Why CannTrust Holdings Revenue And Earnings Should Continue To Improve
Jun. 4, 2018
Gary Bourgeault - Seeking Alpha
Long only, research analyst, portfolio strategy, media
Summary
CannTrust Holdings is one of few profitable cannabis companies.
Healthy mix of extracts and oils sales the leading catalysts.
3 new brands targeting recreational market should boost earnings.
Company targeting Canadian pet market as another revenue stream.
CannTrust Holdings (OTC:CNTTF) is unique in the cannabis industry in that it actually generates a profit, with its latest earnings report showing positive earnings for the third straight quarter.
The major reason for that is the favorable mix of extracts and oils it sells, which enjoys wider margins and stronger earnings. In the last quarter it accounted for over 50 percent of overall sales.
Concerning cannabis oils, in April it also introduced vegan hard-shell capsules for the purpose of differentiating from its competitors.
Recently the company also announced it had developed three new brands that will target the recreational cannabis market once it is legalized in Canada. Assuming the brands take hold with consumers, they should represent another earnings catalyst for the company.
The company has also partnered with Grey Wolf Animal Health to target the pet market.
Finally, it is working on expanding its production capacity, which when completed, could reach close to 1 million square feet.
Latest earnings
In the first quarter of fiscal 2018 CannTrust Holdings generated revenue of $7.8 million. That's up from the same reporting period of 2017, when the company delivered $3.03 million in sales. Net income for the quarter was $11.4 million, up from the net loss of $777,904 year-over-year. Earnings per share in the quarter was $0.12, against the ($0.01) loss in the first quarter of 2017.
The earnings would have been more impressive if the company hadn't had to engage in third party purchases to offset the lack of capacity at its Langstaff Facility, where it had to use a number of its grow rooms to harvest mother plants for the Phase 1 of its Niagara Greenhouse Facility. The company stated that earnings would have been about $2.9 million higher in the quarter if it had been able to utilize that capacity to grow cannabis to sell. The one-off start up costs associated with its Niagara Greenhouse Facility was another factor in its earnings performance in the quarter.
As for the acquisition of third party products, that has now stopped and the company is using its own products to meet demand.
The company increased grams sold from 332,408 in the first quarter of 2017, to 982,269 the reporting period.
One area of concern I noted in the earnings report was the average net selling price per gram, of dried cannabis and extracts. Dried cannabis dropped from $8.33 to $7.27 per gram, while extracts dropped from $9.85 to $7.89 per gram. This may be one of the reasons the company hasn't done as well so far in 2018 as its overall performance seems to warrant.
It's possible the company wasn't able to find more price support per gram because it was selling products from other companies. This is something that needs to be watched in the upcoming earnings reports.
In regard to patients, the number of active patients climbed to over 42,000, up 194 percent year-over-year.
With its three new brands targeting the recreational market in Canada, along with the potential for sales to the pet market, the company does look like it is positioned to produce consistent profits going forward.
Recreational brands
CannTrust recently announced it would introduce three new brands into the Canadian cannabis recreational market once it is legalized. Each of the brands will "specifically targeted towards a particular type of consumer."
The company noted as the time to release the product into the market gets closer, it'll give more detailed profiles of each brand. Here are the initial basic previews from the company's press release:
Liiv: Comprised of specifically selected strains with well-known lineages, this product is designed for the educated and experienced consumer. This Brand speaks to consumers who do not require all the bells and whistles, just quality product. Liiv products will come in dried flower, pre rolled joints, oils and capsules.
Synr.g: From a dinner party to a night out, or just connecting with friends, these expertly crafted strains are perfect for any social occasion and are targeted to consumers who look forward to breaks from their busy lives. Synr.g products will come in dried flower and pre rolled joints.
Xscape: Xscape takes the guesswork out of choosing a strain and is designed to give consumers the confidence that they are selecting the product that fits their needs. Xscape will include strains like “Flix n Chill” and “Walk the Dog”. Xscape will come in dried flower and pre rolled joints.
A couple of things to take into account with recreational marijuana is the results for producers is likely to shrink the margins of companies.
There will be some that do better than others, such as Liiv, which is offered in oils and capsules, which should command a premium price and margins. That assumes consumers don't go more with dried flower and pre-rolled joints, which Liiv is also offered in.
For CannTrust specifically, it still has its oils and extracts in the medical cannabis segment to help support margins and earnings. There is also the question of how much market share the company will win in the recreational segment of the market. If it's more of an ancillary business, rather than a significant portion of its sales, it may not be a huge drag on earnings.
That could be a negative if the market rewards revenue in the early stage of legalization of recreational marijuana in Canada, which I think is going to be how it plays out.
