What to do with Sunniva (CSE: SNN)

QUESTION: “Sunniva?” “Sunniva?” “Sunniva?”

Many Readers from all over

ANSWER: This week, questions on Sunniva (CSE: SNN) (USOTC: SNNVF) filled my inbox from shareholders and followers everywhere. In case you missed it, on September 13, 2019, SNN issued a Press Release that basically said the start-up of the grow facility in California has been delayed again, this time until early in 2020, and because of a lack of liquidity, the company had cut back on the purchase of biomass from their third party suppliers which reduced their extraction activity with the result that the revenue guidance of US $55 to $60 million will not be attained. Read full press release (here)

First, let me clear the air in response to two readers who questioned my motives in writing and reporting on SNN. I understand people’s concerns especially in markets where almost all stocks have declined in price and scandals such as CannTrust have dominated the news cycle. For your information I have never been compensated by Sunniva for any reason in any form. I have paid my own costs related to any site visits as part of my due diligence on the company. I have been compensated as a contributor to Seeking Alpha when I have written on SNN as has been disclosed. The Cannabis Report Model Portfolio is a paid subscription service that compensates me for managing and reporting on the portfolio which has included SNN as one of around dozen different companies that are or have been in the portfolio. Finally, I do not now or have I ever owned shares in SNN either directly or indirectly.

Moving on to discuss the company and its recent disclosures, following the publication of the report, I spoke to Dr. Anthony Holler, Chief Executive Officer of SNN later in the day of the release. I was very surprised and upset as I digested the news that I summarize as follows:

• SNN reported that the glasshouse grow facility in Cathedral City, California has been delayed an additional six months. The major reason behind the delay is the need to install a permanent link to the power grid to replace the temporary connection they have at present. The second reason is to manage their financial resources, SNN could not proceed with the development as quickly as they would have like to.

• The lack of liquidity also required a reduction in the amount of biomass they could buy and process to produced their line of Branded Consumer Packaged Goods. This means, in turn, that the sales guidance that management had provided, that is, expected sales of US$55 to US$60 million in sales this year will not be attained.

Here is a summary of the additional information provided by Dr. Holler in my interview:

1. SNN needs a permanent electrical hook up to the power grid to go into production. Management was informed recently this will take approximately six months to complete. SNN has a temporary connection at present. They are trying to get it faster but that's where it stands.

2. Colliers has been engaged to assess what is wrong with the glasshouse development.

3. Although the power grid hook up is the major reason for the delay, Holler also added that tight financing was a contributing factor that slowed down development.

4. Holler says he reported at the first quarter conference call they would be tight on cash and the priority is to get the glass house operational. As a result, they cut back on buying from third parties and processing biomass which means their branded goods sales will not reach the US $55 to US $60 million targets set.

5. Holler remains confident the sale of the Okanagan Falls property will close in August. They are in touch with the buyer regularly.

6. Holler believes the sale of Natural Health Services will happen in the near future.

7. SNN needs (3) to close in August and (4) in the near term would be a boost. But the bottom line is until then they are tight on cash.

Here is my assessment of the situation:

1. The most consistent problem that has plagued SNN since I have been following the company is a consistent failure to meet targets – either time deadlines or financial goals. This is simply another instance of a missed time target (getting the glasshouse operational) and a financial forecast (sales of branded consumer products). From sources independent of the company I am told there has been a management problem but it is not Holler and his group except to the extent that they did not deal with issues sooner and more decisively. I am told by independent sources there is a housecleaning taking place and Colliers that has been hired recently has the core competency required to move the project to completion that the previous contractors and consultants did not have.

2. I have also learned from independent sources that as the glasshouse evolved, the power requirements have increased significantly. I am told the wiring to the glasshouse runs under a municipal road that has been dug up “a dozen times” to change or adjust the wiring. This takes time and adds to the cost.

3. I am told that Southern California Edison says the electrical was to be completed by the end of October and that has not changed. Apparently one person from the power company has been assigned to the “Sunniva account.” I am not saying that is all he does but he handles everything that involves SNN. This is consistent with Holler’s statement to me. If management was not aware of the October date, it would have been a surprise and given the time of year and the testing required once power it turned on, an early 2020 date would be likely.

4. The market interpreted the news very harshly, SNN shares shed around 40% of its value the day following the news release. This is not a surprise because the two things investors were counting on recently was the commercialization of the glasshouse in Cathedral City and a big bump up in revenue to the range of US $55 to US $60 million. This report produced disappointment on both fronts.

5. It seems that with the benefit of hindsight, the goal of minimizing share dilution was given too much weight. Nine to twelve months ago, it would have been relatively easy to raise $50 million in the $5.00+ per share range. If management could see the future with complete accuracy, when faced with such choices the right decision would always be made. The problem is the market is now focused on the number of times the wrong choice was made which casts doubt on the ability of management. This is obviously hurting investors and the stock price.

6. What is urgently needed now is a couple of positive results such as the closing of the Okanagan Falls property before the end of August and the sale of Natural Health Services (NHS) shortly after. On the theory that it is much harder to regain trust than to lose it in the first place, I don’t anticipate a large rebound in the stock if the OK Falls property sales closes or NHS is sold. Exacerbating these problems is a weak cannabis stock market. So a meaningful recovery in SNN’s stock price might be several months in the future.

7. On the positive side is the fact that the optimistic outlook for California and a generally improving back story in the U.S. remains in place and SNN can still be a major player. In addition, the potential for the glasshouse, as a state of the art grow facility, also remains in place. Generally, it is not a good idea to allow the supply of Branded Consumer Packaged Goods.

Conclusion: The market response to this news has been quite severe. On the first trading day following this news, SNN’s stock dropped 40%. What happens next in the markets is a function of what happens next with the operations of the company. If SNN is able to demonstrate some success with existing commitments such as closing the sale of the OK Falls property or the sale of Natural Health Services, SNN will begin to recover some trust from the markets. This will likely be gradual taking several months. Initially, the response to a management success might be quite subdued meaning the market may not respond positively to the first couple of events. But gradually the market will respond to good news, in my opinion.

I live by the management sword and die by the management sword. In deciding that management is the key to investment decisions, I can tend to be too supportive when things are not going as planned. But given the string of missed deadlines and targets, it is impossible to say I have not been let down management and this applies to readers and investors. With the benefit of 20/20 hindsight, Mistakes have been made and that cannot be overlooked. However, being actively engaged in the financial markets for many decades, I can only say no one is perfect.

The real reason management is important in my way of thinking is management is not an issue when things are going well. But it is important when the going gets tough. For Sunniva management, things are tough right now. In talking to Tony Holler, I have the sense that he also feels let down by some of the people that have been around him. But to my way of thinking, good management does not panic and they certainly do not quit when difficulties arise. Good management continues to try to fix the problems. I sense no panic or surrender from Holler. He remains fully committed to this project.

If, on the other hand, SNN continues to stumble, my expectation is that the company might be acquired by another participant in the California market. At current prices, SNN represents a cheap way to build a dominant role in the Golden State. So that is a possibility.

The investment assessment is different from the corporate assessment. Great companies can get greatly overvalued and vice versa. Right now Sunniva is a company that faces some problems and management has built a track record that creates investor doubt. At this point, shareholders (and I) are justified in believing the ball is in SNN’s court. It is time for them to produce on their promises. At current prices, I expect the stock to remain around current levels until that happens and even after one or two targets are attained. As a result, I would not be a buyer at current levels. However, I would retain positions in the expectation that events will work to restore investor confidence in the company. As that happens I will become a buyer again.