TSI Cannabis Investing Bulletins August 22, 2018

Bulletin 2, Volume 1

TSI Cannabis Investing Bulletins has reports and recommendations on two featured stocks: one a marijuana grower, the other a well-known stock trying to profit from the growing number of U.S. producers. You get our insights and advice on the investment outlook for the cannabis industry; five top news stories on cannabis right now; plus, our exclusive Cannabis Quality Ratings System for marijuana stocks, and more.

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Table of content


Marijuana Producer

Medical grower eyes cheaper outdoor cultivation, pet cannabis

This leading producer distributes its medical marijuana in three countries—and is even developing pet cannabis. Now it’s set to bring its low-cost production to the recreational market.

There’s even greater potential for cost-cutting if the company introduces outdoor production. While it will need to generate strong sales to match its high market cap, the stock remains cheaper than many competitors.


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CANNTRUST HOLDINGS, $8.24, symbol TRST (Shares outstanding: 103.9 million; Market cap: $856.1 million; TSI Cannabis Quality Rating (CQR):  www.canntrust.ca), is a Canadian-based producer of medical cannabis with distribution in Canada, Denmark and Australia. In addition, the company plans to branch into the recreational and pet-medicines markets.

CannTrust started production of medical cannabis under license from Health Canada in 2014. The company currently operates two production facilities.

The largest is a 450,000-square-foot commercial greenhouse located in Niagara, Ontario. This facility delivers five or six crops per year with an annual yield of 200 to 300 grams per square foot. The facility has a high-yield with a below-average production cost of $0.75 per gram. Its current production capacity is 50,000 kilograms of cannabis per year.

The Niagara plant is located on 46 acres of land, which can also be used for further greenhouse facilities or outdoor production. Outdoor production—just recently sanctioned by the Canadian government—is estimated to cost less than $0.25 a gram to grow, while marijuana produced in a warehouse costs an average of about $2 a gram. In greenhouses, most companies are growing cannabis for about $1 a gram.

The second plant is located in Vaughan, Ontario, and is a 60,000 square foot hydroponic indoor facility. The typical annual yield for this type of facility is 250 to 400 grams per square foot at a production cost of $1.20 per gram. The current production capacity of the facility is 3,600 kilograms of medical marijuana per year.

CannTrust’s primary aim it to produce and deliver high-quality, pharmaceutical-grade cannabis products, to grow its market share in Canada and to establish markets for its products in international jurisdictions where marijuana use is legal.

In Canada, the medical use of cannabis has been legal since 2001; there are currently about 270,000 registered patients. Estimates are that medical users could grow to 450,000 over the next few years, consuming 163,000 kilograms of cannabis. Medical marijuana is the core business of CannTrust right now, where the company has 40,000 active patients or about 16% of all registered medical users.

CannTrust also has a joint venture with Apotex, the seventh-largest generic pharmaceutical manufacturer in the world, to develop dosage formats and new products. When permitted, the partners intend to sell these products into the more than 85 countries where Apotex currently has a presence.

In addition to that deal, CannTrust has 25% equity interest in Stenocare, a Danish company, to produce and sell medical cannabis in Denmark. CannTrust has also formed an export partnership deal with a large German pharmaceutical distributor and, separately, it holds a license to produce and sell medical cannabis in Australia.

The company plans to enter the recreational Canadian market, which is much larger than the medical market. Canada’s legalization of marijuana for recreational use is set for October 17, 2018.

CannTrust is in the process of developing three branded products for the recreational market. It also plans to deliver cannabis in beverage and edible form when legislation allows, probably in 2019.

Apart from the medical and recreational markets, CannTrust is also in partnership with Grey Wolf Animal Health Inc., to develop and promote cannabis products for the pet market.

In the three months ended June 30, 2018, CannTrust’s revenue rose 99.2%, to $9.1 million from $4.5 million, a year earlier.  The company made $104,905, or nil per share, compared to a profit of $754,864, or $0.01. However, the profit in both quarters was due to estimated gains on the value of CannTrust’s inventory of cannabis. On an operating basis, it lost money.

