Big changes are afoot in the legal marijuana industry. Two weeks from today, an expected favorable vote from Canada's Senate is expected to move the Cannabis Act one step closer to being signed into law. By sometime next month, Canada could become the first developed country in the world to legalize adult-use marijuana.
What does legalization really entail for Canada's pot companies? How about somewhere in the neighborhood of $5 billion in added annual revenue, which comes atop the sales these companies are already generating from medical cannabis and via exports. It's this rapid sales growth that's encouraged Canadian pot stocks to expand their production capacity at a breakneck pace.
The upside of this rapid capacity expansion is that it could give growers an opportunity to secure long-term supply deals with provinces and/or retailers. These deals provide a guaranteed source to offload a percentage of their production each year, which is invaluable in an industry where uncertainty and oversupply concerns reign supreme.
On the other hand, reinvesting practically every ounce of capital back into growing production capacity has left many pot stocks struggling to stay in the black. In other words, most marijuana stocks are losing money, and may continue to do so for many quarters to come. That, however, isn't the case with under-the-radar medical cannabis company CannTrust Holdings (NYSE:CTST).
This little-known pot stock is a profit and innovation machine
Unlike many of its peers, the Ontario-based CannTrust has generated a profit in three consecutive quarters, which includes its first-quarter results that were released last week.
For the quarter, CannTrust produced record revenue of nearly $6.1 million, an increase of 158% from the prior-year period. Pushing sales higher was a 186% surge in the number of active registered patients, as of the end of the quarter, and a significant push into extracts and oils. Even though extracts target a niche cannabis consumer, and are thus a smaller market item, they have a much higher price point, and in this case a much juicier margin than traditional dried cannabis. In the first quarter, sales of extracts more than quadrupled from the prior-year quarter to $3.47 million. It's these extract sales that helped push CannTrust to a CA$0.12-per-share profit in Q1 2018.
What's really notable about CannTrust is what the company will do to increase its patient exposure, as well as improve its bottom line. Currently, it's in the midst of a phase 2 expansion of its Niagara Greenhouse facility, which when completely finished could give the company around 1 million square feet of aggregate growing space. While phase 1 of the Niagara Greenhouse expansion was being completed in the previous quarter, its Langstaff facility was used to house mother plants for the Niagara facility. In doing so, CannTrust was left with less growing space than normal. Rather than simply produce less, the company purchased product from third-party providers on a temporary basis. Few growers would consider making such a move.
Product innovation has also been key for CannTrust. In April, the company introduced cannabis oil vegan hard shell capsules. In doing so, it moves away from animal by-product gelatin capsules that are most often used in cannabis oil capsules, as well as gives consumers the ability to self-administer proper dosages.
On the same day it announced its new vegan oil capsules, CannTrust also announced a partnership with Grey Wolf Animal Health. This partnership aims to develop game-changing cannabis-based products to support the well-being of pets. Though cannabis is a nascent player in the animal health industry at the moment, CannTrust is aiming to change that.
With growing capacity at the company's Vaughn facility climbed to 60,000 square feet following the end of Q1, and Niagara remaining on track and on budget, CannTrust appears to be firing on all cylinders ahead of Canada's expected adult-use legalization. Plus, at 18 times Wall Street's profit estimates, it might just be the cheapest grower around.
Two sizable concerns
However, as with any pot stock, CannTrust comes with its own set of risks and concerns that investors should be aware of.
The first worry would be the risk of oversupply. Though estimates vary wildly, it's believed that Canadian demand will land between 800,000 kilograms and 1 million kilograms per year. Yet, production estimates, calculated by yours truly, suggest a domestic oversupply of as much as 1.3 million kilograms by 2020 or 2021. Though some of this excess production will be exported to foreign markets where medical marijuana is legal, it's unclear if exports can abate a 1-million-kilogram-plus oversupply. If not, per-gram prices could decline significantly, hurting pot stocks across the board. It is worth pointing out that since CannTrust leans on extracts so heavily, it's unlikely to be hit as hard by dried cannabis oversupply as its peers.
Secondly, even with around 1 million square feet in peak growing space, CannTrust might struggle to crack the top 10 in terms of total annual production. The downside here is that as a mid-tier fish in a highly competitive pond, the company might be left on the outside looking in when lucrative long-term supply deals are made. In effect, CannTrust may have to work harder than its larger peers to find a home for all of its production.
The biggest concern, though, is probably dilution. With most of its operating cash flow heading right back into capacity expansion, CannTrust, like every other publicly traded grower in Canada, has had to turn to bought-deal offerings. A bought-deal offering includes selling common stock, convertible debentures, stock options, and/or warrants, in order to raise capital. All of these pathways eventually leads to a higher share count, which ultimately dilutes existing investors.
Just a day after reporting its stellar first-quarter results, CannTrust announced a bought-deal financing. Then, just one day after the original announcement, it expanded the offering. Originally slated to bring in $58.1 million (75 million Canadian dollars), CannTrust upped the offering to $67.6 million (87.3 million Canadian dollars). It may get even larger if the over-allotment is gobbled up by the underwriters. Though this capital is needed for expansion purposes, it's going to be a major drag on future EPS, and perhaps on the existing shares in investors' portfolios.
Still, given CannTrust's added focus on innovation and extracts, this isn't your average cannabis grower. So I believe it does merit future consideration. I'd suggest adding CannTrust to your radar and keeping a close eye on its projects and bottom line.