TWMJF: Canopy Growth Corporation (TSXV:WEED) Analysis and Research Report

2017-12-14 - by Asif

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Canopy Growth, an early mover in the Canadian market, is a multi-brand cannabis company that believes its strong focus on and investment in brand, market and product differentiation, increased cannabis supply through Company and partner cannabis production platforms, and education, to help citizens safely, effectively and responsibly use cannabis, will create a dominant global business with the potential to generate a significant and sustained return on invested capital over the long-term.

The Company’s strategy is to focus on developing and scaling to be the world’s biggest multi-platform, creator of high value branded offerings in multiple formats for medical cannabis markets in Canada and abroad where federally legal, and for regulated recreational markets when they are federally legalized.

During the second quarter and since then, the Company has directed its efforts on major expansion plans to increase both capacity and capability in six provinces, so far, and six countries to date and ensuring those plans are well funded, as evidenced by the recent investment on November 2, 2017 of $245 million by an affiliate of Constellation Brands (“Constellation”) (NYSE: STZ and STZ.B). The expansion plans under development in Canada include 2.4 million sq. ft. of greenhouse and indoor facilities.

The Company has also committed to making investments in marketing, branding and sales functions strengthening Canopy Growth’s position in Canadian and international medical markets, as well as for the coming Canadian Regulated recreational market in mid-2018.

The Company is also investing in its internal administrative and supporting infrastructure, including governance programs, to build a strong and capable organization to maintain its market leadership and capture and scale into new market opportunities.

The Company’s operations are focused on ensuring a consistent selection and availability of cannabis strains for sale in all formats. As at November 13, 2017, there were approximately 40 offerings for sale on the Tweed Main Street online store including dry flower, oils, soft gel capsules across multiple branded categories.

SECOND QUARTER 2018 HIGHLIGHTS

Financial

  • Second quarter revenue was $17,569; a 107% increase over the quarter ended September 30, 2016 when revenue totaled $8,498, and represented an 11% increase over revenues of $15,873 in the first quarter of fiscal 2018;
  • 2,020 kilograms and kilogram equivalents1 sold in the second quarter ended September 30, 2017, representing an increase of 73% over the second quarter of last year, and an increase of 10% over the first quarter of fiscal 2018 in which 1,830 kilograms and kilogram equivalents were sold;
  • Oil sales, including gel caps, accounted for 18% of second quarter revenue. Oil sales in the second quarter accounted for 1,797 litres (or approximately 223 kilogram equivalents) of the kilogram and kilogram equivalents stated above;
  • Average sales price per gram was $7.99 for the second quarter, as compared to $7.01 last year in the same quarter and $7.96 in the first quarter of fiscal 2018;
  • The weighted average cost per gram before shipping and fulfillment was $1.25 per gram as compared to $1.27 per gram in the first quarter of fiscal 2018 and $1.70 per gram in the second quarter of fiscal 2017. The cost per gram also reflects value-add processing for cannabis oils and sector-exclusive Softgel capsules, both carrying significantly higher margins than dried flower product. The weighted average cost per gram to the point of harvest fell to only $0.72 per gram, the fifth consecutive quarter when the cost to the point of harvest was less than $1 per gram and declined from the previous quarter;
  • The second quarter gross margin before the fair value related impacts in cost of sales was $10,082 or 57% of revenue as compared to $5,098 and 60% of revenue in the same quarter of last year, and $9,025 or 57% of revenue for the first quarter of fiscal 2018. The second quarter gross margin before the fair value related impacts in cost of sales includes costs associated with subsidiaries that are not yet cultivating or selling cannabis, costs of $391 associated with facility improvements at the Mettrum Creemore grow operations continuing into the second quarter and a $703 write-down of hemp products due to discontinued product lines. Excluding these costs totaling $1,781, the gross margin before the fair value impacts in cost of sales would have been $11,863, or 68% of revenue;
  • Net loss in the second quarter of fiscal 2018 amounted to $1,613, or $0.01 per basic and diluted share, compared to net earnings of $5,430 or $0.05 per basic and diluted share in the second quarter of fiscal 2017. The net loss included acquisition costs of $865 in the second quarter, as well as other non-cash expenses totalling $12,507, and offset by the net effects of the IFRS accounting for biological assets and inventory which combined to a net gain of $18,668. Management believes the ongoing investment in building the Company’s production platform, brands, international reach, partnerships, and operations, which directly impacted profitability during the current period, is necessary to strengthen the Company’s global leadership position heading into next year;
  • On July 26, 2017, the Company completed a private placement with one investor (the “Offering”) of common shares (the “Shares”). Pursuant to the Offering, the Company issued 3,105,590 Shares at a price of $8.05 per Share, for aggregate gross proceeds of $25,000. The Company intends to use the proceeds of the Offering for capacity growth initiatives. No finder's fees were paid by the Company as part of the Offering; and
  • Consolidated cash and cash equivalents were $108,211 at September 30, 2017.

