I Will Capitalize On Cannabis Debt Demand By Diversifying Portfolio And Improving Underwriting

Key Takeaways

• AFC's focus on diversifying its portfolio and enhancing underwriting aims to improve net margins by reducing underperforming credits.
  
• Positioning for cannabis industry supply-demand imbalance could increase revenue due to high demand and limited competition.
  
• Exposure to underperforming credits, legal disputes, and a lack of federal reform in cannabis hinder growth and impact earnings and financial stability.

Catalysts

Advanced Flower Capital Inc. originates, structures, underwrites, and invests in senior secured loans, and other various commercial real estate loans and debt securities for established companies operating in the cannabis industry.

• AFC has a strong pipeline of over $380 million worth of deals, indicating potential future growth in originations, which could positively impact revenue.
  
• The company is focused on diversifying its portfolio and enhancing its underwriting process, leading to a potential improvement in net margins through reduced exposure to underperforming credits.
  
• AFC's strategic redeployment of capital from underperforming loans to better-performing credits promises to unlock future earnings potential, enhancing overall earnings.
  
• AFC anticipates a supply-demand imbalance for debt capital in the cannabis industry, positioning itself to benefit from higher demand and limited competition, which could lead to increased revenue.
  
• The company is focused on backing strong operators with successful track records, which should result in improved credit quality and reduced credit losses, positively impacting net margins.

Advanced Flower Capital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Advanced Flower Capital's revenue will grow by 20.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 32.3% today to 64.1% in 3 years time.
• Analysts expect earnings to reach $46.9 million (and earnings per share of $2.06) by about March 2028, up from $13.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 6.7x on those 2028 earnings, down from 10.9x today. This future PE is lower than the current PE for the US Mortgage REITs industry at 12.2x.
• 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 6.22%, as per the Simply Wall St company report.

Advanced Flower Capital Future Earnings Per Share Growth

Risks

• Continued exposure to underperforming credits that have significantly impacted earnings in the past year may lead to further write-downs and affect net margins and distributable earnings.
  
• Legal disputes and defaults, such as the ongoing issues with Justice Grown, could result in potential losses and additional costs, affecting net income and shareholder confidence.
  
• High levels of unrealized losses and CECL reserves suggest potential risks in asset valuation and portfolio quality, impacting book value and financial statements.
  
• Limited success in federal reform, leading to a lack of new capital providers in the cannabis market, may restrict growth opportunities and competitive positioning, thus affecting future revenue streams.
  
• Rising demand for debt capital in a highly regulated and volatile market such as cannabis may lead the company to engage in riskier loans to maintain growth, impacting long-term revenue stability and financial health.

Valuation

• The analysts have a consensus price target of $9.7 for Advanced Flower Capital based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $13.0, and the most bearish reporting a price target of just $6.5.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $73.1 million, earnings will come to $46.9 million, and it would be trading on a PE ratio of 6.7x, assuming you use a discount rate of 6.2%.
  
• Given the current share price of $6.48, the analyst price target of $9.7 is 33.2% higher.
  
• 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.