Cresco Labs: Budding Green King
May 27, 2021 9:46 AM ET
Cresco Labs Inc. (CRLBF)
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Leading marijuana companies like Cresco Labs have the potential to grow into cannabis superpowers.
Cresco is a fantastic bargain among the compellingly valued MSOs.
Accordingly, we think Cresco is the right marijuana stock for investors looking for exposure to a sector that is rapidly taking root.
As one of the top cannabis multi-state operators (MSOs) in the US, Cresco Labs (OTCQX:CRLBF) is an alluring investment. The MSO is the leading wholesaler in the marijuana sector with more than 50% of sales coming from selling its branded products in other retailers. With more positive legislation in the cannabis space coming, Cresco is well-positioned for another incredible year and is poised for massive growth in future quarters. Even more compelling, Cresco is not simply a revenue growth story. Indeed, it is already very profitable with 4Q20 adjusted EBITDA of USD50mn. The Street view calls for the company to reach USD300mn in EBITDA profits this year, and revenues of USD807mn and 2022 witnessing the breaching of the USD1.1bn mark, making the current USD2.7bn market cap highly compelling, in our view.
While there are several promising companies in the cannabis space, many have already undergone a massive run-up in their share prices and as such, while we shall continue to monitor them, we will focus more on what are the more promising names in terms of potential upside for investors. Having said that, our favorite name in the sector is Cresco. While Cresco has already performed very well into the year, the company has been engaging in all of the right moves and is expanding into the right areas, with the right brands and messaging, at the right time.
Because of its focus on the more profitable wholesale business, Cresco is not as well-known as other MSOs. Canopy Growth is the most well-known cannabis company and consensus has it hitting FY23 revenues of USD871mn. While Cresco's cannabis operations are much larger, Google Trends shows Canopy as the more-searched company in the US until very recently. The key takeaway is that Cresco is a fantastic bargain among the compellingly valued MSOs. And because of this, we think it the right marijuana stock for investors looking for exposure to a sector that is rapidly taking root.
Budding green king
Cresco Labs is a cannabis operator in US and was founded in 2013. The company has rapidly become one of the biggest marijuana companies in the US and already has 32 dispensaries in 10 states, 18 cultivation and production facilities, and has 44 cannabis store licenses. It manufactures a suite of cannabis extracts and vape products and is a processor and retailer of cannabis products with operations in ten states, including California, New York, Florida, Illinois, Michigan, Arizona, Massachusetts, Maryland, Ohio, Pennsylvania, Nevada, and Arizona. It distributes its cannabis products to dispensaries. And most lucratively, Cresco sells the top marijuana brand in California, the world's largest and most competitive marijuana market.
While not among the more widely known names to retail investors, we think this will soon change as the company is already breaking even in terms of net income and possesses traits that makes it stand apart from other marijuana companies.
As one of the top cannabis MSOs in the US, Cresco is an appealing investment. The MSO is the leading wholesaler in the sector with more than 50% of sales coming from selling its branded products in other retailers. With more positive legislation in the cannabis space coming, Cresco is well-positioned for another incredible year and is poised for massive growth in future quarters. Even more compelling, Cresco is not simply a revenue growth story. Indeed, it is already very profitable with 4Q20 adjusted EBITDA of USD50mn. The Street view calls for the company to reach USD300mn in EBITDA profits this year, and revenues of USD807mn and 2022 witnessing the breaching of the USD1.1bn mark, making the current USD2.7bn market cap highly alluring, in our view.
While Cresco was somewhat subdued in 2020 as it focused on integrating Origin House and improving financial performance. It shifted back into acquisition mode towards the end of the year by securing assets in Florida, Massachusetts, and Ohio. Given Cresco's incredibly attractive valuation and robust asset portfolio, it is our favorite among MSOs.
