Cascadia Expansion And Margin Pressures Will Challenge Operations Yet Ultimately Support Long-Term Stability

Catalysts

About Rubicon Organics

Rubicon Organics produces premium and ultra premium cannabis products for the Canadian and select international markets.

What are the underlying business or industry changes driving this perspective?

• Although Cascadia increases production capacity by 40% and early crops are planted, the cautious quality ramp and pre revenue operating costs of approximately $1.5 million per quarter risk delaying the expected revenue inflection and weighing on EBITDA margins if yields or premium sell through underperform expectations.
• While demand for premium flower and pre rolls in Canada appears robust, with 1964 and Simply Bare gaining share, rising competition in larger format value oriented packs and the shift toward lower margin 28 gram SKUs could compress gross margins even as top line revenue grows.
• Although international medical markets such as Australia, Poland and the U.K. show a growing gap in high quality premium products, regulatory uncertainty, slow approvals and the company’s deliberate crawl, walk, win rollout may limit near term export volumes and defer meaningful contribution to earnings.
• While automation and yield initiatives at Pacifica, including pre roll automation and targeted cultivation improvements, are expected to add roughly $1 million in annual gross profit and at least 10% more yield, execution risk or diminishing efficiency gains could prevent Rubicon from reaching its stated mid 40s gross margin objective within 12 to 18 months.
• Despite premium brands like 1964, Simply Bare and Wildflower outperforming in structurally growing categories such as vapes and topicals, heavier SG&A investments in marketing, key accounts and new talent to support scale may outpace revenue growth, capping EBITDA margin recovery toward the 20% target.

Assumptions

This narrative explores a more pessimistic perspective on Rubicon Organics compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Rubicon Organics's revenue will grow by 15.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 5.7% today to 0.0% in 3 years time.
• The bearish analysts expect earnings to reach CA$17.4 thousand (and earnings per share of CA$0.0) by about December 2028, down from CA$3.2 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 5644.0x on those 2028 earnings, up from 10.6x today. This future PE is greater than the current PE for the CA Pharmaceuticals industry at 14.8x.
• The bearish analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.12%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The ramp up of the Cascadia facility could take longer than expected to consistently meet 1964 level quality. This would extend the period of roughly $1.5 million per quarter in largely pre revenue production and start up costs and depress reported gross margins and EBITDA margins over the next several years.
• A structural shift in consumer preferences toward larger format 28 gram value oriented packs and infused pre rolls, where Rubicon is less focused and margins are structurally lower, could erode the premium pricing power of 1964 and Simply Bare and weigh on long term revenue growth and net margins.
• Increasing regulatory and cost burdens in Canada, including rising excise taxes and the 2.3% of net revenue Health Canada regulatory fee, may scale faster than Rubicon can offset with efficiency gains. This could pressure long run gross margins and limit expansion in EBITDA margins despite higher sales.
• The international crawl, walk, win strategy into markets like Australia, Poland and the U.K. may remain small scale for longer than planned due to slow regulatory approvals and entrenched low cost bulk suppliers. This would delay any meaningful diversification of revenue and earnings away from the mature Canadian market.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Rubicon Organics is CA$1.0, which represents up to two standard deviations below the consensus price target of CA$1.15. This valuation is based on what can be assumed as the expectations of Rubicon Organics's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$1.3, and the most bearish reporting a price target of just CA$1.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be CA$88.8 million, earnings will come to CA$17.4 thousand, and it would be trading on a PE ratio of 5644.0x, assuming you use a discount rate of 6.1%.
  
• Given the current share price of CA$0.51, the analyst price target of CA$1.0 is 49.0% higher. Despite analysts expecting the underlying business to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.