Near-term profitability sets CropLogic apart

It has been an outstanding start to 2019 for global agricultural technology group, CropLogic Ltd (ASX:CLI) with the company negotiating a lease for a trial industrial hemp farm in Oregon, attaining an Industrial Hemp Grower Licence and increasing its trial farm size from 150 acres to 500 acres, substantially increasing the group’s earnings capacity.

The company also secured $4 million in funding, leaving CropLogic fully financed in terms of bringing the trial farm into production.

In commenting yesterday on the company’s promising outlook for 2019, chief executive James Cooper-Jones said, “CropLogic is well positioned for growth with its high profile industrial hemp trial farm in Oregon to showcase the company’s technology and agronomy experience.

“Our coverage of the Washington State region continues to grow with realTime orders up 50% on last season.

“Varying growing environments present an opportunity for CropLogic to further vertically integrate its agronomy and agtech expertise at both its trial farm and across is operations in Mildura (Australia), Washington State, Idaho and Oregon.”

Earnings not reflected in enterprise value

While this commentary captures the group’s operational progress, what appears to be eluding investors is the company’s earnings profile as CropLogic is poised to deliver tens of millions of dollars in profits in the very near term.

The cannabis industry has attracted numerous new players, but there is only a small clutch of companies positioned to transition to profitability in the near term.

CropLogic’s ability to join the ranks of industry participants delivering substantial profits and shareholder returns stems back to its experience in the broader agricultural technology industry.

For many years the company has been servicing the agricultural industry across a wide range of crops, assisting growers in managing their farming areas and optimising yields in varying conditions.

The company’s hardware and software technology has been instrumental in providing reference data for different growing conditions such as soil types, land contours and elevation in order to optimise crop yields.

Now the company has an opportunity to bring its proven technology and expertise to its trial farm, a development that will generate substantial earnings and provide the company with yet another opportunity to showcase the benefits of its technology in the US.

Consequently, CropLogic shouldn’t be lumped in with other players in the sector that have a record of transitioning from mining to biotech to cannabis, and whatever else is the flavour of the month.

This is a well-credentialled company with a strong and experienced management team that is poised to generate substantial income over the next 12 months.

Price-earnings based rerating in 2019

Management hasn’t provided definitive earnings guidance because there are a number of variables in the mix, but comprehensive industry data backs up the group’s commentary regarding indicative crop yields, overheads and sale prices.

Suffice to say though, a pre-tax profit of more than $50 million from this year’s crop appears achievable, as this reflects mid-range metrics regarding yields, overheads and market prices.

With regard to the timing of earnings, planting should occur in May/June, harvesting in September/October and processing and sales in October/November.

Depending on supply and demand dynamics management could take the decision to sell the whole crop in 2019 or stagger sales so that there is some income recognition that will occur in 2020.

In any case, this is a near-term earnings story boasting outstanding profitability, particularly for a company with a market capitalisation of approximately $10 million.

As the group closes in on its sales window and generates first earnings, it would appear that the company will then be priced on an enterprise value to earnings basis and/or price-earnings multiples which would imply a share price well above its current level, bringing its market capitalisation in line with fair value.

Crunching the numbers

Just to provide an idea of what the extent of a potential share price rerating could be, we will run through the numbers that will feed into the bottom line.

CropLogic conservatively estimates that the 500 acre farm will be able to produce in the order of 800,000 pounds of industrial hemp biomass per annum, having considered other producers within the region who can reach up to 1.1 million pounds per annum on a similar site.

The hemp biomass market price of US$35.00 to US$45.00 per pound has been ascertained from both the company’s own investigations and is in line with third party indices for hemp market spot prices in the region.

Similarly, hemp production costs have been ascertained from the company’s own investigations and are supported by third party research suggesting a cost of US$5.00 to US$7.00 per pound as a conservative production cost estimate.

The yield, market price, and production cost figures are statements of fact which are supported by external research and analysis and from information and farm plans compiled by independent individuals and CropLogic’s advisory and management team who possessed the relative competencies in relation to operations of this nature.

Based on annual industrial hemp production of 800,000 pounds, a mid-range market price of US$40.00 per pound and a mid-range cost of US$6.00 per pound and an AUD:USD exchange rate of US$0.70, the 500 acre farm should generate a pre-tax profit in the order of $40 million.

If management is able to achieve slightly higher prices than mid-range indications while delivering costs towards the lower end of the stated range, as well as achieving production numbers more in line with ‘same site’ comparisons, the pre-tax profit could be as high as $58 million.

Peer comparison highlights discount to fair value

To provide some means of comparison in terms of valuing CropLogic, vertically integrated Australian almond grower, Select Harvests (ASX:SHV) generated earnings before interest and tax of $34.9 million in fiscal 2018.

The company was carrying net debt of $70.8 million as at balance date, implying an enterprise value of approximately $730 million at that time.

This was based on a share price of $6.90, indicating that the valuation isn’t all that far removed from where it was then.

This implies an enterprise value to earnings before interest and tax multiple of 21.

Taking into account a recent capital raising and the prospect of some nominal debt financing in the near future, CropLogic’s enterprise value should be in the order of $15 million.

If one applies SHV’s EV:EBIT multiple to CropLogic’s pre-tax earnings that would equate to an enterprise value of about $800 million based on estimated mid-range earnings over the next 12 months.

There are other metrics to take into account and this back of the envelope calculation by no means should be used to quantify the extent of a potential share price rerating, but it does highlight the significant disconnect between CropLogic’s current valuation and its earnings profile.