Harvest One (OTCPK:HRVOF) should not trade at 5.2x forward revenue as other peers with less revenue growth are trading at more than 25x. Investors should not be able to justify such a low valuation. In addition, the company seems small, which is many times a risk.
With that, if revenue growth continues and the market trusts this name, the EV/Sales ratio should improve. Keep in mind that for the six months ended September 31, 2018, Harvest One had CAD 5.6 million, 3,062% more than that in the same period in 2017.
Business
Founded in 2008, Harvest One Cannabis is a cannabis company cultivating and selling cannabis as well as developing medical and nutraceutical products.
With three subsidiaries operating in three very different activities, investors are able to access many business segments related to the cannabis business. There is United Greeneries, a licensed producer headquartered in British Columbia, which presents its business with the following words:
Source: United Greeneries
In addition, the company owns Dream Water Global, which focuses on the consumer segment and provides a significant amount of revenue for Harvest One. Its main product is a drug-free sleep aid. Investors can check it in the images below:
Source: Dream Water
Source: Dream Water
In October 2018, Harvest One acquired 20% stake in Burb Cannabis Corp., for which it paid CAD 1.75 million. The business strategy of Harvest One seems smart. It intends to become a vertically integrated business. Keep in mind that Harvest One acquired the maximum investment permitted by a licensed producer in a retail cannabis business in British Columbia.
Burb Cannabis does not seem to be well known in Canada, but it comes across as growing retail player in metropolitan areas. The lines below provide further details on this matter:
Source: Press Release
Balance Sheet
With almost no liabilities and CAD 40 million in cash, Harvest One Cannabis owns a financial situation that should please investors. Having mentioned this feature, there are certain items in the balance sheet that should be studied closely. The amount of intangibles worth $7.8 million and goodwill of $30 million comprise 35% of the total amount of assets. This is a bit worrying. Please note that auditors may impair these assets, which could lead to share price depreciation. The image below provides a list of assets:
Source: Prospectus
The goodwill was registered after the acquisition of PhytoTech and Dream Water. The largest acquisition was that of Dream Water. It included a goodwill of CAD 27 million. The image below provides further details on this matter:
Source: Prospectus
Harvest One Cannabis paid for Dream Water a total of CAD 34.5 million. $12.5 million was cash, and the rest was equity. It means that goodwill represented more than 80% of the total amount paid. Investors may not appreciate this feature. It means that the company expects to make a large amount of money with the business acquired from Dream Water.
While Harvest One may be correct, the risk of the transaction does not seem low. If accountants believe that the business acquired is not worth that much, these assets may get impaired. The image below provides further details on the transaction:
Source: Press Release
On the liabilities front, investors will appreciate that the amount of liabilities is low. It amounts to $3.5 million, and the company does not report financial debt. It is quite ideal. Note that Harvest One was able to finance its operations through the sale of equity. The image below provides the list of liabilities and the equity structure.
Source: Prospectus
Income Statement
Like other cannabis companies, Harvest One reports massive revenue growth. For the six months ended September 31, 2018, the company had CAD 5.6 million, 3,062% more than that in the same period in 2017. The gross profit is also impressive, equal to CAD 1.7 million. With that, other companies operating in the same sector report higher gross profit margin. The image below provides the top of the P&L:
Source: Prospectus
The revenue breakdown provides very valuable information on the type of business model of Harvest One. For the six months ended December 31, 2018, the company was very strong in selling products to consumers. The total revenue associated to this activity equals CAD 2.76 million. In addition, revenue associated to cultivation was equal to CAD 2.67 million. It is very relevant noting that cultivation comprises of 38% of the total amount of revenues, which seems beneficial. Keep in mind that the gross profit margin of this activity seems larger than the sale of consumer products. Investors should appreciate this fact, which should increase the total valuation of Harvest One.
In the image below, investors can see that the gross profit margin of cultivation is not only larger than that of the other activities, it is also the only activity that reports net profit in the six months ended December 31, 2018. It seems clear that if Harvest One invests more money in the cultivation segment, the earnings and the share price should increase. 
Source: Prospectus
Having mentioned these beneficial features, value investors may not appreciate the company as it is far from reaching break-even point. The loss from operations reported in the six months ended December 2018 increased by 37% as compared to the same period in 2017. The company seemed to hire more employees as salaries and benefits increased by 206%, and share-based compensation increased by 73%. The image below provides further details on this matter:
Source: Prospectus
Growth investors should not care about the top of the P&L. What should matter to them is that revenue growth and gross profit margin continue to be good.
Equity And Warrants Outstanding
Regarding the total share count, as of December 31, 2018, the company reports 182.09 million shares. In addition, the number of warrants outstanding is equal to 33.7 million. It means that the share count should be equal to approximately 215 million.
Investors should remember that the warrants outstanding don’t represent a small amount. Knowing details about them seems relevant. The most relevant seems to be that many of them should expire in 2020-2021. Bear in mind that the conversion of these warrants could lead to stock dilution and share price depreciation. It is a risk to be kept in mind. The image below provides further details on this matter:
Source: Prospectus
Valuation
Assuming 215 million shares at $0.51, the total market capitalization should be equal to $109 million. Deducting cash of CAD 40 million or $29.79 million, the total enterprise value is equal to $79 million.
For the six months ended September 31, 2018, the company had CAD 5.6 million or $4.17 million, 3,062% more than that in the same period in 2017. Assuming that Harvest One grows like Aurora (ACB), expecting forward revenue of $15 million seems reasonable. The image below shows the revenue growth reported by ACB.
Source: YCharts
With forward revenue of $15 million, Harvest One trades at 5.2x, which looks cheap as compared to other cannabis operators. Many of them trade at more than 25x sales, and some go to more than 400x sales. Yes, Harvest One is small, not well-known, and does not report a lot of revenue. However, the difference between the ratio of peers and that of Harvest One does not seem justifiable. Check the images below, Harvest One reports more revenue growth than most its competitors:
Source: YCharts -EV/Sales Ratio
Source: YCharts
Conclusion
Growing at triple digits, with a cultivation segment that comprises of 38% of the total amount of revenues, Harvest One should not be trading at 5.2x forward revenue. Other competitors are trading at more than 25x and are reporting less revenue growth than Harvest One. Investors should not be able to justify such a low valuation. Keep in mind that the financial debt is also equal to zero, and the convertible securities were included in the valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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