Analyst Dmitry Zaytsev has a bearish outlook regarding upcoming financials in the cannabis space. He notes that the average OCS purchase is approximately $70 and estimates Canadian recreational cannabis revenue in calendar Q4 2018 to be $150 million. He suggests LPs captured 60 percent of that recreational total; as a result, the LPs are competing for approximately $90 million in recreational revenue. Consequently, Zaytsev thinks there is a disconnect between established revenue numbers and analysts’ predictions for upcoming financial reporting. One company Zaytsev believes will hit its targets is Aurora Cannabis Inc (TSE:ACB) (NYSE:ACB) (FRA:21P). Zaytsev attributes the recent surge in the Canadian cannabis space to short covering and FOMO sentiment. Ultimately, he believes US companies offer a better value proposition and are more likely to deliver better revenue numbers than the Canadian names.
James West: Joined now by Dmitry Zaytsev. Dmitry, welcome back.
Dmitry Zaytsev: Happy to be here, James.
James West: Dmitry, you have a less than rosy outlook on upcoming financials that are going to be released starting very quickly here. Give us an overview of what you’re thinking.
Dmitry Zaytsev: Yeah, so just big picture, I don’t know if it’s less rosy, but I think it’s good to be realistic about what the expectations are from analysts; what the expectations are from investors; and what the numbers are that are actually coming out.
So on this first slide, just to remind everyone, you know, share prices go up and down, but the market capitalization of a lot of these firms has rallied significantly. So I have the Top 8 cannabis firms by market cap here, that are based in Canada.
James West: And those numbers are in the billions on the left?
Dmitry Zaytsev: So it’s in the millions, but it’s 20, yes, so it’s 20 billion, for example, if you’re looking on the fourth line there.
James West: Interesting. So WEED’s well up above 20 billion.
Dmitry Zaytsev: Yeah. And so some of the deals, you know, haven’t gone through yet, so it’s as deals close and, you know…
James West: Can you put that chart up again, please? Thank you. Okay, so Tilray is 25 billion; oh that’s when it was at $300 a share.
Dmitry Zaytsev: Yeah, and this is in Canadian dollars, right?
James West: Okay.
Dmitry Zaytsev: So this is just data I’ve pulled from Bloomberg and it’s just latest data, but we’re going to talk a little bit about what we think the Canadian market is worth, and once again, you know, underscoring why we want to be in the US names in my opinion, longer-term.
James West: Okay.
Dmitry Zaytsev: So I think a lot of these names in Canada, they’re good for trading, but the US is where you’re going to find the actual fundamental value. So what I did was, I looked at some OCS order numbers just to get an idea; so a little chart I have here that’s the table on the right, shows the October and November revenue numbers for all of Canada. And then you have the revenue numbers right there, 11.7, 10.1, which are the OCS numbers. And I have a rough estimate of how many orders were placed on the OCS during that time, and from that we can glean sort of the little metric there, around $70 per purchase. So that’s what each individual order, on average, clocked in at.
James West: Okay. So $48 million was for the month of –
Dmitry Zaytsev: It’s 43 for the month of October, which was only two weeks of legalization.
James West: Right. And $54 million was the total sales across just Ontario?
Dmitry Zaytsev: No, no, no, no. So just to explain, all of Canada. All of Canada for rec, all of Canada according to StatsCan, I’m getting these numbers from StatsCan, and there’s a link below to the story where I’m pulling all these numbers from.
So where does that really lead us? So looking on the next slide, you can kind of build it out. So I just said Okay, we have $43 million and $54 million; you know, December, OCS, the sales look like they kind of decelerated a little bit, but there may be more stores open in some other areas, but also people smoke less in the winter, but it’s Christmas; so anyway, 150. So let’s say, 150 million revenue for Q4 of 2018, calendar Q4.
So what I then did is, I said okay, 60 percent of that is going to be captured by the LPs. I think that’s generous given, you know, they’re selling for $4, $5, $6, and a lot of this is excise tax and the margin for the actual retailer.
And so all the LPs are competing for $90 million or so in Q4 of revenue. And so the next table below that shows the calendar Q3 revenues, and then what the analysts project for Q4 revenues and the high mean and the low of that. So some of those numbers, you know, I couldn’t get, or whatever –
James West: So the far right column is the analyst expectation?
Dmitry Zaytsev: So just the first column where it says CY Q3 is their Q calendar, our latest Q3 2018 revenue number. So this is just hey before rec, sort of, to give you an idea. And obviously different companies have different year ends, and they all have their different quarters that start at different times.
But anyway, the key column to be paying attention to is the one that I have in grey, and which just shows the delta between the average analyst’s consensus estimate, and what the companies did in Q3. And so I’m trying to sort of square the $90 million number and this number.
So mind you, some of these estimates, you know, they include February and January data for three companies, I left notes there, but there’s clearly a disconnect. And these are just the top 8 firms; it doesn’t include private retailers, it doesn’t include the other multitude of other, smaller LPs, like, you know, Supreme, or EVO.
James West: This doesn’t include medical numbers, I guess?
Dmitry Zaytsev: No, it doesn’t. So I’m just keeping it really simple, so I’m saying, hey, we’re going to just assume they did the exact same run rate in Q4 as Q3, because that’s a very complex, you know, number to try and project if you’re going to try and estimate medical sales, international sales, new acquisition sales, and all that kind of stuff.
