Small Is Beautiful And Profitable For This Uniqley Positioned Stock

The biggest problem with the Canadian cannabis market is there are simply TOO MANY COMPANIES. That goes double for the number of publicly traded stocks.

I can’t even count how many cannabis names I came across, all trading in the same $10M to $50M range, as I researched HYTN. It makes me very careful about picking a cannabis stock to talk about. To get my blessing a play has to meet three BIG criteria:

1.    There is a legitimate path for revenue growth.

2.    I have confidence they can execute.

3.    Something that differentiates them from the pack.

HYTN checks off all of these criteria. They recently received a license to export processed cannabis flower internationally with its GMP certification (Good Manufacturing Practice), something only a few Canadian companies have.

There are only 5 companies that can do this, and only a couple of those are NOT already vertically integrated–i.e tied to one company’s product. HYTN can produce for any/everyone. This could make HYTN the belle at the ball as the go-to processing partner for growers big and small.

Processing at their capacity–2000 kg/month, at just one shift Mon-Fri–could generate $1 M a month revenue. By definition, 24/7 processing would generate 8000 kg/month, or $4 million revenue.

The company is break even at 500 kg per month. I expect that to happen by calendar Q3 24

QUICK FACTS

Trading Symbols:                                     HYTN

Share Price Today:                                   $0.30

Shares Outstanding:                                77.5 million

Market Capitalization:                             $23.3 million

Net Debt:                                                  $0 million

Enterprise Value:                                     $23.3 million

*Does not include 15.3M warrants at 25c and 2.5M warrants at 50c

POSITIVES

• One of only 5 companies in Canada cleared to process cannabis into GMP-certified medical products for export to the EU and Australia. This is an exhaustive 2 year process; big barrier to entry even for cannabis majors.
• Certification means they can export medical-grade cannabis internationally.
• Fully licensed and operating Kelowna BC facility that can process/produce 2,000 kg of GMP-certified flower product a month.
• No debt.

NEGATIVES

• Small treasury, though they’re clearly adept on a shoestring budget.
• Need to partner to get a foot in the door in international markets.
• Cannabis stock market is saturated with too many companies. (But most can’t execute internationally)

The back story here (we’re going to do that first) is–since the stock went public in 2022, HYTN has executed on their initial plan.

HYTN built out its SMALL COST EFFECTIVE Kelowna facility, launched a number of beverage and emulsion edible products, and distributed those across Canada.

They have worked to increase capacity and capabilities, to produce Canadian medical products, psychotropics (mushrooms) and now–what I believe is The Big One–to expand internationally under GMP, in a much higher margin market which WANTS them.

Unfortunately, the Canadian cannabis market is not kind. Canada is oversupplied. Product is plentiful. Getting your product on the shelves and selling it is an uphill battle.

It has been a wall for HYTN to climb. Their products (infused sparkling beverages, gummies, nano-shots) get high marks in reviews but sales are just not growing. Revenue has been muted and not really trending up since they went public.

These liquid products are almost instantly irrelevant with this GMP certification for their (much higher margin) flower-based product. Not sure what happens with this, though they likely keep it for optionality and to say they have a brand in the marketplace.

Source: HYTN Financial Statements

After exhausting their options within the border, HYTN came to realize two things:

1. That Canada was the problem.
2. That their most valuable asset was their processing capabilities.

HYTN built and owns a small 5,000 sq. ft. processing facility in Kelowna, British Columbia.

The Kelowna facility has capacity for up to 26,000,000 units of Infused sparkling beverages per year and 3,000,000 packages of infused edibles per year.

I keep stressing how small this facility is, which is a good thing. Processing facilities built in the heyday of the cannabis hype are simply built TOO BIG. The costs of upkeep, maintenance, and utilities just didn’t cut it after anticipated market growth didn’t materialize.

HYTN took a different tack. They built a small cost effective facility–they are UNIQUE in that–in downtown Kelowna. But they made sure that it was equipped to produce high-quality, pharmaceutical product.

They showed they can build a product. All they needed was a market that wasn’t already saturated.

HYTN made a sharp right turn to the many international markets. They will shift from producing beverages and edibles to processing GMP certified cannabis flower.

GMP MEANS WORLDWIDE SALES POTENTIAL

Just like everything else they do, HYTN has already shown they can execute on their plan to expand internationally.

In March, the HYTN Kelowna facility received certification for Good Manufacturing Practices (GMP) by Australia’s Therapeutic Goods Administration (TGA). This after a successful, rigorous audit by the TGA.

