This Canadian stock has been losing money with its coffee shops, despite restructuring efforts that have centred on closing unprofitable stores.
As its coffee business continues to struggle against high-profile competitors, the company is turning to marijuana. It has formed an alliance with a cannabis clinic operator to convert some of its outlets into cannabis retail stores. While its shares rose when the alliance was announced, they later dropped back. The new venture offers growth prospects, but still faces strong competition and uncertain demand.
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Second Cup Ltd., $2.70, Toronto symbol SCU (Shares outstanding: 19.9 million; Market cap: $53.8 million; www.secondcup.com) operates 275 specialty coffee cafes across Canada, of which 20 are company-owned and the remainder are operated by franchisees.
Although the company’s total stores fell from 356 in 2013 to 310 in 2015, company-owned locations jumped from 10 to 32. Second Cup gets to keep all of the revenue from its own stores; at franchised stores, it receives only a fee based on sales. The rise in company-owned stores explains why its revenue during those three years rose 37.3%, from $27.2 million to $37.3 million.
Due to increasing competition, Second Cup is closing unprofitable stores. As a result, its revenue fell 18.7% to $30.35 million in 2016, and declined again by 22.1% to $23.6 million in 2017.
The company continues to lose money, mainly due to the declining revenue, store closure costs and writedowns. Its losses expanded from $7.4 million, or $0.74 a share, in 2013 to $27.0 million, or $2.66, in 2014. Losses then improved to $1.15 million, or $0.09, in 2015, and shrunk again to $975,000, or $0.08, in 2016. However, losses worsened to $3.1 million, or $0.21, in 2017.
In August 2017, the Serruya family became the company’s major shareholder when they converted $8 million in debt into a 29% equity stake. The conversion left Second Cup with no long-term debt, and cash of $4.6 million.
If you disregard all unusual items, including a one-time charge related to the Serruya transaction, the company earned $110,000, or $0.01 a share, in 2017.
Second Cup continues to close underperforming stores. As a result, its revenue in the second quarter of 2018 fell 9.8%, to $5.6 million from $6.2 million a year earlier. Same-store sales also declined 1.0%. However, thanks to much lower interest costs, the company earned $577,000, or $0.03 a share. A year earlier, Second Cup lost $315,000, or $0.02.
The company’s coffee business continues to struggle in face of strong competition from bigger chains such as Tim Hortons, Starbucks and McDonald’s. In response, it now plans to convert some of its locations into marijuana stores.
Second Cup recently formed an alliance with National Access Cannabis Corporation (symbol META on the Toronto Venture Exchange). National operates 10 medical cannabis clinics that connect Canadians with licensed producers. The clinic’s staff offer patients an education session and provide liaison services with licensed producers. This assists patients in selecting strains of medical cannabis based on their condition and medical needs.
The two companies plan to take advantage of the upcoming legalization of recreation cannabis on October 17, 2018, by converting some of Second Cup’s outlets into cannabis retail stores (which will operate under the “Meta Cannabis Supply Co.” banner) and vaping lounges.
Second Cup and National will equally own the new cannabis stores and share the conversion costs. National will operate them.
The partners have yet to reveal how many coffee shops they expect to convert. Their initial focus will be on Western Canada, but are also targeting Ontario now that the province plans to license privately owned cannabis retail stores. Second Cup has 130 stores in Ontario.
As part of the agreement, National will issue (subject to regulatory approval) 5 million warrants to Second Cup. These warrants, with an exercise price of $0.91, will expire on April 12, 2023; National’s current share price is $0.96.
The company also continues to shore up its balance sheet to help pay for the conversion costs. In May 2018, it sold 2.9 million common shares at $3.45 a share for proceeds of $10.0 million.
Thanks to that share issue, Second Cup held cash of $13.8 million, or $0.69 a share, as of June 30, 2018. It has no long-term debt.
The stock jumped to $4.05 on April 16, 2018, on news of the deal with National. It has since dropped back to its pre-announcement price. The venture with National offers growth prospects, but will face considerable competition in a market where supply networks and customer demand are still uncertain. Still, Second Cup’s established store network and expertise in serving customers could give it a bit of an edge.
Second Cup is okay to hold, but only for aggressive investors.
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