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Wednesday, October 21, 2020

22nd Century Group Inc (NYSEMKT:XXII) Scalability a Critical Factor

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22nd Century Group Inc (NYSEMKT:XXII) is a micro-cap stock with a market cap just over $110M. Effectively, the company is a type of biotech, with the sole goal of reducing harm caused by the smoking of tobacco.

In order to accomplish this feat, the company has acquired over 200 patents – with the underlying ability to decrease the amount of nicotine in tobacco plants. Not only are they focusing on tobacco, but the patents can also affect the level of cannabinoids in cannabis.

22nd Century Group Inc (NYSEMKT:XXII) owns a few key products; Spectrum cigarettes, Brand A and Brand B, X-22 Smoking Cessation Aid, and Red Sun and Magic cigarettes. Aggregately, the products 22nd Century sells are low to high nicotine cigarettes. Currently the Red Sun and Magic cigarettes are available for sale – yet the other products are in a FDA approval process of sorts. Business Wire does a great job explaining the Magic cigarettes:

“The proprietary tobacco used in MAGIC cigarettes is grown on independently-owned farms in the United States and results in an extraordinary cigarette with all of the taste of a conventional cigarette, but MAGIC yields only 0.04 mg of nicotine per cigarette − 95% less nicotine than conventional cigarettes. No other company anywhere in the world can grow tobacco with such low nicotine content.”

These cigarettes could be a game changer. Everyone today knows the harmful effects cigarettes have. Furthermore, nicotine is a powerful, dangerous and addicting drug. With 22nd Century’s propriety technology/plant, they have effectively reduced the levels of nicotine in their cigarettes by 95%. Moreover, these cigarettes will allow consumers the ability to choose the nicotine content in the cigarettes they smoke.

Counter intuitively, the company’s Red Sun cigarettes are a high nicotine product. Despite the fact that Red Sun has higher levels of nicotine in its cigarettes than your typical smoke, there could be real health benefits. Think about it, smokers smoke more to get nicotine. If there is a cigarette with a high amount of nicotine, wouldn’t a smoker smoke less?

The opportunity for the company mainly lies overseas in Europe. In Europe, the company is allowed to market the levels of nicotine on its package. In the US on the other hand, cigarette companies have strict regulations in regards to marketing. If the company ever gets approval to market on its packages ‘we have a lower level of nicotine’ or ‘these cigarettes have a higher level of nicotine’, it could be quite a game changer for the company. In fact, it would give the company a type of economies of scale.

The big overhang with an investment is the lack of scale. The company isn’t at the revenue size where they will throw-out cash flows. In fact, TTM revenues are only at $11.44 million, compared to a market cap of around $114 million. However, revenues went up 10x last year and are on track to do at least another 30% this year. Given the huge growth opportunity, the market values the company at a lofty valuation: P/B and P/S at 6.70x and 8.17x, respectively.

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The company isn’t profitable either. In order to fund working capital and ongoing expenses, the company has continued to raise equity – and will probably do so until they reach the scalability they need. Although, gross loss on product sales has decreased Y/Y by 52% in the most recent quarter and 94% in the first six months. The decrease is a function of the overcoming of an underutilized factory. As the company continues to ramp up sales, getting closer to the scalability they need, we should continue to expect a decrease in gross loss on product sales.

On a bottom-line standpoint, it appears as if the company is in a worse position today, than last year. However, if you back-out of the one-time legal expenses, the company actually improved their profitability. For such a small company, there may be more one-time hiccups down the road, such as legal expenses with a third party. However, on an operational standpoint, the company is becoming a leaner operator and should continue to do so as times passes.

So yes, the company has been priced by the market as a growth stock and value investors will probably avoid the company for now. However, there is an immense amount of untapped potential with the company’s propriety technology – especially relating to its low level nicotine products.

The FDA has made allegations numerous times that they want to regulate nicotine as its primary objective. Furthermore, the World Health Organization has recommended to its members that they should limit the amount of nicotine and tobacco below addictive levels. This is bad news for the big boys of the industry – but rather good news for a company like 22nd Century. Moreover, as the sole source of naturally grown tobacco below hazardous levels of nicotine, their technology looks to be in a sweet situation.

If the company doesn’t reach a level of scalability where they can become profitable and grow immensely, the propriety technology is attractive enough where they could garner a buyout from a larger company. In fact, I think either of the former are the two most likely end-games. For continuing coverage on shares of $XXII stock, as well as our other hot stock picks, sign up for our free newsletter now and get our next hot stock pick!

 

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