Why is Farmers Edge Stock Dropping Like a Rock?
Successful investors take inspiration from others, not follow their advice verbatim. We always emphasize that we’re not here to give advice on what you ought to hold or not hold. We’re here to tell you how we arrive at our own investment decisions while providing actionable insights along the way. When we “love” a stock, that means it can be found in our own tech stock portfolio, which constitutes less than 18% of our total assets under management. Occasionally, we’ll receive an email like this from a subscriber.
- I sold <STOCK A> months ago because you said to avoid it, but the stock price has been going up. Why do you like <STOCK B> but say to avoid <STOCK A>?
The first part of that question reflects an investor who does not actively manage their portfolio, but instead listens to others for advice. They confuse short-term price appreciation with the quality of a business, something that rarely helps one sleep well at night. The last part of that question is valid enough – why do we prefer one stock over another? Usually, it comes down to risk.
As risk-averse investors, we’re more concerned with not investing in landmines than we are with betting on every single growth story out there. We’re willing to sacrifice some upside in favor of avoiding lots of downsides. One way to keep our emotions at bay is by establishing ground rules that help curtail risk. For example, our disruptive tech investing methodology doesn’t allow us to invest in companies with a market cap of less than one billion dollars. Even if we really like a company, we won’t go long if they’re too small, or too richly valued according to our simple valuation ratio. These rules have kept us from investing in stocks we otherwise liked, one of those being Farmers Edge Inc (FDGE.TO).
The Fall of Farmers Edge Stock
One greentech company we liked which came up against our size rule was a Canadian small cap called Farmers Edge. Here’s what we said in March this year shortly after their initial public offering (IPO) on the TSX. (The Toronto Stock Exchange or TSX is a Canadian stock exchange that’s the third largest in North America based on market capitalization.)
With a market cap of around $584 million USD, it falls short of our $1 billion market cap threshold. That’s about the only reason we wouldn’t consider a position right now. We couldn’t find any red flags in analyzing the company’s filing document, and plenty of reasons why the future looks bright for these clever farmers in Manitoba.
Today, that market cap sits at $164 million USD, which means the company has lost about -72% of its value over the past eight months.
In looking at the above stock price chart for Farmers Edge, we see a decline that starts in May of this year, but it appears Wall Street really pummeled the stock in mid-August when shares dropped on heavy volume. Let’s try to figure out why.
Why is Farmers Edge Stock Dropping Like a Rock?
Companies with strong revenue growth don’t usually drop like rocks so that’s the first place we’ll look. Here’s the annual revenue chart we looked at before which shows some consistent growth over time:
And here’s what revenues for the last two quarters looked like, with Q2-2021 being a particularly rough one:
As you might suspect, the Q2-2021 decline in revenues seen above is what triggered Farmers Edge investors to sell the stock off heavily. On August 12, Q2-2021 earnings were made available, and on Aug 13th, the share price halved. Aside from the decline in revenues, did Farmers Edge say anything else that may have caused such a dramatic drop in share price? There are at least a few statements that merit further digging:
- There were $1.5 million of commercial contract subsidies in the second quarter of 2020 that did not repeat in the current period.
- David Patrick, Chief Financial Officer, will be leaving the Company in September 2021 to return to his former employer.
A CFO leaving a company is often seen as a red flag, but we can’t read too much into that. (He lasted about a year for what it’s worth.) In fact, it may be a good thing. (More on this in a bit.) As for the removal of subsidies, that’s something we need to better understand. In their latest annual report, Farmers Edge states:
Some of our channel partners subsidize the cost of the Progressive Grower program as part of certain joint marketing initiatives, which defrays the cost of that program to us.
We’re not given much additional color but we can imply what this means based on other information contained within their filing documents. Farmers were being provided a free trial of the Farmers Edge subscription product while the channel partner responsible for the customer was subsidizing some or all of that trial period. Now that the channel partners aren’t subsidizing these subscription costs, the number of customers on the platform remains the same, but Farmers Edge is receiving less. If a pure software-as-a–service (SaaS) business model was being used, it would be a lot easier to interpret the effects of this change on the health of the business.
Analyzing the Farmers Edge Business Model
Recently, we classified all companies in our disruptive tech stock catalog according to their SaaS capabilities. Farmers Edge ended up being classified as having “Some SaaS” since the majority of their revenues come from subscriptions.
About the only SaaS metric Farmers Edge uses is “annual recurring revenues” or ARR which currently stands at around $64 million CAD. It’s a shame we’re not given any retention rate metrics because those might alleviate concerns about why revenues have been dropping so dramatically over time.
Some of the Q2-2021 drop can be explained by revenue recognition timing which fluctuates quarterly, so it’s better to keep the focus on annual numbers. Farmers Edge generally expects to see stronger numbers at the end of the year and the beginning of the year.
The accounting for fertility services performed, including carbon related services, results in revenue being recognized generally in the fourth quarter and first quarter when these services are completed.
Part of the Farmers Edge strategy is to upsell customers down the road, so we’d like to see “net retention” which shows how many existing customers are spending more money over time. “Gross retention” is then needed to see how effective they’re able to get existing customers to renew their contracts come renewal time. Neither of these key metrics are provided, so we’ll just have to focus on the bigger ARR number which seems to be enjoying consistent growth over time.