(It takes about 2 years of extensive auditing to achieve GMP certification. Management says that theoretically, with unlimited capital and perfect execution you could achieve it in a year, but it would be difficult.)

That was less than a month ago. These are early days.

GMP is a set of manufacturing guidelines and a quality system that allows traceability of the product and ensures the patients will get the EXACT product they require.

Unlike the infused beverages and gummies, the product HYTN will produce for export is dried and bagged flower, which they will process in their facility from GACP (good agricultural and collection practice) grown biomass.

They cure it, weigh it, test the THC content, bag and label it with THC, moisture content and terpene profile. Workers wear hospital style scrub gowns; the environment is pristine and sterile.

With this certification, HYTN is no longer border-bound. They can sell their cannabis to any market that accepts the GMP stamp. That includes Australia and the EU–two HUGE markets.

Down the road HYTN will be looking at wholesaling their own product. There is a bit more margin there, but also more work and capital required. Their first step will be to act as a toll-processer of flower for other cannabis growers.

Their flexibility and range of product they can produce PLUS the fact they

are 1 of only 5 facilities in Canada with the GMP certification to process flower in this way. That makes their positioning as a processor export a unique one.

This is a GREAT business AND they have no exposure to commodity prices in cannabis–all costs are just passed through and they receive a fee for their service.

HYTN expects to start by selling product into Australia and Germany.

HYTN has the capacity to process 2,000 kg of final product per month. That is with a single shift of 5 workers.

For some context, there are single customers in Australia that can order that much product. So selling out this amount of product is not a pipe dream. It won’t happen immediately, but it’s possible.

In return for processing the cannabis from growers, HYTN can receive CAD$500 to $1,000 per kg of flower processed.

Source: HYTN Estimates

At their volume this quickly becomes a decent and profitable business.

BRAND AWARENESS

Down the road, it could get even better. If HYTN begins to sell their own brand the product, and get a piece of retail pricing, revenue goes up significantly. But again, that will take capital and involve some regular business risk–which they don’t have right now.

By selling their own wholesale product with the packaging and distribution all done in-house, the potential revenue can be a lot higher. Current RETAIL prices in Australia and Germany are 10x the toll that HYTN is expecting. Wholesale prices are about half of retail.

Again, HYTN is a wholesaler, not a retailer. They would realistically need a partner in each location to get a chunk of those kinds of margins. That may be some time off. But I can see the path. And wholesale margins are pretty good as a first step!

How do they get there? It could be a partnership with a domestic Australian or German company, a Canadian major cannabis company, their own expansion, or an acquisition. It is hard to say.

For now, the inbound interest in their GMP processing–the white label business–is very strong, and enough to get revenue in the door in the next few months.

HYTN is still 90 days away from shipping any product. To turn non-sterile, agricultural-grade flower into a medical-grade product requires “stability testing” to ensure the “best before date” for the product

Those tests are ongoing and need at least 3-months for completion (that 90 days is already ticking), though some customers will require 6-month data before proceeding with orders.

That lull is going to be an opportunity to get into the stock before we see the revenue ramp.

NAVIGATING THE FOREIGN MARKETS

Australia legalized medicinal cannabis in 2016. Only one territory, the Australian Capital Territory which is a small district that (similar to Washington DC) is home to the Australian capital of Canberra, has legalized it for recreational use.

The estimate for the Australian medical market size was $400M for 2023. By comparison, the Canadian medical market was about C$500 million last year.

Unlike Canada, a significant fraction of the medical cannabis sold in Australia is imported. In 2022 about 50% came from abroad.

Australia is slow to tabulate their cannabis import data, so the 2023 numbers are not available yet. In 2022, Australia imported 24,877 kg of flower equivalent medical grade cannabis. That was up from only 7,173 kg in 2021. HUGE JUMP!

Importing medical grade cannabis into Australia is very regulated. You need GMP compliance, you need to be listed on the Australian Register of Therapeutic Goods, and you need an import license from the Office of Drug Control. You can only import THC compounds.

The requirement for GMP certification is relatively new. It has only been since August 2023 that GMP certification was truly required for import. That left a lot of cannabis importers scrambling for new, legal supply.

HYTN’s GMP certification also meets the criteria for the EU. They are targeting Germany first, which has made medical cannabis legal since 2017. With its larger population, Germany is a $2B market.