Operations

  • Over 63,000 registered patients at September 30, 2017 compared to approximately 59,000 at June 30, 2017 and approximately 24,000 at September 30, 2016; and
  • Harvested 4,167 kilograms in the quarter as compared to 5,575 kilograms in the first quarter of fiscal 2018;

Corporate Initiatives

Strategic

  • On September 14, 2017, the Company announced that it completed a previously announced agreement with Cannabis Care Canada Inc. ("CCC") to sell its wholly-owned subsidiary Mettrum (Bennett North) Ltd. Under the terms of the agreement, CCC paid the Company $7,000 in cash and entered into a three-year "take or pay" Supply Agreement with Canopy Growth for high quality dried flowers and refined cannabis resin, with the sale of product at the Company’s discretion;
  • On September 15, 2017, the Company and the Province of New Brunswick announced a supply Memorandum of Understanding (MOU) to provide a reliable and high-quality supply of cannabis products into New Brunswick’s retail stores. The first year of the two-year supply agreement between the Company and the province is for up to 4,000,000 grams of cannabis and cannabis
  • derivative products;
  • On September 18, 2017, the Company introduced the Spectrum Cannabis brand to the Canadian medical cannabis market. The new Canadian brand identity, already launched in several jurisdictions around the world is inspired by the industry first strain classification system which simplifies the dialogue around strength and dosage using a straightforward colour-coded guide;
  • On September 27, 2017, Canopy Health Innovations Inc. (“Canopy Health”), the partly-owned subsidiary of the Company, announced that it had filed nine provisional patents pertaining to the applications of cannabis and cannabinoid based therapeutics in sleep and related nervous system disorders. Canopy Health also announced that it had closed additional funding through sales of common shares bringing total funds raised to date for Canopy Health to over $15,800; and
  • During the second quarter, subsidiary Canopy Rivers entered into funding arrangements with two pre-license ACMPR applicants totaling $7,475 comprised of two $2,000 in convertible debentures, $2,500 to be held in trust in respect of a share subscription agreement and $975 in respect of shares subscribed in one of the ACMPR applicant parties.

Capacity Expansion

  • On August 28, 2017, the Company announced it acquired Spot Therapeutics Inc. (“Spot”), an ACMPR applicant based in Fredericton, New Brunswick. Additionally, through Canopy Rivers, the Company entered into a definitive agreement to complete the previously announced purchase of the industrial building and property where the Company’s Fredericton-based production and distribution platform is being established; and
  • On September 8, 2017, Canopy Growth announced that Tweed Farms had finalized the purchase of a parcel of land adjacent to its current facility in Niagara-on-the-Lake, ON including an operational 458,000 sq. ft. greenhouse. In addition, the Company announced that construction had commenced on an additional 212,000 sq. ft. of state-of-the-art greenhouse to be located on the current Tweed Farms property, to be completed by April 2018. Eventually, Tweed Farms will be home to over 1,000,000 sq. ft. of greenhouse space under glass, plus post-harvest facilities including a recently renovated 10,000 sq. ft. of updated space for new drying rooms and an upgraded laboratory.

International Development

  • On September 11, 2017, the Company and its wholly-owned subsidiary Spektrum Cannabis GmbH (“Spektrum”) announced a supply license agreement with Spains’ Alcaliber, S.A. (“Alcaliber”). Per the supply license agreement, Canopy Growth and Spektrum granted Alcaliber a licence to use certain strains and seeds to be grown and cultivated at Alcaliber’s facilities for sale worldwide.
  • On September 13, 2017, the Company announced that it has entered into a supply agreement with AusCann Group Holdings Ltd. (“AusCann”), whereby Canopy Growth acts as AusCann’s exclusive supplier of medical cannabis for the Australian market; and
  • On September 21, 2017, the Company announced that it had established a binding strategic partnership in the Danish market. Spectrum Denmark ApS (“Spectrum Denmark”) will be a joint venture between Canopy Growth and Danish Cannabis ApS (“Danish Cannabis”) which will serve the needs of Danish medical cannabis patients with Spectrum’s proven products. As part of the arrangement, Canopy Growth made an initial capital commitment of $10,000 to be released in tranches. In addition, the Company committed to issuing up to 1,906,214 common shares in Canopy Growth subject to meeting defined milestones.