But it’s just to get a rough idea, right?
James West: Okay, so you’re telling me that the correlation to analysts’ estimates versus companies’ projections is skewed to the downside?
Dmitry Zaytsev: So no, I’m saying that the actual numbers that have come out so far indicate only about $90 million to $100 million of actual wholesale LP sales from the rec market in Canada, and analysts roughly, it’s around $150 million that they’re projecting, right? That sales are going to increase from the last quarter of these LPs, on average.
James West: Okay, so let’s take Aurora, for example, projecting $50 million to $55 million, and that constitutes a huge increase over Q4, blah blah blah.
Dmitry Zaytsev: Yeah.
James West: So do you think that, are you suggesting that Aurora, that there’s a disconnect between the available amount of cash to split up versus what companies are projecting?
Dmitry Zaytsev: Yeah. Market share, I guess you would say, and yes, but I think Aurora is one of the names that actually will hit their numbers. So the 50 to 55, I think they could probably get there; and if you think about it, their last quarter, they had about $30 million of revenue. So if they increase their revenue by 20 to 25 million, and there’s a $100 million pie to split, they’re getting about 20 percent or so market share across Canada. Which isn’t crazy, and especially since San Rafael and some of their MedReleaf acquired brands were getting very good reviews, and they also said something about OCS being 30 percent, they had 30 percent market share, and on the website, could be very positive. And I think they wouldn’t give this kind of guidance if they weren’t going to hit it and maybe exceed it.
James West: Interesting. So where do you see that taking the whole Canadian space for the rest of fiscal 2019?
Dmitry Zaytsev: Yeah, so I mean, I think the Canadian space, generally, there’s a lot of short coming, there’s a lot of euphoria. I feel like a lot of the people that exited their positions in December and just went all cash, they’re seeing, you know, 5, 10 percent day-over-day moves, and they’re getting FOMO. They want to make money too, and they’re getting in.
James West: Fear of missing out.
Dmitry Zaytsev: Fear of missing out, yeah. And they’re just jumping in, and they’re pushing this back up. And some of these names, you know, they’re starting to inch up to where they were pre-legalization, where there was really a lot of hysteria. But, I would argue that these sales may cool things down a bit. So you’re not going to go as low, I think, as December, especially if markets hold in all this. But you might have a little bit of a cooling down period, where, you know, maybe some names will provide some opportunities.
James West: Sure. So from your perspective as an options trader, where do the opportunities lie in that outlook?
Dmitry Zaytsev: So actually something I’ve done today was I bought some puts on Cronos. So nothing against the company or anything like that, it’s just it’s one of those things that has gone parabolic right now. So the price changes and the percentage gains have increased at a shorter and shorter period. So –
James West: Higher highs, higher lows in a compressed time frame.
Dmitry Zaytsev: Yeah. So for it to gain 50 percent, the period has halved. So the first time it gained 50 percent, let’s say since December, it took them maybe two months; now, more recently, it took them about three weeks to do that again and again, and so now you’re at this point where, I think some kind of break in that could be imminent. But, you know, I’m not risking a ton of money on that kind of trade, and I could be wrong, but yeah, it’ll be interesting to see. And I think the premiums were pretty fair for me to get into that trade.
James West: Okay. So what about in the other names like Aurora, Canopy, Aphria – are you doing anything on the options side there?
Dmitry Zaytsev: I haven’t touched anything there. I mean, I had some covered calls that I wrote on Aphria before, and so those are probably, like the shares I got delivered from my put, remember, I wrote the put, I got delivered, I held these shares, and I wrote a covered call. I’ve been writing incrementally covered calls on it, and so now I’m just going to wait for that to expire, and my shares get taken away, and I got premiums on the way down, premium on the way up, and the cycle continues.
James West: Best of both worlds.
Dmitry Zaytsev: Well you hope so, yeah.
James West: Very cool. All right, so you were saying that you think that the US companies are more likely to deliver actual good fundamentals on the balance sheet and in earnings?
Dmitry Zaytsev: On the revenue side. I think no one’s looking at earnings right now; no one cares about any of this stuff. What everyone really cares about is revenues. Revenues, market share. Because once you have a defensible market share it proves that consumers are going to your brands, and that you have your shit together, and you can execute. Because everyone, like especially with the MSOs in the US, like a lot of them as of the last couple of quarters don’t even have any revenue. And so it’s really a show me story where, you know, some of these companies could easily have a $200 million, $300 million, $400 million run rate within a year or so. And that’s a very impressive number.
And I also think generally, the longer it takes for the US to open up –
James West: Federally?
Dmitry Zaytsev: Federally, in terms of the States Act or anything else, it actually allows more of these MSOs to grab more licenses in more prime locations, because the Canadian names can’t participate.
So it’s actually, I think it’s in their interest to actually not open things up. It’s in the US names’ interest to not open things up for the next year or two.
James West: Interesting. Okay, well, let’s leave it there for now. That’s a great perspective, and of course, Dmitry, we’ll have you back again very soon. But lots of food for thought there. Thanks for joining me today.
Dmitry Zaytsev: Thanks, James.
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