This Canadian coffee chain with 270 locations has formed an alliance with an operator of medical cannabis clinics. The deal could see the company tap consumer demand for edibles when the federal government legalizes that profitable segment of the market in the fall.
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Second Cup Ltd., $1.98, Toronto symbol SCU (Shares outstanding: 19.9 million; Market cap: $39.4 million; www.secondcup.com) operates 270 specialty coffee cafes across Canada, of which 24 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 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 under-performing stores. Even so, its revenue in the third quarter of 2018 rose 11.2%, to $5.94 million from $5.34 million a year earlier. That’s mainly because the company continues to expand the availability of Pinkberry frozen yogurt; it now sells those products in 84 stores. As a result, same-store sales in the quarter improved 0.3%. Thanks to much lower interest costs, the company earned $766,000, or $0.04 a share, before unusual items. That’s up 32.8% from $577,000, or $0.03, a year earlier.
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 recent legalization of recreation cannabis 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 are now converting two Second Cup stores in Alberta. They have yet to reveal how many coffee shops they expect to convert, but have identified several stores in Ontario that could become cannabis dispensaries.
As part of the agreement, National issued 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 $0.64.
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 $14.1 million, or $0.71 a share, as of September 29, 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.
The company is now conducting a strategic review of its operations. That could lead to the sale of company-owned stores, or perhaps the entire company. As well, a group of franchisees recently launched a lawsuit against Second Cup. They accuse the company of misusing a funds earmarked for advertising purposes. Franchisees contribute about 2% of their sales to that fund.
Second Cup is okay to hold, but only for aggressive investors.
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