Faircourt Asset Management & Ninepoint Alternative Health Fund CEO on Canopy and Aurora Financials

Faircourt Asset Management and Ninepoint Alternative Health Fund CEO Charles Taerk addresses the global market sell-off in October and recent financial statement releases by leading cannabis companies. In particular, Taerk highlights the financial statements released by Canopy Growth Corp (TSE:WEED) (NYSE:CGC) (FRA:11L1) and Aurora Cannabis Inc (TSE:ACB) (NYSE:ACB) (FRA:21P) as particularly disappointing to the broader markets. Taerk points to the excellent numbers released by CannTrust Holdings Inc (TSE:TRST) (OTCMKTS:CNTTF) (FRA:C9S) and notes it was the only cannabis company to generate positive EBITDA in the quarter. He indicates that most retail investors aren’t paying attention to the details when it comes to the cannabis space and that’s an advantage for the Ninepoint UIT Alternative Health Fund, which is up 27 percent year-to-date. Taerk anticipated the sector downturn and the UIT took profits in anticipation of the market slowdown. The fund is reducing its exposure to Canadian LPs in favour of US companies, believing American companies to be undervalued.

Transcript:

James West: Hey, welcome back. My guest in this segment, returning for the, I don’t know, 10^th time, is Charles Taerk, President and CEO of the Nine Point UIT Alternative Health Fund. Charles, welcome back.

Charles Taerk: Thanks very much for having me.

James West:   Charles, the market has been revalued to the downside since you were here last, mostly starting post-October 17^th, which one would have thought that this would have been a day where the angels would have been bugling from on high. This is not the case. What happened?

Charles Taerk: Well, I think if people look at what’s gone on the last two years, people have sold on the news. And so there was a great rise from the middle of August, when Constellation invested in Canopy, great run for two months until the 17^th of October. I think the combination of that, people being disappointed with rec, and some of the earnings concerns, and people have been selling off. In addition, you know, we’ve seen a global equity market sell-off; the DOW, the S&P, the TSX, oil prices, nothing was spared during the month of October.

James West:   Sure. Would you say that the tendency in the last two weeks that we’ve observed is that the large-cap cannabis index as we track is, which is all companies over 500 million trading in Canada, the action in that index is starting to very closely mimic the S&P 500.

Charles Taerk: Yeah, very much so.

James West:   And is that an expectation that we should carry forward going into the future?

Charles Taerk: Well, no, but I think what is shows you is that the selloff is more than just the cannabis sector. When you star tot get macroeconomic factors taking, you know, a big swipe out other equity market, no sector is being spared. But f you look at the volatility and you take a look at the dramatic decline in some of the cannabis names relative to the broader market, there’s been more of a deficit, let’s say, in the larger cannabis names than in the broader market.

James West:   To what extent would you say the earnings that have been reported by at least almost 20 companies in the last two weeks – how much has that had an effect on the downdraft in the cannabis space, particularly?

Charles Taerk: It should. I think it is having some effect, and this is something, you know, as an active manager in the space, we have been taking a look while the sector was doing really well, and we were paring back. We were taking profits in September and early October. Our view was that there was going to be some type of give-back – not as much as we’ve seen – but we were taking profits in anticipation of that.

I think the market was anticipating better revenue and earnings, with an expectation that some of that revenue was going to be from the domestic recreational rollout. And what we’ve now seen is that, for the September 30^th quarter end, very little revenue was earned because most of the sales went in beginning of October. So you know, there was an expectation of something that didn’t materialize, and then you look at bottom line results of just the medical business, with many of the large players really disappointing – and really disappointing on two key metrics.

Some of the larger players had significant general and administrative expense balloons. So that’s not operational, that’s everything, it has nothing to do with the cultivation side of the business. So it’s marketing and advertising and other non-core operations. And there was some significant disappointment. You know, looking to 2019, I think earnings is going to become a more important issue. People should be paying attention to the EBITDA force of these companies. They should be improving their earnings, because a lot of the buildout is now behind them. So we should see better profitability, and if we don’t, again, companies are going to suffer.

Yeah – you were going to ask me, so…

James West:   Which companies?

Charles Taerk: Go ahead.

James West:   Well, are there any companies that disappointed particularly and any that surprised to the upside, particularly?

Charles Taerk: Yeah. I mean both Canopy and Aurora, I think, were significantly disappointing for the broader market. We don’t hold aurora at the moment; we actually took profits in Canopy during September and early October, and so our weighting in Canopy is greatly reduced. It used to be a Top 10 position, by the end of October it was no longer a Top 10 position. But both have similar quarterly results where G&A expenses were much higher than consensus estimates; magnitudes of adjustment. Like we’re talking $50 Million, $60 million, $70 million in losses, caused largely by huge G&A expenses.

Whereas conversely, see a company like CannTrust, last week was a really busy week; there were about five our six companies that came out with earnings, and four of them were disappointing. CannTrust came out, their earnings for the quarter where they had higher revenue than expected, they had better revenue per gram than expected, they continue to gain more new patients into the medical industry than any other licensed producer, and more revenue from extracts relative to dried bud, which is higher value added revenue.

