QUESTION: “I would like your opinion on PharmaCielo (TSXV: PCLO) compared to Khiron (TSXV: KHRN). Both are Latin American plays on future low cost exports to other countries. However, PCLO seems to be ramping up production faster with efficiencies in mind, while KHRN seems more focussed on the branding and derivative product development. If the original premise is low cost production, isn’t PCLO the better play? Or should be have both?”
R. J. from Rio de Janeiro, Brazil
ANSWER: You have a good understanding of the difference between KHRN and PCLO but we arrive at a difference in opinion. You end up favouring PCLO and I prefer KHRN. Here’s why.
There is more than one way to take advantage of low cost production of cannabis or any other commodity. PCLO has based their business plan on the production and sale of low cost cannabis and extracts. KHRN, on the other hand, has taken the approach that the opportunity is to become the manufacturer of branded consumer products incorporating CBD and, perhaps down the road, THC in the product.
If you look at the tobacco industry, the tobacco grower is the low man on the totem pole. Every year, the tobacco companies that own the cigarette and tobacco brands lay out the specifications of what they want and what they will pay and the farmers scramble to fulfill the orders. One of Colombia’s major crops is coffee. I am told the high volume growers of lower priced generic coffee beans are in much the same boat. I live in Canada and we grow a lot of wheat. Locals know that the wheat farming business is ruled by the international commodity price. So I do not want to invest in a business plan that successfully leads to being a farmer.
Next let’s think about the ability of low cost growers to export to international markets. In Canada we have spent the last three or four years becoming the world leader in cannabis. We have developed an industry that has attracted billions of dollars in investment where the most efficient growers will have production costs of, say, $.75 - $1.25 per gram. The U.S. is slightly behind Canada but still has attracted substantial investment capital. I cannot see the Canadian or U.S. governments allowing cannabis or extracts to be imported into the country, especially if that product has a growing cost of $.05 - $.10 per gram.
When I was a junior financial analyst, the steel industry in the U.S. and Canada was very important contributor to economic growth and employment. As Japan, Korea and other developing nations began to produce high quality, low cost steel, Canada and the U.S. resisted the importation of steel. President Trump is still resisting it today. I expect a similar response to the importation of low cost cannabis and extracts today. I think that over time, cannabis imports into Canada and the U.S. will grow. But I think as with other products such as steel, the timeline will be measured in decades.
But there is always more than one way to skin a cat. Going back to the example of Japanese steel. There was more going on economically at that time than simply steel. For example, Japanese branded and built automobiles became increasingly popular in North America because of better quality and lower prices. A main factor in lower Japanese car prices was lower steel costs. GM, Ford and Chrysler resisted the importation of cars and trucks with some success but it couldn’t stop the growing level of imports entirely. Besides, on the economic front, Japan, Hong Kong and Korea were making headway on many fronts from appliances to toys to electronics. It was impossible to stop everything. I think we will see a similar dynamic with cannabis. One way cannabis will be imported into key markets is as a component of consumer products. This is KHRN’s approach with its initial line of branded products under the name Kuida®.
Is it more difficult to launch the sale of consumer products compared to cannabis as a crop-based commodity? Yes it is. As a consumer product, it requires more sales and hands on marketing effort. More consumer education. But the effort is worth it. First of all, sales of commodities are primarily price driven. Consumer products, on the other hand, develop brand loyalty and are less sensitive to price. With consumer products there is a significant first mover advantage. The first mover has their product on the shelves first and their brand out there first. Finally, of course, the profit margin on consumer goods is substantially greater than on a commodity.
The reason I am confident about KHRN’s chances for success relates to management. Not only is Andrs Galofre a co-founder of KHRN, he is the Vice President of Business Development and has 15 years of experience in pharmaceutical marketing, brand management and distribution of prescription drugs and consumer products in Latin America. For example, he was integral in leading the launch of Advil in the Colombian market, which reached a 28% domestic market share. Galofre has also been instrumental in attracting people such as Elsa Navarro, Skin Line Manager to the company.
Conclusion: I am not knocking PCLO but I am saying as an investor, KHRN seems a far more attractive opportunity. Assuming both companies are successful, I want to end up where KHRN is going far more than where PCLO is headed. I would rather end up as the L'Oral, Unilever or Proctor and Gamble of the cannabis cosmeceutical world. Perhaps the most important consideration from an investment point of view is that Khiron trades at approximately one-third of the market cap of PharmaCielo. So if you offer me all the advantages I see in KHRN’s business plan and the team of people they have assembled to carry out their plan under the leadership of Alvaro Torres, Chief Executive Officer and Chris Naprawa, President and I can have it all for around one-third of the valuation I have to prefer KHRN in a portfolio. If you own both, I suggest KHRN should be the much larger holding.