All eyes are now officially on Canada. On June 19, the Senate, for a second time in as many weeks, passed the Cannabis Act, sending it to royal assent. Not long thereafter, Prime Minister Justin Trudeau announced that adults will be able to purchase cannabis legally beginning on Oct. 17, 2018.
To say that legal marijuana in Canada is going to be huge would be an understatement. This legalization is expected to add $5 billion (or more) in annual sales once the industry is fully ramped up. Mind you, these sales come atop what the industry is already generating from medical weed sales and via exports to countries that've given the green light to medical cannabis.
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This large Canadian cannabis grower just reported its third-quarter operating results
One such company looking to take advantage Canada's historic legalization -- no other industrialized nation in the world has given the OK to recreational pot before -- is Quebec-based Hydropothecary Corporation (HEXO). Though peak production forecasts have been exceptionally fluid, Hydropothecary looks to be among a relatively short list of growers on track to produce in excess of 100,000 kilograms of cannabis when at full capacity. Management has previously guided to 108,000 kilograms of cannabis-equivalent production spanning its 1.3 million square feet of facilities when fully operational.
But, like most growers, Hydropothecary is in the process of expanding its operations, and it's nowhere near peak capacity. This makes the company's quarterly earnings reports and operational updates particularly important. Remember, it's not just about peak production; the diversity of a company's product line, its partnerships, and its cash position to allow for capacity expansion and product development arguably matter more.
This past Thursday, June 28, Hydropothecary reported its third-quarter operating results. Let's dig into seven important nuggets of information that were passed along beyond just the company's top- and bottom-line results.
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1. Hydropothecary secured a massive long-term supply agreement with Quebec
Probably the biggest highlight of Hydropothecary's third-quarter results was its reiteration of a 200,000 kilogram supply agreement with Quebec over a five-year period -- the largest single supply agreement announced with a province to date. Though this agreement was actually announced back in April, the earnings release notes that the company is prepared to supply Quebec with 20,000 kilograms of production in the first year, with incremental growth in what the company is expected to supply in each subsequent year. These long-term supply agreements are crucial, because they generate predictable cash flow for Hydropothecary.
2. Planting in the new facility is ahead of schedule
Another positive was the announcement that the company had transferred plants to its 250,000-square-foot greenhouse expansion a full month ahead of schedule. It's a near-certainty at this point that supply won't come anywhere close to meeting demand in the months following legalization, with most growers scurrying to expand their growing operations. But being able to move some of its production ahead by a full month might help Hydropothecary bring its recreational cannabis to market faster, giving it the opportunity to secure additional market share in the early going.
3. Economies of scale are beginning to take shape
Although it's still very early, and the company isn't anywhere close to full capacity, it's already beginning to reap the benefits of economies of scale. The company notes that its weighted average cost of dried inventory sold per gram tumbled by 57% to $0.66 (0.88 Canadian dollars) from the previous year. Even if dried cannabis becomes commoditized, which is something we've seen happen in Washington, Colorado, and Oregon in the U.S., Hydropothecary's per-gram production costs should be sufficiently low enough for it to still reap substantial profits.
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4. Alternative cannabis products are driving results
As has been the case with a number of its peers, the company's latest quarterly results demonstrated growth in alternative cannabis products, such as oils and extracts. The latest quarter featured a 7.2% increase in revenue per gram equivalent, which the company attributed to sales of its Elixir product line. Mind you, this increase came about despite the fact that the company reported a year-over-year decline in dried cannabis sales volume. Cannabis oils have the potential to make a real difference in margin for Hydropothecary -- and pot stocks in general.
5. The company has a solid cash position
Investors also shouldn't be worried about the company's ability to complete its capacity expansion. According to the report, the company ended April 2018 with $187.6 million in cash (CA$248.9 million) and a debt-free balance sheet. While it's certainly not out of the question that Hydropothecary raises additional capital, either through bought-deal financing or via debt facilities with financial institutions, it would appear to have enough on hand to complete its 1 million-square-foot facility.
6. A name change is on the horizon
Soon enough, Hydropothecary will be no more. The company has signaled its intent to change its name to "Hexo Corporation," assuming it receives shareholder approval to do so. Hexo is the name of the company's newly launched line of recreational cannabis products. Hydropothecary has made its intentions clear that it's focused on the recreational side of the equation moving forward, so renaming the company to Hexo will better reflect that focus.
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7. Dilution is taking its toll
Last, but not least, no discussion of marijuana stocks is complete without mentioning the toll that dilution is taking on shareholders. Aside from the fact that the company lost nearly $1.5 million (CA$1.97 million) in the third quarter, it ended the quarter with nearly 180 million weighted average shares outstanding. That's a 166% increase from Q3 2017 and a direct result of the negatives associated with bought-deal offerings. Even though these bought-deal offerings were necessary to provide Hydropothecary with the capital needed to expand its capacity, its ballooning share count could adversely impact its earnings per share (if it's profitable) in the years that lie ahead.
With a lot of questions left to answer for the company and the industry as a whole, Hydropothecary probably isn't a marijuana stock to buy at the moment. It is, however, worth keeping a close eye on as it angles for recreational weed market share in Canada.
