CannTrust Holdings (CTST) recently announced it has gained entry into the U.S. market via a partnership with Elk Grove Farming, located in California. Over time it'll use it as a base to expand into other U.S. markets as the opportunity arises.
Per terms of the deal, CannTrust signed a non-binding letter of intent with Elk Grove Farming to produce hemp together on up to 300 of the over 3,000 acres Elk Grove farms. Both companies have a 50 percent stake in the venture.
According to CannTrust, its purpose is to supply and scale CBD products derived from hemp. Management believes demand for CBD products will continue to grow at the global retail and manufacturing level.
It should be understood that from the point of view of Canadian-based CannTrust, the U.S. is an international market, and of course, the largest cannabis market in the world. So when the company talks about scaling at the international and manufacturing level, it's primarily referring to doing so in the U.S. That's what this deal is all about.
We'll look at what this means to the company in the near and long term.
The CBD market
The much cited projection from Brightfield Group is that the CBD market could be valued at about $22 billion by 2022; a huge increase from the estimated $591 million in sales generated in 2018. A lot of that growth will come from the U.S.
One thing to consider on the scaling side in the United States is it's not quite as easy as it looks because of the disparate rules and regulations in different states, and even different counties and cities. But for a smaller company like CannTrust, it's not as big of an issue as it would be with industry giant Aurora Cannabis, because even smaller scale for CannTrust could significantly boost its performance over time.
In its press release the company stated it will invest as much as $20 million through 2020 to support U.S. growth. The company assumes cultivation of up to 300 acres by 2020. That will include costs of cultivation, harvesting and post-harvest processing in relationship to the partnership.
How it fits into the company growth trajectory
Concerning production capacity, CannTrust expects to reach its projected full capacity of 50,000 kilograms annually at the completion of its Phase 2 expansion in the third quarter of 2019.
It has also started work on its Phase 3 expansion in Niagara, which should add another 50,000 kilograms in annual production capacity to the company. By the end of 2020 the company estimates its annual run-rate should jump to a range of 200,000 to 300,000 kilograms. Even at the lower end of the projection it would make it one of the top producers in the industry.
One of the challenges for the company is it is taking a long time to reach this level of production. Many of its larger competitors are already close to or above the 100,000 kilogram per year mark. The industry is changing rapidly, and it's impossible to know what the market conditions will be when CannTrust finally reaches a high level of annual production.
That's important because many of its larger competitors may secure significant partnerships and licenses long before CannTrust does, which could essentially lock them out of key markets, or at least, force them to make deals with weaker and smaller competitors.
The reason that could happen even more than it already has, is because the market is looking for consistent and reliable partners it can count on to deliver on their supply promises. This will become increasingly important going forward. Companies must have ample supply in order to attract the best partners and deals.
So with the entry into the U.S. market, it somewhat aligns with the pace of the growth trajectory of CannTrust as the company stands today. A lot of the potential will come together over the next year or two.
Again, the issue is what type of market will CannTrust be competing in once it has its abundant supply ready to sell. Also, what potential major deals will be available by the time it has the level of production capacity that could make a difference for its customers.
The company is one of only several companies to have supply deals in place with all 10 Canadian provinces, but I'm thinking in terms of international deals and the long-term value they'll add to the company. Too much exposure to recreational pot in Canada will become a major problem for many producers once supply catches up with demand. I don't think it's going to be too long before that happens. CannTrust must reduce its risk to that in the not-too-distant future.
Conclusion
While CannTrust is doing a lot of things right, it has been slower than its key competitors in ramping up production capacity and lowering its exposure to its domestic recreational pot market.
On a positive note, it has partnered with Apotex, the largest generic drugmaker in Canada, to develop and build out its medical cannabis business.
Its medical business could offset some of the recreational pot risks, as it has grown the number of its number of registered patients to about 68,000 at the end of the first calander quarter, resulting in medical cannabis sales of C$11.37 million.
It also has a stake in CannaTrek, based in Australia, and Stenocare, based in Denmark, both plays in the medical cannabis segment.
If it wasn't for its medical cannabis revenue, the last quarter would have been more dismal than it already was, as the company company's wholesale revenue, meaning recreational pot, fell from C$6.52 million in the fourth quarter to $C$5.48 million in the last first quarter.
The bottom line for CannTrust is it does have a lot of potential, but it will have to find ways to secure more agreements with significant partners, while building out its international medical cannabis business, and with the partnership with Elk Grove Farming, build out a robust CBD business.
The recent closing of an equity offering of $170 million provides it with the capital to give it a go, but investors will have to be patient as it works on its production capacity, hopefully finds ways to expand the number of international markets its competes in, and see how if it is able to execute on its plans to scale out a CBD business in the U.S.
If it can execute on these things, it could surprise the market to the upside, but it's going to take time to do it. My concern is when the company finally achieves a high level of production capacity, it may find it difficult to leverage its supply to generate sustainable revenue and earnings.
To read more on the nitty gritty of what’s going on in the rising cannabis industry, click here.
