Fire & Flower Earnings Show 24% Revenue Growth During Tough Times

Fire & Flower is a cannabis retailer that operates 33 stores across Alberta, Manitoba, Saskatchewan, Yukon, and Ontario (through brand partners). They reported Q3 earnings today and managed to grow revenues despite the troubles facing major LPs.

We provide a review of their performance, starting with what we like.

Our Take

As a cannabis retailer, Fire & Flower is brand agnostic when it comes to the products on their shelves. At a time when oversupply is leading to increased competition and compressing margins for already unprofitable LPs, FAF will be (relatively) better off.

They are taking a digital-first approach, which we believe is smart given we live in a data-driven world.

As long as cannabis sales continue to grow across the country, they will be able to realize the benefits without the hassle of competing on price, quality, and brand strategy on multiple different SKUs. With that said, retail competition is certainly heating up across the country.

Along with retail operations, Fire & Flower also licenses its retail brand as well as its management platform software (Hifyre). They are taking a digital-first approach, which we believe is smart given we live in a data-driven world.

This will help them be more efficient with shelf space, promotions, and provide them with opportunities to monetize data. It also pairs nicely with their new loyalty program.

This quarter FAF launched Spark Perks, a loyalty program that has seen a rapid growth of its user base and demonstrated it can increase ticket size of consumers (44%). While this does include the recent Black Friday/Cyber Monday, it’s a promising sign for the program.

It also clearly helped them drive 24% quarter over quarter revenue growth at a time when most LPs are seeing shrinking sales.

Overall, Fire & Flower is moving in the right direction. Revenues are growing, margins are at least steady, and SG&A is holding flat. While they will need to make continued investments in retail outlets to see continued growth, they appear to have the cash necessary to do so.

At a time when retail is opening up in the biggest cannabis market in the country and 2.0 products are now ready to hit the shelves, the company has some nice growth catalysts on the immediate horizon. But what about the challenges?

We see two hurdles facing Fire & Flower in the coming quarters.

The first is the retail rollout in Ontario. Obviously, the OCS’ recent announcement regarding the removal of the lottery system and the implementation of a first-come-first-serve model provides them with the opportunity to break open Canada’s largest cannabis market.

However, this opportunity comes at the cost of entering a highly competitive market and dealing with a monopolistic government body that limits their abilities as a retailer (reduced pricing power, no special offerings, etc.).

They may see their gross margins face downward pressure as a greater portion of their revenue is derived from government-controlled markets. At this time it’s unclear how much derivative products will help mitigate these issues, however, they will provide some margin support.

Based on government regulations, Fire & Flower will be looking to operate the maximum number of 10 retail outlets as soon as permissible. With their recent strategic partner in Couche-Tard, they will have substantial expertise and data to fall back on when choosing retail locations.

In the end, the opening up of the Ontario cannabis market will be a net good for cannabis companies. However, outperforming peers will have to be a top priority for Fire & Flower if they want to be the dominant cannabis retailer in Canada.

With a cash balance of $42 million, they are in a solid position, which brings us to the second challenge — financial health.

The company recently received a strategic investment from Couche-Tard of $25.9 million, which when exercised/converted in full will provide them with a controlling interest.

Based on their current cash burn (operations and investing) of $11.6 million and a gross margin of 35%, FAF needs revenues of $33.4 million to become cash-flow positive. With a growth rate of 20% per quarter, this would take just under 5 quarters to achieve and burn $28.4 million cash in the process.

While that would mean, based on the above assumptions, they have enough cash to reach cash flow positive operations, it doesn’t take into account their debt servicing and payment of their convertibles.

Given current market conditions, it’s difficult to say what the ultimate outcome will be. However, investors should expect at least some dilution to come from restructuring the debt, forcing conversion, or securing financing from some other means.

With that said, we still believe Fire & Flower presents an intriguing opportunity given the potential retail cannabis holds and the opening of the retail landscape. We will be watching closely for more details on their plans to handle the pending debt coming due.

Unless you are looking at investing in a craft producer, you will want to stay away from most LPs. While it’s still too early to tell what brands will be dominant, especially with 2.0 products only becoming available, retail is a very intriguing play in the cannabis space.

Quarterly Review

Fire & Flower generated revenues of $13.7 million in the quarter, up 24% quarter over quarter. Cost of goods sold saw an increase of 27% to $8.9 million, which means margins shrunk slightly for the quarter from 36.5% to 34.7%

Management attributed this largely to promotional activities required to sell out slow-moving products from their stores. However, they believe margins will hold steady, if not improve slightly.

As competition heats up, investors should watch margins closely. As prices fall and retail competition heats up, margins will face downward pressures. At this time, it’s unclear what sort of boost they might receive from the sale of derivative products.

On a positive note for FAF, SG&A held flat quarter over quarter, which is impressive given the revenue growth. Management does expect this to increase in proportion with store count growth moving forward.

EBITDA was -$2.9 million,  improving by 22% over the previous quarter. While they posted positive net income of $10.2 million, this was driven entirely by $16.1 million in “other income” generated from the revaluation of derivative liabilities.

The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Capital 10X hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.

Evan Veryard
Evan Veryard has a Bachelor's of Chemical Engineering from McGill University and a MaSc. of Chemical Engineering from RMC. He has over 6 years of research experience focusing on industrial materials. Address: 682 Indian Road, Toronto, Ontario, M6P 2C9. Phone: 416-721-8257.

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