On the M&A front, Cresco was one of the most active MSOs in 2020 with a slew of acquisitions announced. Cresco has recently announced several acquisitions including Florida-based of Bluma Wellness for USD213mn in an all-stock deal, giving it seven open dispensaries and 54,000 sq. ft. of cultivation space. The deal provides Cresco with more opportunities to create value via organic growth and capital investments. The company announced the acquisition of Massachusetts-based Cultivate for USD158mn including max earnout. The deal gives Cresco 42,000 sq. ft. of canopy and two open dispensaries with an additional planned for 2Q21. Massachusetts is frequently overlooked as a very attractive market due to its small number of dispensaries and tight wholesale market that provides an attractive pricing environment. With this deal, Cresco will have 100,000 sq. ft. of cultivation, three medical, and three dispensaries which is the maximum permitted under current regulations. And for Ohio, Cresco recently finalized the acquisition of Verdant which gives it four open dispensaries, providing it with maximum number of five allowed in the state. The company is now vertically integrated with 25,000 sq. ft. of cultivation, five medical dispensaries, and a processing license. Ohio is a small but fast-growing medical marijuana market with around 50 open dispensaries and approximately 160,000 registered patients.
With the latest acquisitions, Cresco will have 33 combined stores open with licenses for 47 stores. However, it is not even close to the largest MSO with others having licenses for north of 100 retail stores, which leaves abundant room for growth. Cresco will have 20 production facilities and a TAM of around 111mn consumers. The company is already in the biggest state markets, or seven of the top 10 most-populous states.
Cresco's strategy to focus more on wholesale with less emphasis on retail, has proven to maximize its long-term margins. To that end, the company has invested to develop cultivation capacities and secure wholesale distribution channels. And the company has grown its business with 4Q20 revenue of USD160mn and an EBITDA margin of 30%, which are among the best figures among MSOs.
Because of its focus on the more profitable wholesale business, Cresco is not as well-known as other MSOs. Canopy Growth (CGC) is the most well-known cannabis company and consensus has it hitting FY23 revenues of USD871mn. While Cresco's cannabis operations are much larger, Google Trends shows Canopy as the more-searched company in the US until very recently. The key takeaway is that Cresco is a fantastic bargain among the compellingly valued MSOs.
Everything's gone green
The legalization of recreational marijuana for adult use in the US, UK, and most, if not all, of the countries in the EU, as well as South America and Oceania is but a foregone conclusion. Once the first dominoes fall and the tremendous revenue-generating opportunities noticed by slower-moving governments, they will likely follow suit. Of course, before the complete legalization of marijuana for recreational use takes place at a global level, widespread acceptance of marijuana for medical and other products will take place, in a pattern not unlike seen in US states. And because the markets are now still in their beginning stages of growth, first-movers which have an edge in cultivation, R&D, distribution, and marketing may become the Anheuser-Busches, Philip Morris Internationals (PM), and British-American Tobaccos (BTI) of the 21st century. And it is for this reason that we recommend investors looking to harvest the fruits of this fast-growing industry to accumulate positions in leading marijuana companies like Cresco which have the potential to grow into cannabis superpowers.
Whitewashed history of cannabis and culture in the US
Products derived from the cannabis plant are among the most widely consumed of any plant in the US and in the world. In the former, many derivatives such as those for recreational or medical use have been under prohibition since the Marijuana Tax Act of 1937, which banned it nationwide despite objections from the American Medical Association related to medical usage. This Act went into effect one year after the release of the propaganda movie Reefer Madness. And the public hysteria and uproar from this film compelled the misinformed federal and state governments to continue ratcheting up punishments for marijuana until the late 1960s, when upper middle-class college students who were using it started to be negatively impacted by the laws. As such, in mid-1970s almost all US states reduced penalties for marijuana possession.