CannTrust sold 1.1 million grams of cannabis in the latest quarter, up 122.4% from 477,837 a year ago. Active patients increased to more than 45,000, a 117% increase from a year earlier.

The company has low debt. It held cash of $99.2 million on June 30, 2018. That includes the $100.4 million it recently raised in a share issue.

CannTrust’s established position in the medical marijuana field is a plus. Its plans to grow marijuana outdoors should help it remain competitive as producers across the industry continue to expand their growing capacity.

Shares of many marijuana stocks may move higher as momentum traders buy the widely followed stocks on the latest upswing. However considering their current sales, many Canadian producers have very high “market caps” (the value of all shares outstanding). That means they need huge revenue growth even to justify their current stock prices. If revenues merely hold steady or rise only slowly, their stock prices will be vulnerable.

This includes CannTrust—although the gap between its market cap and its sales isn’t as big as it is for many of its competitors.

CannTrust Holdings has a 3½-Leaf Cannabis Quality Rating (CQR). The stock is a speculative buy for aggressive investors who want exposure to the marijuana industry.

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Investment Outlook

A growth-by-acquisition strategy could stunt growth

Expanding by acquisition can be risky in any business, but it carries even more risk in a new industry like marijuana production. Buyers could end up with companies whose revenues are completely dwarfed by their outsized market caps.


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Many marijuana producers continue to grow quickly by acquisition.

Some are looking to diversify—either from medical marijuana into recreational cannabis, or into new areas like edibles. Most are simply looking to grab as much market share as possible before legalization on October 17, 2018. That’s because buying an existing grower is a much faster way to boost output than building a greenhouse from the ground up.

Canadian producers are also looking to expand internationally, including buying marijuana sellers overseas as medical marijuana becomes increasingly legal worldwide.

In general, growth by acquisition is riskier than internal growth for a variety of reasons, but especially because acquisitions carry an above-average chance of unpleasant surprises. The buyer of something rarely knows as much about it as the seller. If a company makes enough acquisitions, it is bound to buy something with hidden problems. Eventually, those problems come out in the open and hurt the buyer’s earnings. Growth by acquisition in unrelated areas is especially risky.

That kind of expansion also tends to load up a company’s balance sheet with goodwill. Generally speaking, “goodwill” is the total price a company has paid for all acquisitions it has made over the years, minus the value of tangible assets that it acquired as part of its acquisitions. Goodwill is an intangible asset whose value can drop overnight if it turns out that the company made a bad acquisition.

The purchases that marijuana producers are making are particularly risky. That’s because they are mostly buying firms with huge market values—but with limited revenues and little chance of making a profit anytime soon.

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Cannabis-Connected

Lawn-and-garden firm helps cannabis producers grow more

We believe investors who want exposure to the cannabis industry will find safer opportunities with established companies that serve growers instead of growing the plant themselves.

Since 2013, this industry leader has provided marijuana growers with essential supplies such as fertilizers and “grow lights.” Its sales should rise as more U.S. states legalize marijuana. The company also has a dividend that appears secure.


YOUR MARIJUANA I.Q.

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Do you know the answer to this question? Take our Marijuana Investment Quiz and be ready for October 17.

Scotts Miracle-Gro Company, $75.63, symbol SMG on New York (Shares outstanding: 55.4 million; Market cap: $4.2 billion; www.scottsmiraclegrow.com) manufactures, markets, and sells consumer lawn and garden products worldwide. In the past few years, Scotts has sold most of its foreign operations to focus on the U.S.

In 2013, the company’s CEO Jim Hagedorn decided to branch out into offering products for marijuana growers.

Since then, Scotts has made numerous acquisitions of leading companies providing specialty fertilizers, “grow lighting” and other supplies for hydroponics; that’s the indoor method of growing cannabis favoured by U.S. and Canadian producers.

Right now, hydroponics (through Scotts’ Hawthorne division) represent roughly 10% of the company’s sales, but those sales should rise as more U.S. states legalize cannabis.

