The Favourite

This is, in my opinion, one of the finest and most lucrative ways of playing the cannabis industry.

With a production capacity of just over 100,000kg of flower per annum, international growth, and distribution, and supply agreements that cover the Western Provinces of Canada, CannTrust is very, very well positioned for growth.

This is over and above the fact that they have the industry-leading percentage of oil revenues (60% of their revenue) and a global patent on a zero taste, zero calories, THC/CBD soluble that is purpose-built to work with the beverage companies.

They are simply best in class in my opinion. The best part is that this stock is extremely undervalued against its peers and has significant upside. 

CannTrust was founded for the sole purpose of delivering standardised, pharmaceutical grade, medicinal cannabis to the global market. And they’ve done just that.

 

 

CannTrust operates in 4 counties on 3 continents. They have a very strong focus on the medicinal market. Through their partnership with Danish-based Stenocare, they have distribution rights and access to the two largest pharmacy chains, that together cover 99% of the Danish population.

In fact, CannTrust was the first exporter of cannabis oils to be placed on the Danish Medical List. A list allowing doctors to easily prescribe medicinal marijuana. In the Netherlands, their JV with a licensed producer gives them a cultivation base for greater Europe.

The facility – EU GMP certified – will be able to supply Germany, Portugal, and other European counties as they open up.

And then, of course, there’s their relationship with Apotex.  Apotex – a global leader in the manufacturing and distributing of generic drugs – operates in 115 countries across the globe (basically, nearly every populated place on the planet).

Under this unique joint venture structure, CannTrust will provide cannabis extracts to Apotex at a wholesale price plus a 10% markup. In return, Apotex is required to fund all of the product R&D and commercialisation.

Significant leverage to Apotex’s team of PhD’s comes with very little up-front costs to CannTrust, yet allows it to capture 25% of all gross profits from every product that the partnership develops and sells globally. Just think about that for a second or two.

Apotex also has existing IP that will now be combined with the advances in medicinal marijuana to produce a range of products that can then be easily plugged into one of the world’s most robust distribution pipelines.

Although these relationships currently deliver relatively little revenue, this is where the growth will be as new markets open up to medicinal marijuana (and eventually recreational). In the current embryonic stage of the cannabis industry, land grab is everything, and CannTrust has executed on this very smartly.

 

The Production, Manufacturing, and Distribution

CannTrust sees these as three distinct divisions in their vertically integrated chain.

 

The primary production facility is located in Niagara. The facility, 450,0000 square feet in size, is now in full production, with an annual capacity of 50,000kg.

The facility operates as a hydroponic greenhouse (meaning the plants are growing in nutrient-rich water solvents) and is also in a perpetual harvest system (that moves the containers to regulate light and other factors).

From day dot, CannTrust has been about producing standardised medicinal marijuana, and they have become very good at it. Their current yield per square foot (between 300-400 grams) is nearly double the industry average.

They have redefined the process to such an extent, as to be able to standardise medicinal marijuana and produce strains that deliver a consistent 27% THC potency.

This is simply phenomenal and is at the higher end of the THC scale, which, as it becomes higher, becomes exponentially harder and harder to produce in commercial quantities, let alone standardise.

Standardisation on the level CannTrust executes, also creates significant economies of scale, leading to a very efficient production process.

Back to the facility. They have now started developing phase 2 of the facility, a 600,000 square foot greenhouse, that at capacity, will produce around 50-60,000kg per annum, bringing their total funded capacity to just over 100,000kg per annum.

They had planned a second cultivation facility in Vaughn (an indoor grow facility) but took the decision to transform it into their manufacturing facility. The 60,000 square foot facility will now be HQ for all of their medicinal products (and recreational brands) to prepared and packaged, ready for distribution.

And speaking of that. There’s also their new 50,000 square foot distribution facility in Vaughn. This facility is planned to handle their recreational supply agreements and their growing international export requirements.

 

The Medicinal Market

CannTrust always set out to dominate the medicinal marijuana market, and they have done just that. They now lead the industry for the most cost-efficient range of medicinal products.

In addition to being so medicinally focussed, they also have invested heavily into technology. This has resulted in the development of significant commercial IP, particularly related to oil-based pharmaceutical extracts. Extracts now make up over 60% of their revenue.

