California Gold expects positive cash flow from #hemp sources in 1Q 2020

Earlier this year, California Gold Mining Inc. (“CGM“) [CSE: CGM] / [OTCQB: CFGMF] announced a new business segment involving propagation of high CBD-content hemp seeds, purchased an 80-acre farm in Illinois and planted 40 acres of hemp (~130,000 plants). More recently, in a detailed press release, we learned that due to limited funds and a difficult market, CGM put its seed propagation plans on hold.

Instead, the company found a clear and present opportunity to get a very good return on capital more quickly by, purchasing external (high CBD-content) biomass, paying to get it processed into crude oil or distillate by a third-party, and then selling the end products. Importantly, high-margin hemp seed propagation is not off the table, it has just been postponed.

Regarding CGM’s 40-acre hemp crop in Illinois, unusually heavy rains (the worst in decades) caused biomass yields in Illinois, and several other states, to be substantially lower than hoped for. As the crop progressed over a four-month period, management saw the weather damage and began to proactively seek out other opportunities.

Despite the crop setback and change in plans, I remain excited about California Gold’s hemp segment prospects. The status of the hemp / cannabis industry is marked by wild swings in product pricing & consumer trends, with positive earnings in the sector mostly elusive.

The companies that will distinguish themselves are the ones who remain nimble regarding business plans, asset-lite, financially liquid & profit-focused. California Gold successfully navigated a treacherous 2019 and is now well positioned to play offense in 2020.

By contrast, dozens & dozens of peers have faltered due to liquidity concerns. Companies with — negative working capital, or “busted” convertible loans, and/or no revenue — have hit the wall. Thirty (30) of the top 100 largest hemp / cannabis / extraction / MSO / LP, and related names are down 80% (or more!) from 52-week highs.

As mentioned, a few months ago management prudently branched off in a new direction that I believe will be successful. CGM has partnered with a family-owned extraction facility operator in North Carolina (USA) to “toll mill” CGM-sourced biomass.

This facility is said to have ample capacity and “best-in-class,” highly efficient extraction technology. Currently it can process thousands of pounds of biomass per day, but it’s being upgraded to handle tens of thousands of pounds/day.

CGM is buying high-CBD content hemp biomass from surrounding farmers who, in many cases, are stuck with inventory they can’t easily sell. There’s insufficient extraction capacity online in much of the U.S. during Autumn harvest time, causing a temporary glut in biomass. Management is paying farmers attractive prices to foster goodwill. That way, CGM can come back to farmers on favorable terms after next year’s harvest.

CGM has retained an industry-renowned expert in extraction technologies to conduct due diligence on its North Carolina (“NC“) extraction partner and to evaluate other extraction opportunities in the U.S. Management is working on a number of hemp extraction & cultivation initiatives.

In NC, CGM acquired 35,242 pounds of locally sourced material. Management believes they will end up with ~2,200 to 2,500 liters of crude oil by year-end 2019. Revenue from this initial batch of biomass (converted into crude oil) should be ~$2.5 million.

Once the processing and sale of the company’s 35,242 pounds (converted to ~2,200-2,500 liters of crude) is completed, the press release states that there is (at least) “several hundred thousand pounds” of high-CBD biomass readily available in nearby counties of Virginia & NC. Assuming ongoing access to processing facilities, that suggests the potential for up to 10 times the initial $2.5 million of revenue next year, net to CGM.

We don’t know how quickly hundreds of thousands of pounds of biomass might be able to be sourced, converted into crude oil or distillate, and sold. However, revenue in the C$20-C$30M range in CY 2020, net to CGM, seems achievable from getting CGM-sourced biomass toll-processed.

The chart below is from an article I found on Grizzle.com. It depicts a forecast for hemp revenue in the U.S. derived from CBD sales. If CGM could capture a 1.0% market share in CY 2020, that would be an impressive $28 million in revenue. Striving to attain just 1.0% of the U.S. market is not overly aggressive and leaves plenty of room for winning perhaps 1.5% or 2.0% of the market in 2021/2022.

Another toll-processing opportunity is being pursued in Arizona (“AZ“). CGM is still negotiating, but the plan is to send biomass from its Illinois crop there. With the help of consultants, one or two of whom might join CGM on a full-time basis, management is learning a great deal about hemp processing.

Next quarter, there’s potential for $2 – $3 million in gross revenue by selling distillate produced from toll milling biomass in Arizona. Combined, 1Q revenue from NC + AZ could amount to $4.0 to $5.5 million. In addition to a number of business risks, a noteworthy risk factor to keep in mind is timing. Delays in the sales cycle are commonplace and probably should be expected.

Sourcing biomass, testing it, safely processing it into multiple products, transporting, warehousing, delivering customer samples and the resulting sale of finished goods takes time; months not weeks. There’s a chance the sales cycle will take one or two months longer than expected. During this multiple-month process, prices could move significantly down or up.

CEO Gupta and his board are assessing the pros & cons of buying significant interests in, or fully acquiring, tier 1 extraction assets in the U.S. If done well, processing margins can be fairly high, predictable & steady. Readers should note that 2019 was a painful year for hemp cultivation / extraction operations in much of North America. Many newly-minted hemp farmers will not be back at it again in 2020. This should be supportive of biomass and finished product prices next Fall.

The companies that have survived, with strong financial capabilities, are now poised to thrive. Next year is a clean slate. Companies like CGM will take the valuable lessons learned to strategize with high-caliber new hires and industry consultants to move forward in a prudent manner.

CEO Gupta believes that quarterly revenue could reach $10 million+ in 2H 2020. Compare that to CGM’s Enterprise Value of ~$15 million. Therefore, if management can execute on 2020 initiatives, the company is valued at under 1x 2020 (prospective) revenue, with positive EBITDA virtually from the start.

Six months ago I hoped that CGM would be generating around $20 million of revenue spread over 4Q 2019 & 1Q 2020, mostly from hemp seed propagation (now on hold). So, revenue is coming a month or two later, and probably will ramp up slower, but I truly believe the risk is meaningfully lower as well. Shares, which traded as high as C$0.79, are now quoted at C$0.29.

If/when #cannabis / #hemp / #MSO / #LPs / #extraction companies come back to life (will we see a January-February bounce after tax-loss selling in December?), there will be fewer viable names attracting investment dollars, perhaps 1/3 or 1/4 fewer companies to choose from.

Companies like MedMen, down 81%, TILT, down 91%, Zenabis Global, -97%, Emerald Health, -93%, CannTrust, down 92%, Harborside, -88%, Mjardin Group, -96%, Sunniva Inc., -96%, DionyMed Brands, (halted), -99%+ … the list goes on and on. Will these names rebound? Most probably won’t.

Small companies with clean balance sheets, access to ample cash liquidity, and minimal or no debt, will be in a great position to outperform. For CGM, revenue growth next decade should be very strong.

If margins are as good as I think they might be (no guidance yet), California Gold Mining Inc. (CSE: CGM) / (OTCQB: CFGMF) could be a compelling investment opportunity. Companies trading at under 3x 2020e revenue (CGM could be under 1x 2020 revenue) will likely become highly sought after takeout targets.

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