As well, Scotts recently acquired Sunlight Supply Inc., the top U.S. distributor of hydroponics products, for $450 million. Scotts will now serve 1,800 hydroponic retailer customers in the U.S.—Sunlight has nine distribution facilities across North America. The company expects its efforts to eliminate overlapping operations will cut $35 million from its annual costs, starting in 2020.

Scotts’ sales rose 22.0%, from $2.17 billion in 2013 to $2.64 billion in 2017 (fiscal years end September 30). Earnings jumped 59.4%, from $148.9 million to $237.4 million. Earnings per share gained 65.5%, from $2.38 to $3.94, on fewer shares outstanding.

In its fiscal 2018 third quarter, ended June 30, 2018, Scotts’ sales rose 2.2%, to $994.6 million from $973.4 million a year earlier. While overall sales to U.S. consumers rose 1%, sales for the Hawthorne hydroponics division fell 37% (excluding the contribution of Sunlight Supply). That reflects marijuana regulatory challenges in California, which have slowed revenue growth.

If you disregard costs to integrate Sunlight Supply and other unusual items, earnings in the quarter rose 1.2%, to $150.1 million from $148.3 million. Per-share earnings improved 8.1%, to $2.67 from $2.47, on fewer shares outstanding.

The company ended the quarter with cash of $29.6 million. Its long-term debt of $2.0 billion is a high, but manageable 48% of its market cap.

The stock fell recently after a California judge awarded $289 million to a man who claimed that Roundup weedkiller caused his cancer. Roundup is made by Monsanto, which is now owned by German pharmaceutical/chemical firm Bayer. Scotts is the exclusive distributor of the consumer version of Roundup weedkillers in the U.S. and Canada.

Bayer plans to appeal the ruling. Even if it loses and has to stop making Roundup, that would have little impact on Scotts. Those products account for just 5% of the company’s total sales.

Scotts now expects to earn between $3.70 and $3.90 a share for all of fiscal 2018. The stock trades at 19.9 times the midpoint of that range. The company also just raised its quarterly dividend 3.8%, to $0.55 a share from $0.53. The new annual rate of $2.20 yields 2.9%.

Even if the acquisition of Sunlight Supply fails to live up to expectations, the outlook for Scotts’ main business remains bright. The improving U.S. economy and consumer confidence should prompt homeowners to spend more on their lawns. The company also continues to devote roughly 2% of its sales to research. It’s particularly interested in developing environmentally friendly products such as organic fertilizers.

Scotts Miracle-Gro is okay to hold.

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TSI Cannabis Quality Rating System

Our Cannabis Quality Rating (CQR) considers a range of factors to determine the investment-quality rating for a cannabis producer. Individual ratings range from a 1-Leaf CQR—for stocks we believe lack almost all of the fundamental quality markers of even speculative cannabis stocks—to a 5-Leaf CQR for the highest-quality cannabis stock.

All told, we look at 13 factors in determining the quality rating of a marijuana stock:

13 QUALITY FACTORS

  1. Does this cannabis producer have rising revenue?
  2. Is its revenue stream significantly diversified?
  3. Is the company currently in production?
  4. Does the company have a sound balance sheet—cash and low debt?
  5. Does it have international operations?
  6. Industry prominence?
  7. Is the firm free from high dependence on a single customer?
  8. Does the cannabis producer have a prominent client list?
  9. Is its cost structure competitive?
  10. Is the stock’s market cap in line with the company’s sales (not an outsized market cap in relation to sales)?
  11. Is the company focused on organic growth rather than growth through acquisition?
  12. Has the stock’s price risen in line with the market average (not gone up faster than the market average)?
  13. Is the company outside of the broker media limelight?

Marijuana producers with most if not all of those factors earn a 5-Leaf Cannabis Quality Rating (CQR) for their sound investment quality and reasonable valuation compared to their current price and market cap.

Companies with many of these factors, receive a 4-Leaf or 4.5-Leaf CQR. That means they offer reasonable investment quality, but are somewhat overvalued at their current price and market cap.

Companies with a 3-Leaf or 3.5-Leaf CQR have a few of those key factors, which suggests they have reasonable investment quality. Still, they are likely overvalued at the current price and market cap.