Not only is this the highest ratio in the industry, but it is also a product that commands significantly higher pricing and yields the highest margins. Oh, and the extracts market is the fastest growing segment of the fastest growing industry in the world.

As a result of this, CannTrust has delivered five consecutive quarters of positive net income. Only Aphria can better this stat. You getting the picture yet?

 

 

Their partnership with Apotex, which was recently accelerated, has fast-tracked CannTrust’s range of medicinal brands. The foundation of their brand promise is built on disciplined production.

Production, that when executed with the level of sophistication and technology, allow for the most standardised product in the industry. Some of you will have noted that I already said that. I am repeating it on purpose.

Standardisation is at the core of their valuation. As it is this standardisation that is most in demand from the oncoming recreational consumers.

They want to know what they’re getting, ensuring – just like alcohol – that responsible consumers can get the level of buzz they want, measured dose, by measured dose.

 

The Recreational Market

Their potential for hyperbolic growth in the medicinal marijuana market is not in doubt, yet they have just as much potential for growth and success in the recreational market.

They are currently the third most award licensed producer and have supply agreements with 8 of the provinces (covering 70% of the population). In addition, they also have national distribution agreements in place for their three recreational brands, LiiV, Synr.g, and Xscape.

 

 

LiiV is for the everyday smoker. A range that incorporates 7 different product lines that are all a hybrid of Indica and Sativa. A premium product for the consumer looking for a Groundhog Day level of consistency, in experience and buzz.

Then there’s Synr.g – their social brand. The product lines have been marketed, primarily on taste. Strong flavours of lemon and blueberry create the perfect choice for dinner parties and other social occasions.

And finally, Xscape – strains branded to an experience. Walk the Dog, Go to Gym, and Flix and Chill are just three of the strains genetically bred with the exact activity in mind.

They have ~$25 million in inventory stockpiled for the recreational launch and are currently at production capacity of 28,000kg per annum. This will be at 50,000kg by early January 2019 and should get to a fully funded capacity of 100,000kg, once the Phase two extension at Niagara is completed by the end of 2019.

CannTrust recently partnered with Grey Wolf Animal Health, to create a range of preventative CBD-rich waters for pets. The non-psychoactive CBD acts as a daily vitamin for the animal – as they too have a fully developed cannabinoid system (the system that CBD compounds bind with to create the medicinal effect).

 

In addition, they are producing a range of pet-centric pharmaceutical drugs to tackle issues such as anxiety, pain, and other such indications. And when you’re talking about pets, you’re talking about a fast-growing multi-billion dollar industry. This is a smart play.

 

The CBD Solution

CannTrust has developed and has patent pending status on, a zero-taste, zero-calorie CBD and/or THC infused solution that is completely water soluble, and importantly, stays in solution.

What this means, is that they have the base solution for any beverage to be produced on top of. And they already have the capability to produce this product at scale. And it does not separate, meaning you will never have an oil and water situation where the liquids, over time, settle above or below each other.

By now you should be well aware of the fact that the global beverage market for BOTH recreational THC “buzz” drinks and CBD “wellness” drinks is a sleeping giant. It’s the reason Constellation Brands and Molson Coors are already in the game, and why Coca-Cola, PepsiCo, and Diageo (to name but a few) are looking at potentially joining the game.

And CannTrust has a standardised (there we go again) water-soluble solvent that can be white labeled, wholesale, to anyone. This product alone makes them one of the companies to watch, given the oncoming tsunami that will be cannabis beverages.

 

With the base for recreational and medicinal beverages in hand, they did a deal to secure one of the best beverage distribution networks in North America.  In September, Chicago-based Breakthru Beverage invested USD$9.2m into CannTrust.

The United States’ second largest beverage distributor and Diageo’s agent for Canada is now developing the route-to-market platform to distribute and commercialise the suite of beverage products produced with CannTrust’s patented solution.

Beverages are a big play for CannTrust and they have shown a significant commitment to this channel. I believe this to be a very shrewd move, one that should deliver significant shareholder value in the years to come.

