Initiation of Coverage

Canadian Equity Research
18 October 2017

In Cann we Trust

We are initiating coverage of CannTrust Holdings, Inc. with a SPECULATIVE BUY rating and a C$7.25 target. CannTrust is a Canadian licensed producer of cannabis with a strategic focus on the development of cannabis-based pharmaceuticals. While CannTrust currently operates out of a modest 3,000 kg capacity indoor grow facility in Ontario, the company has nonetheless exhibited explosive growth in its patient base and oil sales in recent quarters. We expect CannTrust will meet this growing demand as it increases its production >10-fold to >40,000 kg annually from its low-cost greenhouse facility; the first phase of construction is expected to be complete by year-end. However, we do see an ~$18 million funding gap for Phase II construction, creating a potential financing overhang and underscoring our ‘Speculative’ rating.

We forecast adjusted EBITDA for CannTrust will grow at a 108% four-year CAGR to

$120.2 million in 2022, and that the company will become EBITDA positive next year and FCF positive in 2019. CannTrust currently trades at 12.4x 2017E funded capacity, compared to peers at 7.7x. Based on the company’s low-cost production, leading growth profile, and forecast superior margins (driven by its medical strategy), we believe that CannTrust deserves to trade at a premium multiple to peers.

Investment Highlights

  • Leading growth generates margin expansion. CannTrust’s customer base has grown 117% since May to 32,500 active patients, placing the company among industry leaders. Oils (which can sell for 2x-3x the price of dried bud) represented >50% of total sales in Q2, vastly outpacing industry at ~15%. We believe product mix will drive pricing and margin expansion for CannTrust as cannabis is increasingly commoditized.
  • Medical strategy is the primary driver of value. Through its partnership with Apotex, CannTrust is developing novel value-add pharmaceutical formulations of cannabis. We believe that standardized dosing and enhanced delivery will lead to significant uptake, driving higher pricing and a forecast leading 10% medical market share.
  • Driving lower production costs. We believe CannTrust’s grow operations are among the best we have seen. Its experience and adherence to operating protocols mitigate the risk of disease pressure and have allowed it to become one of the true pesticidefree producers in Canada. The shift to greenhouse production should drive production costs lower, leading to margin expansion as the rec market comes on line next year.

Valuation

We value CannTrust using a sum-of-the-parts analysis: the Canadian medical market based on a DCF model (14% WACC, 2.0% terminal growth), and the higher-risk Canadian rec opportunity using probability-weighted NPVs (16% WACC, 90% success). Based on this analysis, we arrive at a target price of C$7.25 for CannTrust, which suggests a 62% annualized return and supports our SPECULATIVE BUY rating. Our conservative risk-adjusted valuation of the medical market alone suggests a $5.57 per share value, providing a potential valuation floor. Our un-risked valuation of both the medical and rec markets suggests a potential blue-sky upside of $14.36 per share.

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