Unique Pricing Power, Low-Cost Scale Up Will Make This MicroCap a Winner

The two keys to my largest investment in 2024 are:

1. Big pricing power
2. Small cost structure—likely the lowest of its kind in the world

HYTN Innovations, HYTN-CSE / HYTNF-PINK, has something unique—which is rare in the cannabis world, where everyone thinks all the products are the same.

They have the smallest GMP-certified production facility (that I’m aware of after a bit of digging) to manufacture cannabis and psychedelic products in North America, (located in Kelowna BC) and almost certainly the world. I’ll explain GMP in a second.

But know that these products have VERY high margins, and HYTN’s ability to process them in small, low cost batches will make them the most sought-after toll processor for not only upstream (growers) and downstream (product marketers) segments of the global cannabis trade, but other midstream (other GMP facilities!).

Other GMP facilities are so overbuilt, have such huge cost structures, that they are likely better off to sub-contract HYTN and let their own facility sit idle.

HYTN is a toll-processing company (for now).  They don’t GROW anything.  They don’t SELL/MARKET/DISTRIBUTE anything. They don’t have exposure to cannabis commodity prices (any fluctuations are passed through to customers).

This is set up to rapidly become a highly profitable picks-and-shovel play on this nascent global business, where industry players and regulators are still trying to figure everything out.

HYTN just takes raw inputs into their small facility, and puts it through their GMP-certification process, and packages it all up the way the customer wants so that when—whatever the end product is—it contains EXACTLY what the label says it does; nothing more and nothing less.

And that, dear friends, is a lucrative business if your cost structure is right-sized. Arguably, everybody besides HYTN is wrong-sized (too BIG!).

In this case, smallest = lowest cost (and biggest profits!), but let’s back up one step.

WHAT IS GMP?
Good Manufacturing Process

 
To sell/export these types of products—and these are now multi-BILLION dollar markets, and still growing—across international international boundaries, they MUST be GMP-certified.

As the global market for cannabis products and psychedelic products grows and matures—and trans-border trade increases—quality standards are being created and adopted by the entire supply chain. The main QA standard—quality assurance—is called GMP, which stands for Good Manufacturing Process.

Being GMP-certified gives you a BIG moat; this is incredibly hard to do.  It is an incredibly meticulous methodology to ensure purity and consistency—at every stage of production, AND verify it in real time and store all that data—in every product that leaves the facility. 

It takes into account a myriad of both 1. Safety 2. security and 3. cleanliness factors that would boggle the mind of most management teams.

It takes over two years to accomplish. It creates a big moat.  And the team at HYTN—led by COO and scientist Jason Broome—did it differently than everyone else.

SMALL IS BEAUTIFUL

 
From my research, I think HYTN’s GMP facility in Kelowna is 1/10^th (ONE TENTH) the size of its nearest competitor (probably less)—and you might ask, um…why is that good? Isn’t economies of scale good?

The short answer is NO.  HYTN’s tiny facility has capacity to produce 24,000 kg of dried flower product a year for export—that’s the entire market, 100%, of Australia and Germany combined! AND…HYTN can expand in their current facility with no outside funding required.

Now, HYTN made their facility so small because they had to—they had no money!  Just like Canopy (WEED-TSX) and MediPharm (LABS-TSX) have such big GMP production facilities because they could afford to do that—LABS was $7/share in 2019!

Because everybody else in Canadian cannabis had So! Much! Money! and built such big facilities, Broome and McKerr had to work with regulators to show them the validity of their small-is-beautiful plan.

Everybody in the industry interpreted the language of the various acts and legalities from a Big-Company point of view. 

But they worked with regulators on many issues and were able to build a SUPER TINY GMP-certified facility, that will almost certainly have the lowest cost processing in the country.

THIS SMALL GMP FACILITY CAN FULFILL
AN ENTIRE COUNTRY!

 
Germany and Australia are two of the biggest cannabis related product markets in the world—billions and hundreds of millions annually, respectively, and they are both demanding all product be GMP certified.  They don’t have in-country GMP facilities.  The opportunity for HYTN is incredible!

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

The margins that their customers get for the products that HYTN processes for them, allows HYTN to take a big profit—like in a 10 x 10 x 10 hyper-clean lab room, HYTN can generate $100 million in annual revenue if they process 24/7/365 with just two workers.  I will show you the simple math to back this up below.

Right now they only have one “hyper-clean room” in their production facility.  But there is room for (at least) two more in the current Kelowna building—which would each take 6-9 months and $200,000 (payback in weeks), moving potential revenue run-rate to more than double that.

Now, that’s a big, blue-sky number—almost ridiculous.  But from what I see, it’s doable within 3-5 years as nobody else has such a low-cost structure as HYTN—because they are SO SMALL.  

Their initial goal, for 2024, is to move up to $1-$2 million a month revenue and show not just positive EBITDA but real PROFIT.

Management says they’re getting calls from other facilities looking to potentially refer business as they see HYTN can make GMP certified much cheaper than they can—because these other facilities are much too big (many tens of thousands of square feet with lots of employees) to compete.

AUSTRALIA AND GERMANY ARE
IMMEDIATE AND LARGE MARKETS

 
Australia legalized medicinal cannabis in 2016.  Only one territory, 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.
 

Source: Pennington Institute

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 that GMP certification was truly required for import.  That has 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.

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.

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 ones with the head start from their existing medical use business.

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.

HOW THE NUMBERS COULD WORK
(I SAVED THE BEST UNTIL LAST!)

 
HOWEVER…see the 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. 
 

Now, these are RETAIL prices.  The best price that HYTN will likely get—as the wholesaler or tolling company–is $6.50 per gram, and $4.50/g is a certainty. 

So 2000 kg = 2,000,000 g x $4.5 = $9 M per month revenue. ($6.50/g = $13 M/m)

There is an immediate and large market for GMP-certified cannabis and psychedelic products in many countries, and it should be very profitable for HYTN to supply this.  Breakeven for HYTN is roughly 400 kg/month.

HYTN has the smallest, most cost-effective production facility in North America to make these products. 

Even companies with their GMP certified facilities would want to use HYTN, as it’s a lot cheaper to run a 5500 sq ft facility vs a 70,000 sq ft facility.

After visiting the Kelowna plant, I think they can build TWO more clean labs there if demand warrants it. 

As I outlined, this expansion is incredibly cheap; the ROI is astronomical.

An intense, two year certification process gives them a huge moat.

HYTN is just waiting for its 90-day stabilization proof period to end in July to be able to ship/export its first products. I expect that to the be The Big Inflection for the stock.

That’s why I’m long!

Keith Schaefer