Along with their focus on growing ARR, Farmers Edge has also been cutting costs for a critical consumable their platform relies on – satellite imagery.
Farmers Edge and Planet
In their 2020 Annual Report, Farmers Edge talks about a new multiyear contract they entered into with Airbus for geospatial imagery.
We recently entered a new multi-year contract with our satellite imagery provider Airbus DS Geo Inc.
Then 6 months later, Planet announced that Farmers Edge entered into a new contract.
We’re thrilled to announce that Planet has signed a new, three-year, non-exclusive contract with Farmers Edge, a valued customer since 2017.
This doesn’t mean that Planet’s imagery replaces Airbus’s imagery. The Farmers Edge press release makes this clear.
Farmers Edge will meet its cloud and imagery cost savings guidance provided during the IPO process by adding this new contract in combination with other contractual commitments.Credit: Farmers Edge
The astute subscriber who pointed us to this news item also noted that back in 2017, the two companies announced a similar partnership which seemed to have more exclusivity – “Farmers Edge is now a sole distributor for Planet in key agricultural regions.” This summer’s press release makes it a point that the contract is non-exclusive.
If Planet has a competing imagery product, they still need to accomplish the hardest part which is to sell it to farmers. Farmers Edge gives us a glimpse into how tough this can be. They need to engage channel partners who have relationships with the farmers, then give the product away for a year to convince the farmers it’s worth buying. That doesn’t seem like the sort of low-hanging fruit a company like Planet would be looking to pick as they try to scale as quickly as possible.
Planet is in the business of selling imagery, and Farmers Edge knows they can’t just buy satellite imagery and resell it without adding any value. That’s why they’re phasing out their “Imagery Only” clients and moving towards only servicing customers where they’re able to add a great deal of value to the images they provide. The breakdown of acres covered under the “Digital Agronomy” umbrella and “Other Acres” umbrella shows this new direction.
Planet happens to be another stock we like which we’re kept from buying because of a rule we adopted for special purpose acquisition companies (SPACs) – don’t even consider buying a SPAC until the merger has gone through. Once Planet has passed that hurdle, we’ll take another look at the company and the extent to which they’re moving towards vertical integration.
Should You Buy Farmers Edge?
We have no idea what you should do with your money, but one thing is certain. Don’t ever let anyone tell you what stock you should or shouldn’t invest in. For us, our $1 billion market cap minimum rule keeps us from even considering Farmers Edge, but that’s not a very fun way to leave this. If we pretend that rule wasn’t in place, it’s a tough decision as to whether today’s prices represent a buying opportunity or the first chink in the armor of a SaaS business that isn’t what it seems.
The latest drop in subscription revenues was related to subsidies being removed which should have no effect on ARR. If that’s the case, then the volatility of quarterly revenues is all about timing, and this would actually be a good buying opportunity because we know the revenues will eventually come. As for valuation, our simple valuation ratio doesn’t work so well because of the volatility surrounding Farmers Edge quarterly revenues. If we use 2020 revenues instead of ‘last quarter annualized,” then we get a valuation ratio of 4.4. Here’s how that number compares to a handful of SaaS stocks from The Nanalyze Tech Stock Catalog (company names link to our research).
|Artificial Intelligence||Sumo Logic||9|
Our biggest concern surrounds not having enough information to gauge the health of the Farmers Edge SaaS offering. In looking at a previous annual report, Farmers Edge says about 75% of farmers convert to a paid subscription following a year of enjoying the offering for free. (Farmers wisely opt for a “show me the money” approach to any promises technology might make.) In that respect, the solution is selling itself. If farmers are opting in to four-year paid contracts, we only need to track gross retention to make sure they’re still signing up after that contract runs out. We also want to see those same farmers getting upsold, something that’s tracked using a net retention rate. Perhaps the new Farmers Edge CFO will realize the importance of these SaaS metrics and start producing them.
Given the volatility surrounding shares of Farmers Edge, we’d probably opt to wait a few more weeks and see if Q3-2021 holds any more surprises. If ARR has been growing consistently over time, then annual revenues need to be growing consistently over time. Per the below chart, we’d expect to see a blowout second half of 2021 with the company showing annual revenue growth over 2020.
We’re a bit puzzled as to why investors would react so strongly to fluctuating quarterly revenues when that becomes irrelevant when you look at the annual picture. Maybe the new CFO can also adjust revenue recognition so that Farmers Edge has nice smoothly growing revenues every quarter just like most other SaaS companies out there.
The nature of disruptive technologies is that they’re inherently risky. When a company tells a promising growth story, it may not always reflect what’s happening under the hood. One of the reasons to avoid smaller stocks is that they’re more volatile, and Farmers Edge is no exception. The last half of 2021 needs to be a strong one that assures investors all the quarterly revenue volatility eventually translates to annual growth. When the CFO chair finds a new occupant, providing additional SaaS metrics may help investors stomach this volatility with fewer knee-jerk reactions.
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