Snoop Dogg has hopped aboard as a partner
Juri Zguri | Ubika Research Analyst | May 24, 2016: Legal marijuana is an industry with big growth potential but significant risks. For those willing to take that gamble, Canopy Growth Corporation (CVE:CGC) has set itself up to be the market leader in Canada, and is poised to reap those benefits for the foreseeable future.
Recent Developments at Canopy
Since the industry at large is advancing at a rapid pace, an assumption can be made that developments for each company are also rolling out at a fast pace. Some key developments that have driven the Company’s stock price include:
• Tweed acquired Bedrocan last summer, boosting its market share to roughly 20% of all Canadian patients. That number has since grown to ~1/3 of patients.
• June 11th, 2015, Supreme Court ruling deemed consumption of MMJ legal in all forms. This has led to Tweed receiving licenses to sell cannabis oil – the 10:1 (10ml of sunflower oils to 1g of marijuana). The bottles will be sold for $95-$155, representing a new revenue stream worth 10-20% of total revenues in the next year.
• Federal Liberal government majority caused a surge in its share price as a result of their positive views on the medical marijuana (MMJ) industry, as well as the legalisation of the drug at large. The stock entered October, 2015 with a price of $1.60 and surged over 70% to $2.75 by the end of November.
• Entertainer Snoop Dogg signed a 5-year term partnership with Tweed. Tweed gave up 386,100 shares at $2.59 each (~$1 million), with 135,135 shares issued immediately, and the rest upon a 3-year term completion.
• Capacity increases continue to be met, GMP securities has estimated total production capacity to reach up to 30 million grams annually, suggesting revenues of $200 million at current prices.
• Legalisation timeline set: Liberal Health Minister Jane Philpott conveniently chose April 20, 2016 to announce that legalization will commence in spring 2017. The stock soared ~15% that day. LCBO could be the end retailer for recreational marijuana.
Investment Thesis
Best Positioning for Upcoming Surge of Demand
With so much hinging on the likely legalization of marijuana in Canada, investors must be cognizant of overall trends in the industry.
Historically, and (although much less so) in the present, there has been substantial drug war rhetoric against marijuana. Politicians have used the classic “it is bad for our kids!” line to relay compassion to their voters. As such, there has been little development in the space, except for the MMJ sub-industry, which has (and continues) to take off. In our view, society’s perceptions regarding the drug are changing. As more funding and leaner regulations surround the industry, entrepreneurs and health organizations continue to monitor and advance the uses of marijuana (i.e. anxiety disorder, depression, PTSD, etc.).
Ahead of the Canadian marketplace are the US states Colorado and Washington, as well as some South American countries, such as Uruguay. While Washington State has reported problems involving city by-laws prohibiting use of marijuana, Colorado’s business seems to be booming: in 2014, the State recorded $700 million in revenues from recreational and medical use. The distribution between medical use and recreational use were split 55% – 45%, respectively.
Figure 1. Colorado’s Marijuana Sales in 2014
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Source: Washington Post
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The $700 million business in the State generated $63 million in taxes, and another $13 million in company licenses and fees. Perhaps the most encouraging news out of Colorado is that the consequences to the implementation of the industry has been essentially non-existent. Crime is down considerably, and local police departments have noticed no surge in marijuana related offenses. In fact, the industry has run so smoothly even Colorado’s own Governor John Hickenlooper, who was initially opposed the legalization laws, has stated it has run “much smoother than expected.”
Canopy is the industry’s largest player: market cap of $256 million compared to the second-largest player Organigram (CVE:OGI) with a $68 million market capitalization.
The Company has four different licenses to produce under its belt, and a licensed sales capacity (LSC) of 5740 kg, compared to Mettrum’s (CVE:MT) 3500 kg. While that represents an EV/LSC multiple of 48x for Canopy, and only 13x for Mettrum, we believe Canopy’s hold onto its ~1/3 market share makes the premium justifiable. This can be further exemplified through the number of patients the Company has been able to bring in: from 893 in Q3 2015, to the current 8289. Finally, we would like investors to remember that medical marijuana patient revenues are recurring by nature.
Figure 2. Patient Growth Continues Q/Q
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Source: Company Filings
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Financial Feasibility with Healthy Balance Sheet
Despite conceiving repeat losses as well as more recent FCF burn, the Company has a significant amount of cash on its books: $20 million, with just $3.7 million in debt. While investors continue to wait for positive EBITDA and cash flow, they should realize that due to the fact that the (medical) marijuana industry is in its infancy, paying now for establishing and maintaining market share seems to be the best way to go.
We believe Canopy’s financials show this trend, and the real question is not if their operations will be successful in terms of expanding Canadian market share, but rather how successful their operations will be.
Figure 3. Strong Upward Trend in Revenues
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Source: Company Filings
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With revenues exhibiting exponential growth Q/Q, it is clear Canopy is heading in the right direction, and claiming significant market share. In addition, the Company is succeeding internally as well. In terms of costs per gram, the Company has managed to lower its average, while maintaining smaller decreases in prices per gram.
Figure 4. Average Cost per Gram
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Source: Company Filings
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Finally, inventories have accumulated to over $23 million in finished goods. Management has noted that the accumulation is a positive sign as demand continues to ramp up. The Company is also experiencing strong waves of demand for oils, as well as wholesale selling to other players that may need inventory.
Catalysts
• International expansion could materially positively affect top-line revenues. Management has expressed interest in exposure to the Jamaican, German, and South American markets. With such regulations and competiveness in Canadian market, we believe expansion (or strategic partnerships) into international markets is quite possible. Given Canopy’s size, it is best positioned to take advantage of this potential catalyst.
• Snoop Dogg deal exemplifies management’s alignment with recent talks of recreational legalization of marijuana. The entertainer has his own venture capital fund (Casa Verde Capital), which he opened to promote cannabis producers across Canada and the US.
Investment Risks
• Like the majority of the 31 licensed MMJ producers in Canada, Canopy has not yet reached profitability in their operations. The longer this goes on, the more negative sentiment the Company accumulates from investors. That being said, Canopy has a significant cash balance of ~$20 million. This opens the door to possible accretive acquisitions, leading to further advancement in market share.
• The industry as a whole faces risk from two key factors: 1. Marijuana for Medical Purposes Regulations (MMPR) via its regulatory prowess across the sector, and 2. Liberal Party promises regarding legalization, as well as its timely schedule.
• Competition is another risk worth noting. Again, as the industry continues its rapid growth in its infancy stage, competition will intensify. This is especially true as there are no big monetary barriers to entry. One key to mitigate this risk is the scale and market size of the current producers. It will not be easy for competitors to enter the space and grab share from the developed leaders.
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