Pot Stocks – Bulls & Bears Week 14

This week saw most of the market down, with Cannabis stocks falling harder than the general markets. This is always going to be the case with pot stocks as their beta is far higher than traditional stocks.

The star of the week was Alcanna, up 44% for the week. Could this perhaps be as a result of our article on them and other retailers last week? We're only kidding, but we did mention just how much value we saw in Alcanna given you are either getting a free cannabis or a free alcohol business, depending on how you look at it.

 

 

This week's biggest loser was without a doubt, CannTrust. One of our favourite companies, and to date, one of the best performers, they simply had a shocker. Not only did their revenue per gram of extracts halve, but management then went on to do the worst job possible in explaining why. Many investors ran for the hill and the stock got hammered. We bought the dip, and continue to be very bullish on their prospects. People have short memories when it comes to a bad quarter. After all, it was only .two quarters ago that Canopy released their worst results to date.

 

Newsworthy Updates

 

Michigan became the 10th State to legalise cannabis for recreational use in the mid-term elections of November 2018. This week, Cresco Labs announced that it had completed the most comprehensive portion of Michigan's application process, being pre-qualified for a cultivation and processing license by the Department of Licensing and Regulatory Affairs Medical Marihuana Licensing Board. The pre-qualification represents the authorisation of Cresco Labs to move forward with the licensing process for its intended facilities.

Entering Michigan brings the total number of States that Cresco Labs covers to 11, and means the company now covers over 46% of the American population. Michigan is a very large market, with estimates putting just the medicinal patient count at over 300,000. To put that into perspective, estimates put the Australian medicinal cannabis market (when near maturity) at 250,000 patients.

 

Down in the dumps

This week saw Cronos release its Q4 2018 and Full Year 2018 Results. And they were underwhelming, to say the least. Yahoo Finance analysts had predicted revenues of between $6.6 million and $12.2 million, averaging out at $7.8 million. Cronos reported net revenue of only $5.6 million (compared to $3.8 million in the previous quarter) with their gross margins coming in at 44% (down from 63% and 55% in the two previous quarters).

The revenue numbers are very small compared to its Canadian Peers. They have the second lowest revenue numbers, yet (at the time of writing) also boast the 4th highest market cap ($5.9 billion). This reinforces our belief that Cronos is one of the most overvalued companies in the sector (you can place Tilray in this same group).

 

 

What was also interesting to note is the way that management avoided any mention of the numbers and rather focussed on what the company had achieved (outside of numbers) over the past quarter. They stated the following:

  • Closed C$2.4 Billion Strategic Growth Investment from Altria Group, Inc.
  • Completed first harvest in Peace Naturals expansion to Building 4
  • Launched Two Recreational Brands: COVE™ and Spinach™
  • Announced Landmark Partnership with Ginkgo Bioworks to Produce Cultured Cannabinoids
  • Became first Pure Play Cannabis Company to list on a Major U.S. Exchange

Management went on to talk about the nature of their moat creation around high-value segments of the industry, including their clinical trials in Israel and the deal with Ginko Bioworks to create biosynthesised cannabinoids. In the end, underwhelming results, and the market reacted with Cronos down for the week on the back of these earnings.

 

A flag in the ground

This week, THC Global announced that Vertical Canna, its wholly-owned Canadian subsidiary, has acquired a site in Nova Scotia in order to cultivate and produce cannabis for the Canadian and International markets.

The proposed facility will have a first stage build footprint of just 1,850 square metres, allowing for significant scalability of operations over time across the entire landholding.

The funding of the project has been structured in such a way that it will have a minimal impact on the cash THC is required to outlay, with the balance of the purchase price being funded by a combination of debt and hybrid facilities.

The project is set for two stages, with stage 1 being the cultivation of cannabis and stage 2 being the addition of high-value production capabilities. At full capacity, stage 1 should yield 37,000 kilograms of dried flower per annum, with associated revenues of over $250 million.

