Description

Pyxus International (“PYX”, fka Alliance One International) equity offers an asymmetric risk/reward with >100% upside over the next 6 – 9 months as PYX has greatly de-risked the downside (i.e. limited risk around refinancing the balance sheet esp as junior security currently trades ~98) and has provided more clarity around the upside initiatives (recent Investor Day helped frame cadence) that has largely being ignored by the markets as we creating the “growth” for free but should augment value by ~$20 – 30 / share (versus ~$25 current). Notably, we are taking a punitive approach and have assumed mgmt can only execute on less than 10% of the growth initiatives (i.e. we assume ~$20MM of profitability from these initiatives versus mgmt’s view that it could drive >$200MM in 4-years). Every additional $20MM of profitability is worth >$20/share using a relatively punitive EBITDA multiple (not the “blue-sky” multiples that the market is currently applying).  Additionally, there are multiple catalysts in the n-term to unlock value on the growth initiatives including: 1) commencement of retail CBD sales through Criticality investment (<1 month), 2) October 17^th go-live of cannabis sales in Canada, 3) further clarity on licensing process of FIGR Norfolk facility (1 – 3 months most likely), 4) greatly improved liquidity in PYX trading (post name change, more volume + active options market). Lastly, if investors are cautious on the core tobacco business, investors can effectively hedge out this risk w/ UVV short (liquid, at all-time high levels, and trades at >2x multiple premium to PYX) and can effectively “create” the PYX growth business for free. While we posted Alliance One on VIC approx 5-months ago, given additional clarity around the growth initiatives, it’s timely to revisit PYX equity.

Why the opportunity: the market is ignoring the growth initiatives and taking a wait-and-see approach … but evidence will be more apparent over the next 3 – 9 months. PYX hosted an investor day on September 12^th that provided more clarity into the growth initiatives and strategy, highlighted by their aspirations to generate ~2/3 of consolidated EBITDA from their various growth segments including e-liquids, industrial hemp / CBD and legal cannabis by 2023 implying upwards of $500MM consolidated EBITDA or over 2.5x current LTM of $178. We very conservatively see near-term “growth” EBITDA generation of $20MM+ which augments the equity by $30+ / share over the next 12 months but is under-appreciated by investors given the infancy of the operations, but will be much more evident in the very n-term. Despite a tiny float of 9MM shares, since the name change to PYX average daily volume in the stock has been 1MM+ and PYX now has an active options market that further improves liquidity and should command more capital to the name. As highlighted in our initial write-up in May, for investors seeking to play PYX’s “growth” businesses and hedge the tobacco risk, comp UVV operates a nearly-identical business and trades ~10x vs. PYX at 8x LTM. Longer-term, we see the potential for PYX to spin out the growth segments once the businesses reach critical scale – this thesis is supported by a recent reorganization of PYX’s management structure around the core and growth businesses and management’s plans to begin breaking out financial performance between the two business units – likely beginning in FQ4 of this year.

As we highlight in more detail below, the 1) core business is worth $8-35 / share (~$21 base case), 2) currently-operational cannabis business is worth $14-20 (does not factor in FIGR Norfolk facility) and 3) CBD is worth $8-11 (commencement of sales in the next few weeks). In aggregate, we think PYX equity is worth ~$30 on the low end, $47 to base case and has the possibility of being a $65+ stock if the growth initiatives surprise to the upside (versus ~$25 current).

1): “Core” Tobacco

PYX’s tobacco business has consistently generated EBITDA in the $150-200M range with minimal capex needs in the $15-20MM/annum range. On their FQ4’18 call, management provided forward consolidated EBITDA guidance range of $170-190MM which we think is constituted of a marginal improvement YoY in the tobacco business offset by incremental losses from the growth businesses which are in varying degrees of start-up mode and profitability. We had previously estimated that tobacco could generate north of $185MM EBITDA next year however we have somewhat revised downward our forecasts to $178MM in light of a weaker than anticipated North American crop. We value PYX’s tobacco business on an after-capex basis given the limited capital needs to support operations. Applying an 8.5x multiple to EBITDA-capex (implies ~7.5x EV/EBITDA, in-line with historical trading levels) of $161MM and adjusting for seasonal revolver and cash balances implies a “core” equity value of $21/share.

2): Cannabis

PYX is exposed to the legal Canadian cannabis market via two investments: 1) 75% interest in Canada’s Island Garden in Prince Edward Island (referred to as FIGR East) which is fully licensed for both flower and oil and recently signed a supply agreement with PEI for 1,000 kilograms of cannabis for the upcoming recreational markets and 2) 80% interest in a second operation in Ontario (FIGR Norfolk) which is currently in the pre-license stage but will, if successful, ultimately have twice the square footage capacity of CIG (~670k square feet Ontario vs. ~330k CIG). Our discussions with management suggest that licensure of Ontario could be imminent however for sake of conservatism we exclude any near-term financial impact from this in our analysis though highlight that it could represent significant upside to our assumptions.

