Description

CanniMed Therapeutics (TSX: CMED)

Background: There is quite a bit of attention paid to Cannabis markets globally as countries and states move out of decades of prohibition and into regulated medical and recreational marijuana consumption regimes.  Canada has the unique position of being the only developed nation with a federally-legal and robust medical marijuana program (and is moving quickly towards launching a recreational program). As such, Canadian investors have reflected a strong interest in funding these businesses and Canadian exchanges have become the go-to place to raise public capital for cannabis companies pursuing both domestic and international strategies.  This enthusiasm hit a precipice in late 2016 as the Liberal Federal government announced their intention to continue with the current medical regime and introduce a regulated adult-use recreational market, expanding the estimated market size from ~$4BN to ~$10BN.  Valuations of many publically-traded cannabis companies peaked at >12x two year forward EBITDA multiples on arguably inflated expectations. However, in the ensuing 8 months, a degree of normalcy has returned to the Canadian cannabis market, with those multiples coming down to ~6x 2019 EBITDA estimates, on more conservative assumptions. While the market overall may still experience meaningful volatility, one company in particular appears to have been washed out with the group while putting up strong operational results and moving quickly towards establishing a commanding presence in multiple international markets. As a federally-legal market, licensed cannabis producers in Canada that have the unique first-mover advantage to take their commercial scale growing, QA/QC and customer preference knowledge and either export or set up operations in newly opening foreign countries. CanniMed (“CMED”) has leveraged their long-standing track record of producing pharmaceutical grade product into not only a rapidly expanding domestic medical presence but a quickly growing list of international export agreements with intentions to add many more.

·         CMED was founded 1988 as a plant biopharmaceutical R&D company and in 2000 was selected by Health Canada (“HC”) as the sole provider of medicinal cannabis to the first federal medical marijuana program. With the introduction of MMPR in 2013, CMED became the first Licensed Producer (“LP”) with both cultivation and sales licenses. Due to its cultivation track record with Health Canada, the company was granted a two-year license for dried bud, as compared to one year for most other LPs. In 2016, CMED also became one of the first to receive its cannabis oils production and sales license.

·         In December 2016, CanniMed completed the first IPO on the primary TSX exchange by a medical cannabis LP, raising $69 million of gross proceeds (5.75 million shares at $12.00/share) and is one of only two LPs (along Canopy Growth) listed on the TSX

·         At $8.00/share today, shares are trading at ~4.6x 2019 est. EBITDA vs. the comparable average of 6.3x 2019 EBITDA and at $14,000 EV/KG/YR of funded capacity vs. the comparable average of $18,000, representing a ~25-30% relative valuation discount, and a >50% discount to where it should trade based on our internal forward expectations and LT cash flow.

·    Another key distinguishing factor is that CanniMed’s earnings estimates are entirely from the currently legal, federally regulated medical system – there are zero revenues/earnings in either the street analysts or our internal model from the yet-to-be-launched adult-use recreational market. However, analyst estimates for every other public LP include meaningful contribution from the recreational market, and as such, would suggest there is materially less risk for CMED to achieve their posted forecasts.

·       This valuation discount exists largely because CMED has stated their current focus is on the established medical market while most investors remain fixated on upside from the domestic recreational market (expected to launch mid-2018). We believe CMED has a number of competitive advantages that will allow them to capture strong market share in the medical market (both domestically and internationally) with the optionality to participate in specific, higher-margin areas of the recreational market.

·        CMED cultivates and processes dried cannabis to “Good Manufacturing Practices” (GMP) standards – a pharmaceutical-grade process in place since 2006 that exceeds the “Good Production Practices” (GPP) required by HC. The Company utilizes over 30 proprietary technologies and processes, including cultivation equipment, lights, irrigation, and extraction techniques. This process has meant CanniMed has never had a cannabis crop failure during its 15+ years of production, and that it manages its harvests such that it has never had a product stock-out. Only 4 other LPs have achieved the GMP certification. The remaining LPs have only been growing at commercial scale for 1-3 years, with many experiencing stock-outs and product recall issues.

·         CMEDs long track record and superior physician outreach programs have also been critical intangible assets with regards to increasing the number of referring doctors and in signing partnerships with Canadian pharmacies. A recent survey found that over 4,000 physicians self-reported recommending CanniMed products to patients, up +66% from June 2016 and over half of all referring physicians in the country. CMED is also the first LP to sign a wholesale supply LOI with a Canadian pharmacy chain (700+ stores under the PharmaChoice banner), a market that could begin fulfilling cannabis prescriptions as soon as 2018 and could represent an additional 100,000 KG/YR wholesale market opportunity (worth ~$500MM/YR).

·         CMED is one of only 4 LPs who have successfully navigated the complex export licensing and distribution process in multiple foreign countries. With current operations in Australia and Grand Cayman and further expansion plans underway in Mexico, Germany and other Euro nations, CMED has established sales channels into foreign regions which, at maturation, will likely dwarf the total Canadian market potential. Despite establishing a crucial first mover advantage, no international sales are included in any sell-side analyst’s forward earnings forecasts, leaving room for those estimates to increase as export volumes grow. Based on discussions with management, a conservative upside scenario would see export sales exceed $10MM/month by the end of 2019.   

·       Finally, CMED is one of the largest and most sophisticated producers of cannabis extracts – a product category that commands higher margins vs. conventional dried flower. In both the domestic medical market and established recreational markets (ie. specific US states) sales are quickly moving toward products in extract formats. Extract‐based products are measurable and allow for novel products and formulations which are favoured by physicians and consumers alike – including capsules, topical creams, vaporizer pens and edibles. CanniMed is also the only LP using an ethanol-based extraction process, which is both highly efficient and consistent. This allows CanniMed to produce for a lower cost per mL versus other LPs using a CO2 process while also achieving consistent potency from batch to batch (several other LPs disclose that their oil potency can fluctuate significantly from the stated levels). With over 50% of revenues already coming from extracts, CMED has recently broken ground on a $10.5MM extracts facility with a capacity to produce >$1BN in product (at wholesale prices), positioning them to continue as the leader in this area of the medical market while also allowing them to participate in the higher-value extract category of the recreational market.

Catalyst

- Continued operational execution reflecting >100% revenue and >200% EBITDA 2-year CAGR (driven purely by domestic medical market growth, recreational participation would be entirely upside to our internal or street estimates)

- Launch of retail sales for medical marajuana in pharmacies (currently online-only across country)

- Launch of new capsule and sub-lingual tablet products, unique to market (only 2 other players have comparable easy to consume

- Sales ramp from international export agreements and potential local licenses to produce in new foreign jurisdictions (namely Germany, an 80MM population market with 100% insurance coverage)

- Downside protection is there no contribution for recreational sales in current street figures, so any delays in the launch of that market might impact product pricing temporarily but would be beneficial to CMED given deep doctor/pharma relationships.