CannTrust – a leading Canadian Licensed Producer – reports Q1 earnings
CannTrust, the Ontario-Based, Licensed Producer, has long been a favourite of the Green Fund. We've had them in the Paper Portfolio since inception and have recently added them to our latest portfolio on Stock Card.
They have firmly positioned themselves as one of the strongest medical players in the Canadian market, and have commanded premium pricing and margins on their medicinal cannabis extracts. However, although most analysts and industry insiders believe that medicinal will ultimately hold the most value in the long term, in the short-term, investors are looking for the large LP's to fund some of this cash burn through increased recreational sales. And CannTrust hasn't necessarily shot the lights out on this one.
They recently delivered their Q1 2019 results for the period ended 31 March 2019. The results were actually pre-announced on April 26, with revenue, margins and their share of the Canadian recreational market all up. Bottom line – they were a substantial improvement on the previous quarter.
In Management we trust?
Peter Aceto took over as CEO almost 8 months ago and it has been a pretty poor management effort since then. One only needs to look at the previous quarter and the disastrous capital raise, to understand this.
CannTrust's Q4 2018 results were simply horrific. First off the gross margin declined from 69% in Q3 to 35% in Q4. This was primarily as a result of the fact that their medicinal extract selling price per gram dropped 52% from $8.89 per gram in Q3 to a dismal $4.29 per gram in Q4. To compound this, management mumbled and bumbled their way through the earnings call and had no tangible explanation for it. It was very amateurish, to say the least.
The market's reaction to this? A 19% share price decline the next day. Bottom line, management fluffed their lines on this one. But it got worse from there.
In April the company announced a massive capital raise. $30 million shares would be sold off-market and an additional $170 million would be raised as new shares. The round, completed on the 2nd of May, created an additional 35.5 million shares at $5.50 each, a 25% discount on the share price at the time the deal was announced.
Management did a terrible job of not planning and executing this properly. Instead, they flooded the market with a 35% dilution (with the share price near the 52-week low mark) and the stock plummeted 13% the next day. Horribly handled and terrible for shareholder value.
It looks bad, and it is. But with the above out of the way – as it is done and has happened – let's consider the Q1 2019 results.
Revenue for the quarter was $16.9 million up 4% on the previous quarter and 115% on the previous year. The primary reason for the higher revenue was a higher dollar value per gram earned across all of their channels.
Overall, the average revenue per gram was $5.47 which represented a 15% increase on the previous quarter. This added to a much healthier gross margin with an increase of $2 million to the net revenue line.
Of particular significance, was the selling price per gram for medicinal cannabis extracts. Understand that CannTrust is very much a medicinal cannabis company and over 67% of their revenue come from the sale of medicinal oils (extracts). This quarter saw the average selling price per gram grow from $4.29 in Q4 2018 to a much better $5.67 per gram this quarter. This is a big plus in our books.
Gross Margin of 46% was a very comforting 11% increase of Q4 2018. Ultimately this was driven by across the board increases in the selling price per gram of their products. It is still off the high 60's it was about a year ago, but a significant improvement none the less.
The company also delivered very well managed operating expenses. Expenses came in at $16.2 million for the quarter, a little more than the $15.8 million in the previous quarter, but the company also took on the costs associated with their up-listing to the NYSE, which was a bit positive for the company. However, CannTrust remains unprofitable albeit their EBITDA loss of $7.2 million was an improvement on the $10m loss in the previous quarter.
Where to from here
Margin is back on track
With revenues per gram up across all channels (flower and extracts across both medicinal and recreational markets), the gross margins for the quarter took a significant turn..in the right direction. CannTrust believes that its gross margin percentage before fair value changes to biological assets should increase throughout 2019 as the company increases its production levels and gains production efficiencies. As the Phase 2 expansion contributes to positive operating leverage, the Company is targeting a return to profitability in 2019.
Production is on the up
CannTrust has started to ramp up production and this is starting to show. Their perpetual harvest facility in Pelham, Ontario, produced a 96% increase in harvest on Q4 2018, and with the Phase II expansion plans complete and Phase III underway, CannTrust project production capacity of 50,000kg per annum by Q3 this year and with the completion of Phase III, over 100,000kg per annum by Q3 2020.
"Harvest production numbers increased drastically for CannTrust — between January and March, the company harvested over 9,400 kg of cannabis, a 96 per cent increase from the prior quarter."
– CannTrust chief executive Peter Aceto
In addition to their indoor production, CannTrust has also started to grow cannabis outdoors. CannTrust's outdoor cultivation initiatives are targeted to deliver material future revenue contributions. They are planning for this initiative to yield 75,000kg of production in 2019, subject to regulatory approvals, and between 100,000kg to 200,000kg of cannabis in 2020, also subject to regulatory approvals.
The outdoor production will be extracted into oils to further support the growth and demand for medicinal oils, and area of the market that CannTrust dominates.
Medical business all guns blazing
This quarter saw CannTrust add another 10,000 patients, bringing the total patient number to 78,000 at the end of the quarter. This delivered a staggering 70% increase in the number of medical patients over the previous year. This is remarkable given that the Canadian medical patient growth numbers are starting to slow rightly so, given it has been operating since 2001).
"We have always been a leader in the medical space. With some degree of limited supply, we are still prioritizing our medical patients over the recreational market." said chief executive Peter Aceto on the management call.
International footprint still not great
If CannTrust has a glaring weakness, it would be the lack of any significant global presence. When you consider what some of their peers are doing – Aphria and Aurora in Germany as one example – CannTrust is lagging in a big way. There are some positives, however.
They have a relationship with Apotex – one of the world's largest pharmaceutical companies – and have a JV in Denmark with Stenocare. They also have a minority interest in the Australian market via investment in CannaTrek. Still, none of it has delivered any significant revenue or market share, and this is an area CannTrust will need to address if they are to command their current valuation – which is one of the best.
However, they are busy preparing and planning for "Legalisation 2.0" when Canada legalises edibles and extracts in October this year. According to the company, they continue to invest in their people, process, technology and innovative products. These products include vape pens, beverages, confectionaries, and healthcare products. CannTrust is also making strategic investments into its operational capacity to prepare for expected increases in demand for its products.
Just recently, GMP Securities analyst Martin Landry put out a research report wherein he stated that GMP is still bullish on the company. Landry maintained his "Buy" rating and a one-year price target of $15.00 on CannTrust Holdings, implying a return of 83 per cent at the time of publication.
"CannTrust's Q1/19 results showed an improvement in the company's margin profile which supports its long-term earnings potential. TRST's valuation is attractive relative to its senior peers which trade at over 40x. In our view, the recent pullback in TRST's shares presents investors with a compelling entry point."
The Bottom Line
CannTrust has not performed well this year when considered against its closest peers. Looking at the performance against Organigram and HEXO really drives this point home. Management has had a shocker in the way they have handled everything over the past six months, and investors would be a fool to ignore this.
They certainly had a better quarter this quarter, with all the numbers moving in the right direction, however, the disastrous capital raise – a flood on the market – has left the stock hovering in the $5.50-4 range. We believe it could sit in this range for some time.
However, we are still very bullish on the company and believe they have the right ingredients for long-term success in the medicinal cannabis industry. Let's just hope management pull their heads in, get their shit together, and steer this ship in the direction it is meant to go.
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