CIG is currently operating on a 44,000 SF footprint (10,560 “growing” square feet) with expansion plans underway to size this to a 330,000 square foot facility and an estimated 165,000 SF of grow space – completion is expected in Spring 2019. Management disclosed the current operations are producing 40.4 grams per growing SF per harvest (5-6 harvests per year) which implies ~220 grams / SF annually or 37,000 kilograms. Given the expansion timing, we assume for F2020 (calendar 2019) 50% production capacity or ~18,000 kilograms sold implying C$78MM 2019 revenue assuming $4.25 wholesale price (px somewhat of a moving target given nascent nature of legalized market; our discussions with a number of larger LPs suggest our estimate is reasonable). CIG is currently operating at an EBITDA loss (we estimate $3-4MM) however margins are expected to expand rapidly as fixed COGS are levered over a dramatically larger volume base and pre-market SG&A costs moderate. Management believes the cannabis business can achieve margins north of 30% - we forecast 25% in year one. Net net, the CIG business could contribute ~$12MM of EBITDA to PYX in 2019 or $14-20 per share assuming a 12.5-17.5x ascribed multiple (pure-play comps trade 20x+ forward).

Assuming full licensure of the Ontario entity, management believes they can expand the growing footprint to over 500,000 square feet – applying the same math as above suggests a “blue sky” near-term scenario of C$450MM+ in revenue and $70MM+ of attributable EBITDA.

3): CBD

PYX has a 40% stake in Criticality, a grower of industrial hemp in North Carolina with near-term CBD extraction capabilities upon the completion of its facility in Wilson, NC the fall of 2018 (currently extracting out of a smaller, nearby facility). Criticality will be selling its product both B2B on a wholesale basis and B2C through its website www.korenthemp.com. PYX has an option to increase its stake to 50% after 3/31/2020. Though more “under the radar” than PYX’s cannabis ambitions, we think the CBD business represents considerable upside to the equity thesis at a much lower risk profile than cannabis given the existing nature of the operation, more favorable regulatory environment (we expect further clarity with the likely near-term passage of the Farm Bill) and quicker scaling of profitability. Industry research has pegged the current domestic CBD market at $287MM, growing to $1.6BB by 2021 or a 75%+ CAGR over three years.

While PYX management has not highlighted the current revenue or profitability of Criticality, they did offer the following datapoints which help us to frame the current and future opportunity: 1) 200 acres of hemp growing fields with room for expansion (tobacco farms can be easily converted to grow hemp), 2) 32 kilograms of CBD per acre and 3) $8,366 weighted average selling price per kilogram. From this, we impute that the current crop in the ground should generate ~$54MM of forward revenue – on a 25% EBITDA margin (recent pure-play IPO CWEB is guiding 35% forward), AOI’s 40% stake in criticality could contribute ~$6MM of EBITDA in 2019 and offer an additional $8-11 per share of equity value assuming a 12.5-17.5x range of EBITDA multiples (again, CWEB trades 20x+). It is worth noting that unlike cannabis which will largely be a 2019 catalyst, we expect CBD to be revenue and potentially EBITDA generative by Q3 and Q4 of this fiscal year which will be meaningful as management seeks to gain credibility in “putting points up on the board” in terms of executing on its growth initiatives.

Catalysts

·       Commencement of retail CBD sales through Criticality investment (< 1 month)

·       October 17^th go-live of cannabis sales in Canada

·       Further clarity on licensing process of FIGR Norfolk facility (possibly 1-3 months)

·       Improved liquidity in PYX trading – since the name change, average daily volume has increased to over 1MM shares and the stock now has an active options market

Risks

·       Hurricane Florence made landfall in PYX’s North Carolina tobacco regions in September, potentially putting the NA crop harvest (25% supply) at risk which could impact achievability of F2019 guidance

·       While we are constructive on PYX management’s actions to pursue higher growth industries,  the team has limited track record in the space and the stock remains a “show me” story

·       PYX remains highly levered with ~$1.4BB debt – successful refinancing contingent on maintaining “core” performance and demonstrating growth from new business lines

Catalyst

·       Commencement of retail CBD sales through Criticality investment (< 1 month)

·       October 17^th go-live of cannabis sales in Canada

·       Further clarity on licensing process of FIGR Norfolk facility (possibly 1-3 months)

·       Improved liquidity in PYX trading – since the name change, average daily volume has increased to over 1MM shares and the stock now has an active options market