Germany has a history of domestic supply shortages, which has increased their openness to imports. Estimates are that between 80% and 95% of Germany’s cannabis comes from imports. It all has to be processed via GMP certified companies!!!

Germany’s cannabis imports have increased every year since 2017. In the first 9-months of 2023 they were 8,000 kg per quarter.

Source: Business of Cannabis

Beginning April 1st, Germany made overtures to legalizing recreational cannabis when the German parliament voted in favor of legalization for limited recreational use. So the potential for that already big market to grow quickly is very real.

Under the new legislation, put forward by Germany’s ruling coalition party, adults can cultivate up to three plants for private consumption and be allowed to possess 50g at one time at home, and 25g in public, starting from April 1.

This change has a two-fold effect. It will drive growth in the medical market as it removes the stigma, and allows for easier transportation and storage of product by pharmacies and distributors. Physicians that might have been on the fence are now more likely to prescribe it.

Second, just as in Canada, the biggest winners in the recreational space tended to be the one’s with the head start from their existing medical use business.

It is worth mentioning that HYTN’s expected export capacity (24,000 kg per year of GMP-certified dried flower) is a big portion of the TOTAL imports from Australia and Germany (in 2022 these two countries together imported 50,000 kg).

We’ll have to see if HYTN is able to add more partners from additional countries because it seems unlikely that Australia and Germany will be able to absorb all of HYTN’s additional product. HOWEVER–HYTN CEO Elliott McKerr says there are potential customers, right now, that import 2000 kg per month already.

HOWEVER…see the POTENTIAL numbers here. They believe they have the capacity to supply almost an entire country’s worth of demand out of their 5000 sq ft facility in Kelowna.

But having said that, ANY degree of market penetration here and the financial numbers get very big very fast.

This is early days. This is what’s possible. When you buy a 40 cent stock, even if it’s already in revenue or even positive cash flow (this is not!), you are always buying what’s possible.

Like I said, there are single customers in Australia who could buy 2000 kg a month. But management says the goal is to get a rotation of customers who are ordering between 30-500kg orders.

As you can read, the leverage and timeliness here excites me. This could rapidly be a CAD$40-$50 million a year tolling business at 24/7/365 production–with no price risk on cannabis commodity pricing–and be quite profitable doing it.

I don’t want to raise expectations too quickly, but the opportunity is huge, and imminent–when the 90 day stabilization period ends in July, less than 90 days away.

ON THE BANDWAGON

HYTN’s new direction is echoed by some other big cannabis players.

Aurora Cannabis (ACB – TSX) recently acquired MedReLeaf Australia, the #2 distributor in the Australian medical market, for $45M. At the same time, Aurora received their own GMP certification for two of their Canadian production facilities in March.

Similarly, Curaleaf (CURA – TSX) acquired a privately held Canadian company, Northern Green Canada (NGC), which also has GMP certification.

They already supply flower to Curaleaf, which is exported to Germany and Curaleaf announced plans to expand this distribution to Australia and New Zealand.

These are both big names that are positioning themselves to be vertically integrated. What positions HYTN so well is that there are SO FEW competitors that are GMP ready and can step in with a partner to provide certified product.

CONCLUSION

The idea here is that

1. with HYTN’s newly received GMP certification,
2. its’ super low cost structure compared to anyone else in their industry plus
3. the interest to tap into the EU and Australian market increasing quickly,

HYTN could have multiple majors either wanting their own GMP facility (take-out), preferred partner status or want some of that great margin, low risk cash flow flow from processing (tolling) GMP certified cannabis products.

A news flow of deals and orders from that interest–whenever that happens–should send the stock higher.

This certification is clearly worth A LOT of money. If HYTN management is correct in estimating (and executing) what kind of revenue can come out of a very small 5000 sq ft facility, this 77 M share company (92 M FD), this stock can go a lot higher.

No terms were ever made public, but my research suggests Curaleaf paid roughly CAD$40-CAD$65 million for NGC. That gives HYTN a valuation of 84 cents at the top end, now trading 35 cents. I would suggest that makes them a big takeover play in Canadian cannabis right now.

Most importantly, this is a company that HAS PROVEN they can execute.

They have no debt. They have shown they can operate on a shoestring budget and have already launched product all across Canada.

But maybe for the first time, they aren’t facing the headwind of a saturated market. If they can show they are up to the challenge of exporting internationally, I expect a much more successful result.

I just don’t know if there is a corporate lull here until the stability is over in July, or if they can start announcing deals pending that. I think any deal with a cannabis major takes the stock up to a new level.