Cresco Labs Inc (CRLBF)

[FUNMAN]

Cresco Labs: Right On Track In Difficult Market

Nov. 16, 2021 12:40 PM ET
Cresco Labs Inc.

Summary

Cresco Labs reported a solid quarter when focusing on adjusted EBITDA margin expansion.

The MSO remains primed for any long-term move to a branded wholesale cannabis market.

The stock trades at an insanely cheap multiple of 11x '22 adjusted EBITDA targets while the opportunity remains massive.


The MSO (multi-state operator) space finally saw a relieve rally to end last week. Cresco Labs (OTCQX:CRLBF) continues to be the best way to invest in the wholesale market in a world where branded cannabis becomes the focus over running cultivation facilities and retail stores. My investment thesis remains very Bullish on the MSO space with a preference to own a basket of stocks such as Cresco Labs.

Decent Quarter

As previously reported by other leading MSO players, the September quarter was tougher than normal. The U.S. cannabis space didn't see sequential revenue growth as New York delayed medical cannabis flower sales and states like Pennsylvania and Florida were more price competitive.

Cresco Labs still reported Q3'21 revenue grew 2.6% sequentially to reach $215.5 million. The company only grew revenues 40.6% YoY for some of the lowest reported growth rates in the MSO space.

The numbers were partially deflated from shifting away from distributed wholesale sales in California. The MSO might've seen revenue growth dip, but EBITDA margins surged 220 basis points in the quarter. The company pushing for more profitable sales will ultimately be rewarded by the market.

For the quarter, Cresco Labs grew adjusted EBITDA sequentially by 24% to $56.4 million. A lot of these MSO have plenty of levers to pull in order to boost margins in the short term. In the case of Cresco Labs, the company simply needed to exit low margin distribution sales agreements in California to focus on higher margin branded sales.

As with most MSOs, the December quarter and 2022 are expected to generate far more growth. Whether due to acquisitions or the expansion of cannabis sales in both New York and New Jersey, sales should return to solid growth rates.

The addition of the Cultivate business in Massachusetts along with the growing store base in Florida, Cresco Labs forecasts a big boost in Q4'21 sales. The MSO now forecasts sales of $240 million, up nearly $25 million sequentially.

The sales boost comes as the company will likely lose several million dollars in wholesale distribution revenues in California. The forecast for Q4'21 adjusted EBITDA margins to reach 30% is another sign of the low margin revenues obtained in the Origin House transaction where Cresco Labs took a $290 million impairment charge.

The company will have to boost adjusted EBITDA margins another 380 basis points to reach the 30% clip. Just on the Q3'21 revenue base, these higher margins would generate another $8.2 million in adjusted EBITDA.

All About Valuation

As with most of the MSOs, the valuation on Cresco Labs is absurdly low for the opportunity. The MSO is a strong wholesale player with leading positions in states such as Illinois and Pennsylvania. The Cultivate deal gives Cresco Labs another state with a strong wholesale position.

For the quarter, wholesale revenues were $109.3 million placing the company with over 50% of revenues from the wholesale market. The MSO only had 37 open retail stores leaving the company with the smallest store base of the major MSOs.

The Republican led cannabis bill released today would appear to favor a wholesale focused company where interstate cannabis sales allow for easy transition into other states. The Rep. Nancy Mace (R-SC) sponsored bill won't likely obtain approval, but the States Reform Act does push forward the cannabis agenda with collaboration from both sides of the aisle.

The company lists 421 million shares outstanding heading into Q4'21 where the deals for Cure Penn and Laurel Harvest will boost the share count while the Blair Wellness deal appears all cash and debt. The stock has a market cap of only $4.0 billion before these deals close while adjusted EBITDA reached $56.4 million in the quarter. The path to 30% EBITDA margins underscores the incredible valuation gap here.

Even at the current EBITDA run rate, Cresco Labs trades at a massive discount to growth rates. The adjusted EBITDA hit $226 million in the quarter and the stock only trades at 18x these estimates.

Assuming the company hits the $1.2 billion consensus revenue estimates for 2022, the stock trades at 11x 2022 EBITDA targets. This incredible valuation assumes just a 30% EBITDA margin while competitors have achieved higher levels. The revenue growth could accelerate with any progress in the future $5 billion New York cannabis market where sales have been minimal up until the approval of medical whole flower sales in early October.

Cresco Labs does already have a net debt position of $123.8 million, so the risks do exist. As parts of these outstanding acquisitions are paid for in cash, the MSO will increase the net debt position.

Takeaway

The key investor takeaway is that Cresco Labs remains the best way to play a future market focused on branded wholesales cannabis sales. For now, the market is still mostly focused on owned retail dispensaries, so this MSO could struggle in comparison without any changes to the market from federal legalization. As with most of the MSOs, the stock has risk due to changing market dynamics, but Cresco Labs is far too cheap for the likely risk to the U.S. cannabis market.

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Stone Fox Capital Advisors, LLC is a registered investment advisor founded in 2010. Mark Holder graduated from the University of Tulsa with a double major in accounting & finance. Mark has his Series 65 and is also a CPA.


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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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