 

"THC Global entering the Canadian cannabis market as a local producer is a significant step in its global strategy. Our near term focus is to ensure profitable cultivation activities"

 – Ken Charteris, CEO THC Global

 

It is rumoured that THC is also investigating specialised growing technologies that might significantly increase the production and yield capabilities of the new facility. Off-take agreements to secure forward revenues at both production stages have already commenced in addition to discussions with other commercial partners to maximise the profitability of the project. The company will look to use some of this production to feed its world-class extraction facility in Southport, Brisbane.

THC Global also advised that it has appointed Jonathon Inkley, a construction and project management expert with significant experience in the Canadian cannabis sector as a director of Vertical Canna, the company's Canadian subsidiary. Jonathon's experience includes roles working with ExxonMobil Canada, and Imperial Oil.

 

This is how a pot stock drops 20%…in one day

On Wednesday, CannTrust released their Q4 2018 results and the only way to describe this was horrific, simply horrific. Not only did they miss analysts expectations, but their revenue per gram for medicinal extracts literally halved and fell off a cliff.  And the market punished them heavily for this, with the stock losing almost 20% of its value the next morning.

 

 

Their earning results were as follows:

  • CannTrust reported record revenue of $16.2 million, a 132% increase from the fourth quarter of 2017.
  • Active patient count increased to 58,000, up from 37,000 at the end of the prior year, an increase of 57%.
  • The Company sold 3,407kg of dried cannabis equivalent, a 4.5x increase from 758kg in the fourth quarter of 2017.
  • Cash costs per gram decreased to $2.94 from $5.16 in the fourth quarter of 2017.
  • CannTrust was voted Top Licensed Producer of the year and received six other service and product awards at the 2018 Canadian Cannabis Awards.
  • The Company closed the purchase of a 19.4 acre property on land adjacent to its Perpetual Harvest Facility in the Town of Pelham, which will be used to construct its Phase 3 expansion and bring total production capacity to 100,000 kg per year upon its completion.

CannTrust's recreational cannabis sales were 1,390 kg equivalents, although that figure includes a "minimal" amount of wholesale B2B sales. These sales give CannTrust approximately 5% market share in the Canadian recreational market. 

Dried cannabis flower prices dropped, but this was expected, as all of the Licensed Producers saw their revenue per gram drop, given they have to sell their product for the recreational Market at wholesale values to the various Provinces.

 

However, in CannTrust's case, this is compounded by the fact there was such a precipitous drop in the revenue per gram of their medical extracts (an area normally associated with higher margins). Extracts make up more than half of CannTrust's sales (by volume), but prices fell 52% this quarter. To put that in perspective, Organigram's only dropped 2%.

During the earnings call, multiple analysts asked about these low extract revenues. Management suggested that revenue was low because of how excise taxes are calculated. Excise taxes are calculated based on the weight of input products used to make cannabis extracts.

According to management, given the company is using low-potency product to make their full plant extracts, which by definition requires higher quantities of the cannabis plant, this results in high levels of tax. Canadian excise taxing may change when Canada enacts its next budget.

Bottom line is management could not have done a poorer job in explaining the reason for such a massive decline in revenue per gram of medicinal extracts. This is the most concerning part of all as if they cannot really explain it, then how on earth are we supposed to?

We will be updating these earnings in more detail soon.

 

Woof, there it is

We recently wrote about the global Pet CBD market and its potential for the coming years. Next Green Wave – a stock we are now actively watching – this week announced their entry into the Pet CBD space, with Loki Naturals Love Biscuits, in a partnership with Loki the Wolfdog. The company's first CBD and revenue generating product is now officially available for sale in the United States through Loki's website.

 

 

This will be Next Green Wave's first initiative to bring over 45 products to market through its recent acquisition of California-based consumer products goods leader and innovator, SD Cannabis, which brought a selection of exclusive licensing relationships defined by their connection to a core loyal global audience, their reach across digital/social platforms and their ability to partner on product development and marketing.

