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CannTrust Holdings: Will the fire last?

The shares of CannTrust Holdings (OTCMKTS:CTNNF) have been on fire lately. So far this month the stock has added 35 percent. This compares with roundly 6 percent for the various cannabis indices. Only Trulieve (TCNNF) + 40 percent has enjoyed a better month.

The stock just started trading on the New York Stock Exchange under the symbol (CTST). This holds the promise of bringing in new investors. Most of the time that creates a positive driver for stock prices.

The question is: Should investors chase the stock at this point or take a pass? Before answering the question, here is a bit of a tease. CannTrust financials are beyond impressive. Revenues are growing more than 100 percent. Gross Margins are over 67 percent while net income amounts to 41 percent of every dollar of revenue.

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If that doesn’t open your eyes, consider the balance sheet. Total Assets are 10 times Liabilities. This means the company is capable of some aggressive growth. So what is behind the numbers.

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Background

CannTrust has been described as one of the lesser-known companies in the business. With a target of 100,000 kilograms of production, that seems accurate. From a financial standpoint, before their recent run-up, the market cap was around $700 million. This also fits in with one of many mid-sized companies.

However, CannTrust has been around for more than 40 years bringing pharmacy and healthcare experience to the business of medical cannabis. This expertise helped earn the title of 2018 “Top Licensed Producer of the Year.” So this is a company to be taken seriously.

Until recently, total emphasis has been on medical applications. Here the company likes to point out its push behind research.  The company operates under a Health Canada license to do research including pharmaceuticals. Yea team CannTrust.

Canadian market focused

Marketing is limited to Canada, conducted online with a line consisting of 30 SKUs. The range consists of dried cannabis and oil extractions. Each requires documentation from the patient's health care practitioner. There are no limits imposed by their license on the strains that may be produced nor is there any requirements for pricing.

Production is carried out from a 40,000 square foot, hydroponic facility in Vaughan, Ontario, with a potential capacity of 3,600 kg of medical cannabis per year. The Company also owns a 430,000 square foot commercial greenhouse facility in the Niagara region of Canada. This provides the Company with an additional 40,000 kg of cannabis production capacity per year.

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So far CannTrust has the perfect profile for today’s market. For the present medical cannabis is likely to be larger than recreational cannabis and CannTrust’s online marketing covers the entire Canadian market at very attractive cost levels. But what about the future?

Going for the recreational market

Following Canadian legalization last October, CannTrust announced their entry into the recreational cannabis market with three entirely new brands: Liiv for the “educated and experienced user, Synr.g for “consumers who look forward to breaks from their busy lives”, and Xscape “that will include strains like “Flix n Chill” and “Walk the Dog”, and Peak Leaf – that will be exclusively available in British Columbia.

To facilitate the marketing CTST recently finalized a deal with Breakthrough Beverages Group, one of Canada’s top distributors of alcoholic beverages. The marketing partnership is appropriately named Kindred. Financial benefits include over C$9 million in gross proceeds to CannTrust and options for Breakthrough to buy 2 million CNT shares down the road.

What’s to like?

The headlines make for exciting reading about CannTrust and certainly haven’t hurt the stock price. But let’s take a look at the risks. First is the fact that CannTrust is entering what is essentially an entirely new business: recreational cannabis using entirely unknown brands.

Even in a market with massive growth, the odds are against success.

CannTrust management has proven their skills. But their partnership with Breakthrough Beverage is curious. Unlike Constellation Brands (NYSE: STZ), Breakthrough is principally a distributor in Canada.

In the 14 states of the US where beverages are distributed, only three (Colorado, Nevada and the District of Columbia) are legal recreational cannabis jurisdictions. So the question is, where is the synergy from the deal?

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There is no reason to question CannTrust in the medical cannabis business. Their record speaks for itself. But when it comes to placing a bet on their prowess in the business of recreational cannabis, something is missing.

Most investors in cannabis these days are looking for the big score: the legalization of recreational cannabis on a global scale starting with Canada in 2018, spreading throughout the US and elsewhere over time. CannTrust is a high risk in this market right now.

So, after a huge 35+ percent move in February and more than a doubling in price from last December lows, it may be time for CannTrust to take a breather. There is no need to chase this leader in the medical cannabis field.

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