Companies with a 2-Leaf or 2.5-Leaf CQR have a number of investment flaws and are very likely overvalued at the current price and market cap.

Companies with a 1-Leaf or 1.5-Leaf CQR have little investment quality and are almost certainly overvalued at the current price and market cap

Note: Even a 5-Leaf CQR is not the same as a BUY recommendation. In a new market where production is just now ramping up and both demand and supply are uncertain, most of these stocks lack fundamental value. Plus, most move up or down on the latest swings in investor interest and momentum regardless of their individual quality rating.  

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Cannabis by the numbers

The HORIZONS MARIJUANA LIFE SCIENCES ETF (Toronto symbol HMMJ) invests in North American firms that are legally involved in the cannabis industry. Canadian companies—including Aurora Cannabis (12.1% of assets) and Canopy Growth (11.0%)—make up 80% of the portfolio. As such the fund’s performance—specifically, its Daily NAV* and trading volume—reflects the ups and downs of this country’s cannabis producers.

*Net asset value (NAV) per unit is the underlying value of the ETF’s stocks and other assets at the end of each trading day divided by the number of outstanding units.

Read more on horizonetfs.com

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Cannabis in the news

Cannabis stories seem to be more prominent in the headlines every day, but here’s five stories this week  that give investors important insights in the run-up to full legalization on October 17, 2018.

1. Ontario has now signed agreements with 26 cannabis producers to supply the province’s online cannabis store starting in October. The selected producers include Aphria, Hydropothecary, Tilray Canada, CannTrust and Canopy Growth. Together, all 26 will exclusively supply the online retailer with recreational cannabis until April 2019. That’s when the new Conservative government plans to open the market to bricks-and-mortar stores run by private retailers.

2. Environmentalists warn that the mass cultivation of cannabis will have significant environmental impact in Canada. A U.S. study suggests that the average plant grown indoors consumes the energy equivalent of 70 gallons of oil. Moreover, the energy required to produce a single marijuana cigarette roughly equals the energy needed to run a 100-watt light bulb for 75 hours.

In a presentation to the federal government on the legalization of recreational cannabis, Canadian academics pointed to outdoor cultivation as a way to lower energy and water consumption.

3. THE SECOND CUP LTD. $3.23 (Toronto symbol SCU) will now capitalize on the Ontario government’s plans to open the recreational cannabis market to private sellers.

The coffee chain—in partnership with marijuana clinic operator National Access Cannabis—is combing through its list of Ontario locations to find sites suitable for conversion to cannabis stores.

The Second Cup has already identified candidate stores in Western Canada. All converted shops will operate under the National Access Cannabis banner.

The announcement comes after Ontario’s newly minted Progressive Conservative government said it would allow private retailers to sell recreational marijuana starting next April. Beginning Oct. 17, Ontarians will be able to buy recreational cannabis online but only through the province-owned website.

4. Richmond Hill and several other “family-focused” communities in Ontario say they’ll opt out of the government’s plan to introduce privately owned cannabis stores.

The mayor of the town just north of Toronto says the community largely opposes having those shops within city limits.

Mayor David Barrow says he was presented a petition with more than 1,000 names—all concerned cannabis shops may promote recreational use, especially among teens. Richmond Hill is not alone, with cities such as Oakville and Markham also planning to prohibit private retailers of marijuana.

The new Ontario government says it will, in fact, allow individual cities and towns to make that decision.

5. New research suggests nearly 70% of today’s legal marijuana supply in Oregon goes unsold.

Unlike Colorado, when Oregon legalized recreational cannabis, it decided against giving the state’s existing medical marijuana growers priority over new applicants. According to the study by the Oregon-Idaho High Intensity Drug Trafficking Area, the state also decided against limiting the number of licenses it would issue.

The researchers argue those factors have led to an oversupply in Oregon. They’ve also lowered prices—retail prices in the state have fallen 50% since 2015.

Colorado has also seen the same level of price decline. Still, its growers have moved more quickly to shore up prices by lowering supply.

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Comments

  • What are the legal ramifications if i invest in marijuana stocks and want to go to the US,and am asked at the border if i hold marijuana stocks.

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