RECENT DEVELOPMENTS

  • On October 30, 2017, Canopy Growth announced that it had entered into a strategic relationship with the leading total beverage alcohol supplier in the United States, Constellation Brands (“Constellation”) (NYSE: STZ and STZ.B). Constellation is a leading international producer and marketer of a fast-growing, high-performing portfolio of beer, wine and spirits brands. As part of the strategic relationship, an affiliate of Constellation invested approximately $245 million in Canopy Growth in exchange for common shares that, following the transaction which closed on November 2, 2017, represents a 9.9% equity share in the Company. The strategic relationship will see Constellation provide broad support in the areas of consumer analytics, market trending, marketing and brand development to Canopy Growth. In addition, the Company and Constellation intend to collaborate to develop and market cannabis-based beverages that can be marketed as regulated recreational products in markets where and when such products are federally legal. In exchange for the investment which closed on November 2, 2017, a total of 18,876,901 Canopy Growth common shares were issued at a price of $12.9783 per share based on a 5-day volume weighted average price (VWAP) as of the close of markets on October 27, 2017. An equal number of common share purchase warrants were issued at the same price, subject to certain restrictions, expiring 30 months from the closing date. The common shares and warrants will have a hold period of four months and one day from the closing date, with the warrants being exercisable in two equal tranches, with the first exercisable tranche date being August 1, 2018 and the second exercisable tranche date being February 1, 2019. Canopy Growth will principally use the proceeds to fund the expansion of its growing platform and to support ongoing investments in value-add processing and new product development and research.
  • On October 16, 2017, the Canadian Securities Administrators (CSA) and the Toronto Stock Exchange (TSX) released staff notices regarding their respective treatment of issuers with cannabis-related activities in the United States. The Company believes that neither staff notices apply to the Company and its subsidiaries and affiliates as no cannabis-related activities are conducted in the United States. In CSA Staff Notice 51-352 – Issuers with U.S. Marijuana-Related Activities, the CSA endorsed a disclosure-based approach and set out their expectations regarding disclosure for issuers that currently have, or are in the process of developing, cannabis-related activities in U.S. states where such activities have been permitted within a state regulatory framework. The TSX went beyond the CSA’s focus on disclosure and issued TSX Staff Notice 2017-0009. The TSX bulletin stated that TSX listed issuers that are engaged in activities relating to the cultivation, distribution or possession of cannabis in the U.S. (U.S.-Related Cannabis Entities) raises serious policy concerns for the TSX over illegality and potential exposure under U.S. federal money laundering legislation. As a result, the TSX concluded that issuers operating in violation of U.S. federal law regarding cannabis are not acting in compliance with the TSX’s listing requirements and such issuers should proactively address any gaps in compliance with the TSX requirements. The TSX notice also stressed that it has the discretion to initiate a delisting review of issuers engaged in activities that are contrary to the TSX requirements. The Company strongly supports the approach taken by the TSX to ensure its listed companies fully comply with all laws at all levels of government.

The Company has long made clear that it only operates where lawful to do so at all levels of government, and specifically does not directly or indirectly have operations in the United States.

  • On October 25, 2017, the Company announced that it launched a strategic partnership in the Jamaican cannabis market as part of its ongoing international expansion. Grow House JA Limited – to operate as Tweed Limited JA ("Tweed JA"), will serve the needs of the Jamaican medical cannabis market. Canopy Growth holds 49 per cent of the share capital of Tweed JA, which, with conditional license approvals already in place, has already begun construction of its facility; and
  • On October 11, 2017, the Company announced that it has entered into a definitive joint venture agreement to form a new company, BC Tweed Joint Venture Inc. together with a large-scale greenhouse operator to develop 1.3 million sq. ft. of greenhouse growing capacity in British Columbia with an exclusive option to develop a further 1.7 million sq. ft. of existing greenhouse infrastructure at a second BC location.

DESCRIPTION OF THE BUSINESS

MEDICAL MARIJUANA REGULATORY FRAMEWORK IN CANADA

On August 24, 2016, the Government of Canada introduced new regulations governing the use of cannabis for medical purposes. These new regulations, known as the ACMPR, were introduced in response to the February 24, 2016 decision rendered by the Federal Court of Canada in the Allard et al v the Federal Government of Canada case. The plaintiffs in the Allard case argued that the MMPR violates their Charter of Rights and the court, in a lengthy and detailed judgment, agreed with the plaintiffs. The court gave the Government of Canada until August 24, 2016 to determine how existing regulations should be amended to ensure that patients have the access to medical cannabis that they need.

The ACMPR, remained largely consistent with the former Marihuana for Medical Purposes Regulations (“MMPR”), but restores the ability of patients to grow their own cannabis at home, including the ability to designate a third-party grower through regulations akin to the former Medical Marihuana Access Regulations (MMAR). Under the ACMPR, patients who choose to grow at home, subject to a maximum number of plants, will be required to register their production sites and provide copies of their medical authorization to Health Canada to allow for monitoring and auditing of their activities.

Under ACMPR, patients are required to obtain a medical approval from their healthcare practitioner and provide a medical document to the licensed producer from which they wish to purchase cannabis. Since the requirements under the new regulations are both simpler and involve fewer obstacles to access than the previous regulatory regime, it is anticipated that the growth in the number of approved patients will accelerate. Moreover, the new system allows for competition among licensed producers on a host of factors including product quality, customer service, price, variety and brand awareness, allowing for well-positioned and capitalized producers to leverage their position in the marketplace.

Health Canada recently reported that over 200,000 patients had enrolled into the ACMPR program by June 30, 2017. By 2024, Health Canada conservatively estimates that the number of patients using medical marijuana will grow to 450,000, creating a medical cannabis market worth an estimated $1,300,000.

When regulated recreational to cannabis is legalized, it is expected that the ACMPR will be replaced by a new regulatory framework that will cover both the medical and regulated recreational markets.

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