Loki's Love Biscuits have been formulated with 100% natural and locally sourced raw ingredients and are free of preservatives and fillers. The pet treats contain infusions with the full spectrum of CBD and quality oil extracted from US grown hemp.

 

A mixed back of tricks

Charlotte's Web reported their Q4 2018 earnings this week, and the results were slightly mixed.

  • Organic consolidated revenue growth of 71% to $21.5 million (up 21% QoQ)
  • Gross profit increased 63% to $16.3 million, or 76% of consolidated revenue
  • Adjusted EBITDA decreased from 37% to 20% of consolidated revenue, due to extraordinary items
  • Retail doors increased more than 80% to 3,680 at December 31, 2018
  • 57% of revenue from eCommerce
  • 2018 Farm Bill passed on December 20, 2018, removing hemp from the Federal CSA and designating it as an agricultural commodity governed by the USDA and FDA

Although the revenue growth was solid (up 21% for the quarter), what is concerning is the fact that the Gross Margin is at its lowest since the middle of 2017. Although, it can be explained as the company ramps up its wholesale value, with increases stockists, and now deals with CVS and other large retailers.

However, it is the EBITDA margin which is the most concerning element of financial results. Their EBITDA margin has been in a steady decline since the end of 2017.

EBITDA was impacted by one time costs relating to legal and governance issues relating to its IPO, and by increases in SG&A, the results of which can be seen in the significant growth in retail stockists and online sales (57% and 76% respectively). We are still very bullish on Charlotte's Web and believe they will go from strength to strength in 2019.

 

Safe but not yet sound

In the US this week, the House Financial Services Committee approved the bipartisan SAFE Banking Act, by a vote of 45-15, which would ensure that state-legal cannabis business can access basic banking and financial services.  The Act is aimed at ensuring state-legal cannabis businesses are able to access basic banking and financial services. It is the first time a bill related to cannabis banking has been approved by a congressional committee. Now it makes its way to the Senate, and make no mistake, this is not a laydown. But it is progress, and another step in the right direction of legalisation of cannabis at the Federal Level.

 

If you can't beat them…

Last week we brought you news that CVS Pharmacy will begin selling hemp-derived CBD products in 800 stores across eight states, calling the products "an alternative source of relief." This was the horse bolting through the gates, and we mentioned last week that we foresaw more of these deals happening.

This week, Walgreens announced its plans to sell CBD products, such as CBD-infused creams, patches and sprays in nearly 1,500 stores across select states.

"This product offering is in line with our efforts to provide a wider range of accessible health and wellbeing products and services to best meet the needs and preferences of our customers," Walgreens spokesman Brian Faith.

 

And finally

We think of this as Pineapple Express meets The Truman Show. This week Seth Rogen fulfilled a very long-long-held dream when he officially entered the recreational cannabis industry in Canada. He became the latest celebrity to team up with Canopy Growth (after Snoop Dogg and ~Martha Stewart) to bring his Houseplant cannabis brand to market.

"Houseplant is a passion we've brought to life through drive and dedication. Every decision we've made for the business reflects the years of education, first-hand experience and respect we have for cannabis," said Seth Rogen, Co-Founder of Houseplant

The first strain, Houseplant Sativa, will be available for purchase in early April 2019 through provincially regulated retailers and online in British Columbia. The Houseplant Hybrid and Houseplant Indica strains along with softgels and pre-rolled joints will follow throughout the year, and will soon be available across all of Canada.

Although we are not a fan of the name – seriously they could have done better than houseplant – it is cool to see more and more celebrity endorsement of cannabis, as the more this happens, the more socially acceptable cannabis will become, and the cobwebs of propaganda can be wiped away.

Until next week friends.

Mark Bernberg
Mark Bernberg

Mark Bernberg is a long-time cannabis investing enthusiast and founder of The Green Fund, Asia Pacific's preeminent media house, positioned at the forefront of the global cannabis industry.

Leave a Reply

Your email address will not be published. Required fields are marked *