Supreme Cannabis’ plans for derivatives market look promising: GMP

GMP Securities analyst Robert Fagan is staying bullish on Canadian cannabis licensed producer The Supreme Cannabis Company (Supreme Cannabis Stock Quote, Chart, News TSX:FIRE) after reviewing the latest news on FIRE’s entry into the Cannabis 2.0 market.

In an update to clients Thursday, Fagan maintained his “Buy” rating and $1.75 per share target price, which at press time represented a projected 12-month return of 178 per cent.

Toronto-based Supreme Cannabis, which has a portfolio of businesses including the 7Acres brand, the Blissco wellness brand, processor and distributor and Truverra medical cannabis brand and cultivator, gave an operational update on Thursday, saying that it had leased a new processing, packaging and distribution facility in Kitchener, Ontario.

The company plans to retrofit and license the facility in three phases with phase one already completed and awaiting licensing for flower packaging and pre-roll manufacturing. The later stages for the facility will include cannabis derivative production for both Supreme and third parties. Altogether, the capex is expected to be between $15 and $25 million.

“With Supreme Cannabis Kitchener, we add the infrastructure to centralize internal processing and manufacturing and the ability to act as a packaging, manufacturing and distribution partner for third-party producers,” said Navdeep Dhaliwal, CEO, in a press release.

“Centralizing this increasingly important function in the value chain will create manufacturing, packaging and distribution synergies across our brands and allow for our existing operating assets to maintain a focus on their core capabilities.”

“With this manufacturing centre of excellence, we gain the flexibility to respond to market trends such as working with third-party cannabis cultivators and long-term optionality to move into additional cannabis 2.0 product categories,” he said.

Supreme also announced that it would be making vape pods at its Blissco facility in Langley, BC, through its partnership with PAX Labs and the production of small-batch concentrates and R&D at its Truverra facility in Scarborough, Ontario.

Fagan likes the new direction that Supreme is taking, saying that bringing the manufacturing of derivatives in-house will result in better control over production and better margins.

“We believe past commentary from management suggested FIRE would largely make use of third-party manufacturers for its Cannabis 2.0 products. However, today’s update indicates the company will internalize the production of its PAX-affiliated vape offerings; positive in our view given greater margin potential and offering greater management oversight over quality,” wrote Fagan.

“While the timing of PAX vape product launches by the end of March 2020 is somewhat later than we had hoped, we note the higher profitability potential with increased vertical integration could provide upside to our margin forecasts, which call for gross margins to decline ~1,000bps in Q3/FY20 from Q1/FY20’s level of ~65 per cent,” he said.

Fagan adds that FIRE’s entry into concentrates could also bode well, as he sees a relatively low level of competition in that space, potentially allowing Supreme to capture an outsized market share.

“Data from US recreational markets suggests the concentrates category accounts for about ten to 15 per cent of total demand, highlighting in our view the material potential of these product formats in the Canadian market,” Fagan said.