Indeed, Europeans had been aware of the medicinal benefits of marijuana since the early 19th century. It was at this time that an Irish doctor stationed in India documented that cannabis extracts eased ailments such as stomach pain and vomiting. By the late 19th century, cannabis extracts were widely available in North American and European pharmacies and from doctors. Of course, because substances in the past were used for medicinal purposes does not necessarily mean it was the prudent thing to do. However, modern research supports claims that marijuana possesses an array of tangible medical and health benefits. But despite its medical benefits, at the turn of the century, American attitudes towards cannabis changed. As is well-documented, the widely used drugs alcohol and tobacco are far more dangerous than marijuana. Unlike tobacco or alcohol, marijuana will not cause death from an overdose. Indeed, the US DEA states that in no uncertain terms that "No death from overdose of marijuana has been reported."
Despite being nonaddictive, nontoxic, and having relatively few negative side effects for both individuals and society, the continued prohibition at the national level has been a source of tension between Washington DC and the states. Adding fuel to the prohibition later was the global push by the Reagan Administration in the 80s in its 'War on Drugs', which is widely agreed to have been a complete failure. This phase was in large part triggered by the crack cocaine epidemic in the US, which brought with it myriad social ills (not unlike the current opioid crisis). Of course, prohibiting such dangerous and highly addictive drugs cannot be compared to marijuana but the latter fell victim to misperception by the uniformed around the world due to the prohibition on dangerous drugs such as heroin, cocaine, methamphetamines, etc. While some countries such as Portugal have completely decriminalized all drugs, we believe such a liberal policy with regards to hard drugs is unlikely to be accepted anytime soon by most Americans, and by extension other countries.
Marijuana, on the other hand, is widely accepted in the west and is widely consumed despite the prohibition. Indeed, we only need look at US Presidents Clinton and Obama, two of the most popular US presidents in recent history and see that they had been consumers. Basically, the current prohibition can be viewed as being similar to the failed federal prohibition of alcohol in the 1920s, which not unlike the situation with drug cartels, only benefited organized crime who fed demand, and gave rise to gang violence due to a myopic government policy which it deemed a social responsibility. While the prohibition on marijuana is longer lasted and is taking longer to unwind, it is nevertheless in its death throes and will as marijuana will be legalized at the federal level in the US (two congressional Republican lawmakers introduced a bill to federally legalize marijuana, protect banks that service state-legal cannabis business and ensure that veterans are allowed to use marijuana in compliance with state laws).
And this will be the first domino of what will evolve into a global mega growth trend as other countries follow suit, regulate, and tax. Big tobacco sees the writing on its wall and the sale and consumption of the highly addictive drug that is nicotine is growing more unacceptable the world over. Indeed, in many places people are accepting of marijuana whilst rejecting tobacco as the socially unacceptable. We expect this trend to accelerate going forward.
But the winds of change are rapidly transforming into a tempest with changes taking place at all levels of national and state governments at a blistering rate. And this means that prohibition will soon face its inevitable demise in the US, opening the floodgates of opportunity for investors to grow incredibly high returns on investment.
The bottom line
We like the stock, and its bargain-basement valuation is just one reasons for our bullish view. Cresco is well capitalized with USD136mn in cash and USD185mn of debt as of end-2020. It raised USD125mn post 4Q from equity issuances to help fund its acquisitions. While the cannabis market is highly cyclical and sector stocks are already off their recent highs. Cresco has ample liquidity and is generating cash which is an advantage.
Furthermore, the company also controls some best-in-class assets in top markets and just penetrated emerging growth markets via its latest deals. While Cresco's organic growth slowed in 4Q20 when sales grew a mere 6% without contributions from M&As. In 2021, revenue will grow on the back of acquisitions and there are some concerns about Cresco's organic growth, which is the same challenge faced by most MSOs, its rapidly growing brand awareness will should help to catalyze growth going forward. In addition, its discounted valuation relative to peers provides a cushion, albeit one that is unwarranted, in our view.
In sum, we are optimistic that Cresco will benefit from its acquisitions and ongoing growth in its core markets such as Illinois and Pennsylvania. Combined with its cheap valuation, we are optimistic about Cresco shares within the cannabis MSO space.