So they’re firing on all cylinders. They were the only company to generate positive EBTIDA in the quarter. And that’s important – at least for us, as portfolio managers. I think retail investors aren’t paying enough attention to some of the nitty-gritty, and that’s where I think we have an opportunity to outperform where, regardless of the valuation of some of these companies, or the size, you’ve got to be looking at some valuation metrics that we believe are going to be meaningful going forward.

James West:   Sure. What about Trulieve? Trulieve reported $100 million in run rate revenue for the year.

Charles Taerk: Yeah, so Trulieve is doing very, very well. This is a Florida medical dispensary business. About six months ago, the interesting change with Trulieve is they had about 70 percent of the Florida market. So really, significant control.

Of late, you’re seeing new entrants into Florida, Curaleaf being one of them, Liberty Health is also expanding its footprint, and so they’re nipping away at Trulieve’s leadership. By the end of the quarter, Truelieve was down to about 55 percent. I mean, still commanding performance but you’re starting to see more competition in Florida. So it’ll be interesting to see how truly it is about to move forward, keeping hat control

James West: do you think that the somewhat, lets call it, less than perfect best-case scenario rollout of government cannabis distribution in Canada was to blame, in part, for t dismal earnings in the last, as reported by the companies? Even though it was only weeks of October, I would have thought that if they could have sold everything that was ordered, so that everybody could have put that on their balance sheet, it might have been a bit of a different story.

Charles Taerk: Well remember, the earnings were released were from September 20^th.

James West:James West:  Ah, right.

Charles Taerk: So there was only about a week of revenue impact, and so what each of them have done is they’ve said, out of their quarterly revenue, this was the amount that was allocated toward domestic re.

James West:   But they didn’t pre-sell any quantities to the Ontario government.

Charles Taerk: The expectation to investors was, well, given that October 27th is the day when the stores open, we would expect that 45 days before, the provinces are going to have the logistics going such that they’re going to have inventory, such that there would be sales slips coming in. and that didn’t happen.

James West:   Okay, so that’s what I’m getting at: is that the fault?

Charles Taerk: Well, that’s’ part of it, but I think that was an expectation. I think the other part of it is, ramp-up in some of the production facilities is maybe more gradual than others have anticipate. You’re seeing lower revenue per gram with some people, and that could be a sense of quality, whether you’re an outdoor grower or an indoor grower. And then where your focus has been. If you’re focused on the medical market, and you’re gaining patients, then your revenues, I think, are going to be stabilized by the lack of recreational rollout. Whereas if you’re putting more of your resources into the rec market, and you’ve got these disappointing logistical challenges still present, and think that’s going to take months to unravel, then you’re going to see maybe some weakness or disappointment in the next quarter, as well.

James West:   Right. Some of the money managers I talk to have been reducing their exposure to Canadian LPs in favour of US ones because the perception is that the Canadian market is now more or less saturated and the US market still is representative of opportunity, especially ahead of any federal de-prohibition that might becoming down the pipe. Is that something you’re doing in the health care – ?

Charles Taerk: Sure. So the Canadian companies, I think, from an addressable market standpoint, the domestic recreational and medical market is only about $1 billion in Canada, whereas in the US, currently it’s estimated around $15 billion. Because of the challenges that the US companies have to become public companies, they’re coming to Canada through RTOs on the CSE. Many of them don’t get treated with the same multi-billion-dollar valuations that the large Canadian companies have had, that have listed on NASDAQ. So from a valuation mismatch standpoint, yeah, the US companies are undervalued. They’re trading similar to the junior Canadian companies, those Canadian companies that trade under $1 billion, are trading somewhere between 12 times 20/20 earnings and less, and that’s where the US companies are.

And yet the US companies have very large addressable markets, have historical revenue and historical earnings, and are very well capitalized. So yeah, it’ something that people should be paying attention to.

James West:   So, but the UIT fund, is it still predominantly focused on Canadian names?

Charles Taerk: No, we look everywhere.

James West:   Okay, so great. So tell me, how is the fund doing year-to-date at this point.

Charles Taerk: Yeah, you know, great. It’s relative to the market, we’re doing well. We’ve given back a little bit, but year-to-date, our fund is up 27 percent, and that’s really important, because when people look at the sector, there’s usually a couple of ways to look at it: either you want to buy an index, or you want to buy an actively management product. We believe that our actively managed approach lowers volatility and puts people in a better position.

So year to date to yesterday, we’re up 27 percent; the passive strategy, the ETF, is down 2 percent. So that’s a wide difference, and really what we’re demonstrating is being active, taking profits at the right time. It’ not that we don’t like the name, but the valuation doesn’t warrant our attention.

We’ve got to move into other areas where other people aren’t, and so having a wider portfolio allocation, occasionally owning some private companies, which we take advantage of so we can own them earlier before they get accepted into the index, those are all different elements that we use in our fund.

James West:   Charles, that’s great. Okay, we’re gong to leave it there. Tank you very much for your participation again.

Charles Taerk: Terrific. Tanks for having me on.

Original article: Faircourt Asset Management & Ninepoint Alternative Health Fund CEO on Canopy and Aurora Financials

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