CannTrust Returns to Profitability (With a Catch) as Sequential Sales Growth Slows

The legal cannabis industry is transforming into a big-money business before our eyes. Having generated just $5.4 billion in full-year sales in 2015, the legal weed industry is projected by Cowen Group to deliver $75 billion in annual sales by 2030, representing a compound annual growth rate of more than 19% if Cowen is correct.

One of the largest expected players in this burgeoning cannabis market is CannTrust Holdings (CNTTQ), which just so happens to have reported its fiscal first-quarter operating results before the opening bell on Tuesday, May 14. CannTrust, which expects to slot in as a top-five grower by peak annual production, wound up delivering a surprise profit for the quarter, albeit the company's sequential sales growth from the fiscal fourth slowed notably, proving it's not immune to the supply chain issues currently affecting Canada.

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CannTrust Holdings Q1 results: The raw numbers

Data source: CannTrust Holdings. All data expressed in Canadian dollars.

As you'll note, CannTrust recorded healthy year-over-year sales growth of 115%. However, supply chain problems, which include a combination of regulatory red tape, compliant packaging shortages, and the ongoing ramp-up and construction of capacity among growers, have led to logistical bottlenecks in the early going in the adult-use market. CannTrust's 16.85 million Canadian dollars in sales represent only a 4.2% increase in sequential quarterly sales from the fourth quarter.

Furthermore, CannTrust reported a decline in wholesale net revenue (i.e., primarily shipments to provinces for the adult-use market) to CA$5.48 million in the first quarter from CA$6.52 million in the fourth quarter. But more than making up the difference was a steady rise in registered patients (approximately 68,000, as of March 31, 2019), leading to CA$11.37 million in net medical cannabis sales, up from CA$9.64 million in net medical revenue in Q4 2018.

As for the all-important bottom line, CannTrust reported a CA$0.12 profit per share, reversing a sizable loss from the fourth quarter. Although EBITDA (earnings before interest, taxes, depreciation, and amortization) was still negative, this loss was more than halved from the fourth quarter thanks to an 11-percentage-point (pre-fair-value adjustment) increase in gross margin to 46%. Ultimately, fair-value adjustments on biological assets (i.e., cannabis plants) provided the bulk of the lift into the black for CannTrust in the first quarter.

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What happened with CannTrust Holdings this quarter?

This was a busy first quarter from a logistical standpoint for CannTrust as it laid the foundation for significant capacity expansion over the next year and change. Here are a handful of highlights from or subsequent to the first quarter.

• The company acquired 81 acres of land in British Columbia that it'll be using for outdoor growing purposes. The goal is to acquire up to 200 acres of land for outdoor planting, which will double or triple CannTrust's peak annual capacity to between 200,000 kilos and 300,000 kilos. The initial 81 acres of land are forecast to yield 75,000 kilos at an annual run rate once permitted and planted. Much of this outdoor planting will be used for extraction purposes to create high-margin cannabis derivatives (i.e., oils, vapes, edibles, beverages, and topicals).
• All permits were obtained to construct a 390,000-square-foot expansion to the Niagara facility in Ontario. Once complete, the combination of Niagara and the much smaller Vaughan campus should yield 100,000 kilos a year when fully operational.
• Subsequent to the end of the quarter, CannTrust raised $170 million (U.S.) in gross proceeds through a share offering, which gives the company ample capital to acquire land, plant its outdoor grow farms, develop new products, and complete the phase 3 construction on its flagship Niagara facility. The company ended March with CA$42.7 million in cash and cash equivalents ($31.8 million).
• Also subsequent to the end of the quarter, CannTrust finalized a letter of intent to supply Quebec with recreational pot. With this deal, the company now has supply agreements in place with all 10 of Canada's provinces.

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What management had to say

As you might imagine, management is excited about what the future will hold. Here's what CEO Peter Aceto had to say about CannTrust's aggressive capacity expansion plans:

With the successful closing of our equity offering providing gross proceeds of US$170 million (before exercise of the over-allotment option), we are well positioned to execute on our growth plans. Our fully permitted Phase 2 expansion is expected to reach its full capacity of 50,000 kg on an annual basis in the third quarter of 2019, and our 81 acres of land for outdoor cultivation has been prepared and we are awaiting regulatory approval to start planting. We have commenced work on our Phase 3 expansion in Niagara, which we expect will add a further 50,000 kg of annual capacity. All told, we continue to expect to exit 2020 at a production rate of between 200,000 kg to 300,000 kg per year. This is a very exciting time for CannTrust and we plan to continue executing on our vision of becoming a global provider of innovative cannabis products and brands.

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Looking forward

In the interim, CannTrust really has two forms of guidance for investors.

First, it wants its shareholders to know that its "investments into people, process, technology and marketing are expected to impact near-term profitability as the Company continues to scale." This isn't a big surprise, as CannTrust said the same thing when it initially announced its plans to acquire 200 acres of land and boost its production capacity by 100% to 200% during its fourth-quarter operating results press release. It means that investors should expect higher costs over the next couple of quarters as the phase 3 Niagara expansion continues, additional acreage is acquired, and outdoor planting commences (once permitting is in place).

The second bit of guidance offered by management is that CannTrust will be laser focused on derivative products, which are expected to be approved before Oct. 17, 2019, by Health Canada. Unlike dried cannabis flower, which has shown a tendency to be oversupplied and commoditized in select U.S. states, cannabis derivatives are a much higher-margin product that'll pack more punch for growers like CannTrust.

Although we're still in the early days of Canada's cannabis rollout, today appears to be a step in the right direction for CannTrust.