Under that scenario, CannTrust, if it does fairly well in recreational marijuana sales, could get a boost in its share price. In the short term the market isn't likely to punish the company if it does eat into earnings. That could become an issue in the long term when investors start looking for earnings and value.
Pet cannabis potential in Canada
There has been increasing talk of the relevance and legitimacy of medical cannabis for pets. Consumers in Canada reportedly spent about C$6.6 million on their pets in 2014, and that was projected to climb to about $8.3 million by 2018. While that has been suggested as a baseline to work from, there are a couple of caveats that need to be considered.
The first is that in 2014, the high cost of veterinary care in Canada was driving consumers to U.S. vets to get care for their pets. That said, even in the U.S. veterinarians reported the market was shrinking.
It appears consumers are spending more on the quality of life of their pets, rather than on medical care. Pet food remains the biggest portion of spending on pets.
With that in mind, the $8.3 billion figure, while probable for 2018, has to be measured against the fact most of that is for pet food. Other spending goes to things like "pet-sitting and dog-walking services, pet daycares, spas and puppy kindergarten classes...."
Since there is declining spending in Canada on medical for pets, how much of the $8.3 billion makes up the medical pet market is what matters for CannTrust and others competing in this space. Canopy Growth has created an entire division to compete in medical cannabis for pets.
I think what is likely to be offered as a main product is a blended combination of pet food and cannabis. There could be other things like products that relax hyperactive animals, and other behavior-related conditions.
Since Canadians are spending less on vets and medical care for their pets, it seems companies will have to position their products as a preventatives or additives to food, rather than as a treatment.
The point is the cannabis market for pets, while having some potential, doesn't seem to be one that will be huge. That could change if CannTrust and others can market and position their products in a way that differentiates from the way vets in the country are perceived as high-cost solutions to the medical needs of their pets.
If CannTrust can take the lead in the Canadian pet market, it could be a meaningful revenue and earnings category for the company. The size of the medical pet market in Canada doesn't appear to be huge, and it remains to be seen how much CannTrust can carve out of that, while fending off its larger competitors such as Canopy Growth.
Some risks
As will all cannabis producers competing in Canada, a major risk is whether or not they'll be able to meet expectations in relationship to the upcoming legalization of recreational marijuana.
There is a fairly wide range of projections in that market, and the outcome for CannTrust will be determined by whether or not it's on the higher or lower end of the size of the market. Another factor will be how quickly the market transitions to licensed recreational producers. A number of users on the recreational side may prefer to go with their unlicensed suppliers rather than change.
With a number of its competitors being much larger, how much of the recreational market CannTrust will capture if demand isn't as robust as some think it'll be will determine its growth trajectory.
It should continue to do well in the medical cannabis segment of the market, but the upside there could be close to hitting a ceiling, or at least slowing down dramatically. And while the pet market has promise, that is likely to take longer to build out and influence its top and bottom lines.
With all that in mind, that goes back to my concerns the company may be experiencing some weakness on its price per gram, which if revenue growth starts to slow down, it could put downward pressure on earnings.
On the share price side of things, I do think the company is at a good entry point. It isn't facing something unique to the industry, and as long as it successfully maintains its oil and extract mix, it shouldn't experience any surprises on its market value. I think most of the downside has already been priced in.
Conclusion
CannTrust has been on a nice roll over the last three quarters, generating positive earnings in each reporting period. It is boosting its production capacity while preparing to compete in the recreational and medical pet segments of the market.
What's most important to me though is whether or not CannTrust can continue to sell more extracts and oils than dried cannabis products, which have lower margins. The other question for the short term is how much will recreational sales impact the mix of oils, extracts and dry cannabis. Also, whether or not management has an internal cap on recreational sales in order to protect its margins.
The good news on that front is the company could go after recreational sales in the short term, and if it wants to in the future, pull back the reins and increase the mix of sales to extracts and oils in the medical segment. It could also be more aggressive with Liiv as a brand, focusing on the oil sales in order to increase profits. How much it'll be able to do so will of course be determined by the response of the market to the brand.
I see the pet market as being a long-term play that over time, could add significant revenue and earnings if the company can build the market and retain the lead. If it doesn't gain the No. 1 position there, it's questionable as to how much it'll add to its top and bottom lines.
One thing that will probably drive CannTrust over the next year is its added capacity. What has yet to be determined is how that capacity is utilized in relationship to the mixture of dried cannabis versus oils and extracts. If it can continue to grow both while retaining a favorable sales mix, it should do very well and eventually reward shareholders.
At the same time, if the market rewards revenue over the next year or two, because of the legalization of cannabis in Canada, CannTrust could be positioned to grow there as well.
For those reasons, CannTrust appears to be undervalued and should ultimately gain a positive bid from the market. Only the collapse of its price per gram is likely to push its share price down in a big way.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
News 
Market Data 
Discover 
