CannTrust Holdings Inc. (CannTrust) is a licensed producer and a licensed dealer authorized by Health Canada to produce and sell medical cannabis as well as perform R&D on narcotics in Canada. The company has a small indoor growing facility in Vaughan, Ontario and a large greenhouse on 46 acres in the Niagara region, which is in the midst of a two phase expansion.
CannTrust has experienced rapid growth recently which resulted in its Canadian medical market share tripling in the last year, going from 3% in Q3/16 to 10% in Q3/17. Furthermore, despite its smaller production capacity than peers, the company boasts the third highest EBITDA in the last 12 months. A near-term catalyst is the potential graduation to the TSX from the CSE, which should help the company narrow its valuation gap with senior LPs. Our positive stance on CannTrust is supported by the following:
Best positioned to capture a leading share of the domestic medical market. CannTrust has a partnership with Apotex, the largest generic pharmaceutical manufacturer in Canada, to develop new cannabis-based pharmaceutical products. New products such as capsules, and new delivery technologies could drive higher physician adoption by facilitating dosage and titration. In our view, the domestic medical cannabis market could be less competitive and generate higher profitability levels than the recreational market.
Great operators. CannTrust has been one of only four public LPs to generate positive EBITDA in the last 12 months. This stems from the company’s impressive yields, 60-80% higher than the average, low production costs (third highest adjusted gross margin) and SG&A expenses of ~5$/gram, the second lowest amongst public peers. We expect efficiency and scale to improve these metrics considerably this year with production from the large greenhouse.
Appealing relative valuation. CannTrust appears undervalued relative to the nine largest public licensed producers, which trade at 28x CY19 EV/EBITDA. With a trading multiple of 13x CY19 EV/EBITDA, CannTrust trades at a discount of ~55% to the group. We feel this discount is unwarranted given the profitability level of the company and the potential upside of the Apotex partnership.
We are initiating coverage of CannTrust with a BUY rating and a $17.00 target price. Our target price is derived using a DCF calculation with the following assumptions: (1) a discount rate of 9%, (2) an average ~6% share of the recreational market in Canada over our two stages, (3) an average EBITDA margin of 27% over our two stages, and (4) a terminal growth rate of 3%.