 

The Commodity Disrupter

It gets better. CannTrust has developed a genetic strain of seed that is daylight neutral and goes straight to flower. This makes the seed very easy to grow and through a strategy of large-scale seed propagation, CannTrust aim to sell their seeds to farmers and double that down with the contract to buy their production back.

In this way, they are creating a massive cultivation pipeline without the upfront capex required to fund this level of growth.

They are also creating low-cost cannabis on a massive scale that allows for better margins in their mass recreational brands. This is why their revenue is set to continue growing the way it has been.

 

The financials

In their recent Q2 2018 financial report, they produced $9.1 million of top-line revenue. This is a 99% increase over the corresponding period (Q2 2017).  As previously mentioned, this also resulted in their fifth consecutive quarter of positive net earnings.

Amazing, considering that CannTrust now covers the 10% sales tax on all medicinal marijuana. Ensuring those in need can afford it. Only Canopy Growth currently also offers this financial benefit to its patient base.

Extracts made up just over 60% of revenue and grew by 135% over Q2 2017. And their patient numbers moved past the 50,000 mark (120% up year on year), representing approximately 15% of the registered Canadian medicinal market.

More promising than that is the fact that they are currently capturing 1 in every 3 newly registered Canadian patients.

Only 0.6% of the Canadian population is currently using medicinal marijuana. That number is projected to double to 1.2% in the coming 3 years. And CannTrust is grabbing 33% of that growth.

 

Management

CannTrust has a very strong management team. Eric Paul, who founded the company and until just recently was the CEO, has overseen the creation of an industry leading medicinal marijuana company that has cracked the commercial holy grail of producing high quality, standardised medicinal cannabis, at scale.

He recently stood down as CEO and took on the role of Executive Chairman. In doing so, he made way for the appointment of Peter Aceto to take on the role of CEO as CannTrust moves boldly into the recreational era. 

He adds a very impressive track record to the CannTrust leadership team. His previous experience is highlighted by his time with ING/Tangerine, where he spent 20 years in various executive roles.

Most notably, he was CEO of the company for nine years, during which he led the $3.1 billion sale of ING Direct to Scotiabank in 2012 and successfully transitioned the company’s branding to Tangerine shortly thereafter. And this kind of acquisition experience could work well for CannTrust…more on that later.

 

The Valuation

First off, CannTrust has a relatively low number of shares on issue (103.9 million with ~12 million in options and warrants) which bodes very well for the long-term investor. The balance sheet is very healthy with over $100 million on deposit, enough to fund cash flow for the next 2-3 years.

Secondly, CannTrust trades at an enormous discount to its peers. This is clearly evident when you first look at the market cap. CannTrust’s current market cap (at a share price of CAD$13.90) is CAD$1.44 billion. Consider the market caps of its closest peers.

Now, with the above in mind, consider the most recent quarter’s revenue of those same peers. And yes, TGOD still does not have any revenue. TGOD’s valuation is 2x that of CannTrust and it has no revenue, and no patients. Oh, and Aurora just declined to increase their stake in TGOD. Am I done here?

The Bottom Line

CannTrust is my number one stock pick at the moment. I think the company is very well placed for growth in both the medicinal and recreational marijuana markets. 

It’s an incredibly well-run business, with quality leadership, that has nailed the standardised production of medicinal marijuana.

A big near-term catalyst could be their listing to the Nasdaq (rumoured to be in the coming 30 days). Other Canadian cannabis companies that have made the move over to the US exchanges have done incredibly well. Canopy Growth is up over 100% since it listed on the NYSE in May of this year. And I don’t need to tell you about Tilray do I?

CannTrust is, in my opinion, prime candidates for an acquisition. This could come from many angles. One might be another large LP looking to strengthen (and significantly grow) their medicinal patient base and genetic IP bank.  Based on what we’ve seen this year alone, that would be at a significant premium.

Alternatively, they would be the perfect fit for a big pharmaceutical company looking to enter the industry given their high capacity and robust medicinal focus. Based on the Canopy-Constellation II deal, this could drive the share price even higher. Now’s the time to think back to Peter Aceto’s experience.

Not to mention that without any of this, the stock is horribly undervalued.

I am buying CannTrust and will continue to do so. This would be the first stock I would add to any of my portfolios.

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