio – which factors in respective earnings growth rates and thereby enables more informed comparisons of company valuations – particularly between sectors and especially when comparing Growth vs. lower growth companies.

Closing thoughts

As noted in our last piece on Elixinol, the market for hemp-based nutraceutical, dietary supplement and cosmetics products is currently in a hyper-growth phase – which will attract a raft of new competitors all keen to get a slice of this rapidly growing market. To this end, Ecofibre investors will be keen to see how the company can grow market share and defend against new market entrants – and will be very focused on preliminary FY20 guidance, which I hope will be given in August at the release of full-year FY19 results.

The next few years represent a land grab as the global market opens up gradually as different countries relax regulations at different speeds, and existing and new industry participants wrestle to build defensible market positions. It will take some time to identify which companies will be the long-term cannabis winners. Ecofibre, with its focus purely on hemp is another comparatively smarter way to play the cannabis boom (but without the uncertainty in relation to licenses for medicinal cannabis cultivation and export etc). In particular, I personally find the Hemp Black division very interesting, though it is unlikely to be a significant revenue generator for a couple of years at least – however Ecofibre CEO Eric Wang (18% shareholder, alongside Chairman Barry Lambert (of Count Financial fame) who controls 24% of the company) has stated publicly that he believes in time Hemp Black will eventually be the largest part of the business.

The company may also move into the medicinal cannabis at a later stage. Chairman Barry Lambert has been a vocal advocate of the legalisation of medicinal marijuana for several years, with his granddaughter suffering from Dravet Syndrome (a severe form of epilepsy), and donated $34M to the University of Sydney in 2015 to establish the Lambert Initiative for Cannabinoid Therapeutics.

We feel that EOF, along with EXL, represents the second wave of the ASX cannabis boom (or Cannabis 2.0 if you will) – denoted by more professional, better organised, and more appropriately capitalised operators than those that mostly comprised the first wave over 2015 to 2017 (including a number of back door listings and pivots from other industries).

While the share price return of EOF to date is dwarfed by those briefly enjoyed by the first wave of more speculative players, there is little doubt that the company has been caught up in the renewed hype for cannabis stocks in 2019 following the passing of the US Farm Bill in late 2018, and the explosive YTD returns of EXL (at its recent high point up 137% from the end of December). As such, investors in EOF should expect continued volatility for the time being while cannabis stocks are once again in vogue with the shorter-horizon trading community, and we recommend Ecofibre only in small doses to readers with a high risk appetite (as with EXL).

Personally I am very curious to see initial FY20 guidance provided in August – and will be holding my EOF shares in the meantime.

Note from Claude: I am very proud to present this excellent research into a second investable ASX cannabis company. However, I do note that I would not mind if the company did not provide any specific guidance.

Disclosure: I (@Fabregasto ) subscribed for shares in Ecofibre in the IPO (though due to scaling back only received half the number of shares I was hoping for) – and may add to my position in the future – though not for at least 2 days after the publication of this article.

Claude Walker owns shares in Ecofibre and will not sell for at least 2 days after the publication of this article.

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This article contains general investment advice only (under AFSL 501223). Authorised by Claude Walker.