Cresco Labs Stock: A Cannabis Company Owned by Political Deadlock (OTCMKTS:CRLBF)

Baramee Temboonkiat

The cannabis industry operates in a highly regulated environment within a fragmented state-by-state structure in the United States. Although a multi-billion dollar business, the product has faced general macroeconomic pressures that include conflicting federal and state laws. Multi-state cannabis companies such as Cresco Labs (OTCQX:CRLBF), Columbia Care (OTCQX: CCHWF), Trulieve Cannabis (OTCQX:TCNNF), Green Thumb Industries (OTCQX: GTBIF) and Curaleaf Holdings (OTCPK: CURVE), among others, have faced various bottlenecks, such as a ban on doing business with US financial institutions. Additionally, small US businesses involved directly or indirectly in cannabis are barred from accessing loans and other business development programs, especially in states that have not yet legalized the drug. However, 2022 is turning out to be a very busy year for marijuana law.

Thesis

Cresco Labs develops its strategic footprint in the market by driving organic growth and accretive mergers and acquisitions (M&A) to create shareholder value. The company believes its acquisition of Columbia Care will help it achieve a strong position by adding new markets to the company, such as the lucrative states of New Jersey and Virginia. The company is also bullish on launching new cannabis brands later in the year with additional store openings to drive strategic retail. However, the political ground is still soft as the United States has yet to pass key legislation under the Biden administration that will facilitate the cannabis trade and make this stock attractive in the long term.

The share price of Cresco Laboratories is trending down 72.54% in the 1-year analysis, which translates to almost 300% below the 52-week high. Initially, the stock has yet to reach its dominant levels, mainly due to the difficult consumer environment marked by shrinking portfolios. The annual inflation rate in the United States jumped up to 8.6% in May 2022, the highest in 40 years.

Rising inflation in the United States

Trade economy

However, inflation may not be the direct reason for the decline in cannabis stock prices, given that companies such as Cresco Labs are posting record revenues. It may come as a shock to investors that CRLBF is still trading at $3.06 despite earning over $840 million in the quarter ending March 2022 and a market capitalization of $1.22 billion. The same growth has been replicated in other cannabis players.

Cannabis revenue growth over the past year

Looking for Alpha

We can rightly infer that the cannabis sector appears to be somewhat immune to the impact of inflation (on the surface) given the direct relationship between inflation and revenue. Marijuana prices have been on a downward trajectory, which means that many factors come into play before dissecting the low marijuana prices embraced by the market.

Quite rightly, the price of cannabis is primarily influenced by the maturity of a state’s cannabis laws. In states like Massachusetts, which are still in the early stages of cannabis legalization, wholesale marijuana prices can go up to $3,000 a pound. In contrast, states that have legalized cannabis for a while, such as Colorado, will have marijuana priced below $1,000 a pound.

Before looking at online legal processes that could have implications for the cannabis industry, we will first recap Cresco’s financial performance for the first quarter of 2022.

Financial results

Cresco’s quarterly revenue decreased 1.6% as of March 31, 2022 (to $209.5 million), resulting in a 20.9% decline in gross profit to $102.5 million during the quarter. Additionally, the company’s operating profit was also reduced by 43.17% to $20.8 million. This decline consolidated Cresco’s negative revenue status of 86.4%. Cash and short-term investments also fell 19.78% to $179.3 million from $223.5 million realized in the quarter ending December 31, 2021.

By calculation, it can be seen that Cresco’s cash balance can only sustain the business for the remaining 12 months and will need to raise new funds by March 2023. The business has used $1.9 million in operations and An additional $171.4 million as CapEx (TTM) through March 31, 2022. With free cash of $179.3 million, this means Cresco will need to increase the dilution of its shares or increase the balance of its debt, which currently stands at $640.5 million.

Cresco Labs’ total retail footprint now stands at 50 after adding 3 new stores in Florida and another in Pennsylvania during the quarter. It seems that these new stores absorbed a lot of capital expenditures. Adjusted EBITDA was $51 million, representing 24% of quarterly revenue and a 45% increase over the prior year. Collectively, Cresco operates in 10 states across the United States, with 21 production facilities, 51 retail licenses and 50 dispensaries.

On the primary front, wholesale revenue increased by $95 million, with Cresco’s flower, concentrate and vape categories taking the top spot in branded cannabis products. Additionally, retail revenue also jumped 44% (year-over-year) to $119 million, with up to $2.5 million recorded per average store opened during the quarter. Same-store sales also jumped 9% (year-on-year), a sign of strength and resilience despite a slow start to the year with declining gross margin and net profit.

Acquisition of Columbia Care

Investors are thrilled after Cresco received overwhelming approval for its acquisition of Columbia Care in an all-stock deal. At a general meeting held on July 8, 2022; Columbia Care shareholders have approved the business combination between Cresco and the company, bringing together experienced cultivators, manufacturers and suppliers of quality cannabis brands in the United States.

Columbia Care’s quarterly revenue was nearly half the amount Cresco achieved at $123.1 million, while gross profit jumped 105.1% to $56.6 million. Still, CCHWF needed this transaction to manage its dwindling finances as it had a debt of $574.1 million against a cash balance of $176.2 million. However, in terms of asset coverage, it is essential to note that Cresco gets more in return. Up for grabs, 19 licenses in 18 US and European jurisdictions. In addition, CCHWF operates 131 facilities including 99 dispensaries and 32 cultivation and manufacturing facilities as well as those under development.

Yet Columbia Care’s cash flow was already in the red zone. Operations and CapEx used $235.7 million against a cash balance of $176.2 million. The company had until October 2022 to deplete its cash balance. Additionally, it had already issued 399.5 million shares outstanding, which means further dilution in search of more capital would have plunged the stock price below $0.50, as it trades still under $1.60.

Legislation in preparation

Investors are optimistic that passage of the SAFE plus Banking Act would allow cannabis companies to access the US banking system before the end of 2022. But the reality on the ground is that the US Senate as it stands, doesn’t have enough votes to pass a sweeping marijuana decriminalization bill. There seems to be a cut between the House of Representatives and the US Senate regarding the passage of this law.

In a letter by Senator Jacky Rosen, the Senate Appropriations Committee has been asked to allow cannabis companies to access commercial loans through acceptance by the US Small Business Administration (SBA) in fiscal year 2023. In As it stands, the SBA prohibits all small businesses with cannabis involvement from taking advantage of loans and entrepreneurial development programs. The senator’s letter is in itself a channel to ensure that the federal government partially agrees to guarantee a loan to budding companies that are currently classified as illegal entities due to their products. The ultimate goal is to engage investors and politicians in the discussion of cannabis business as a social equity entity. This will lead to a change in federal law and thus help provide SBA loans to cannabis businesses over the long term.

Carry

Approval of cannabis companies in the United States is still a long way off, although various states have legalized the drug for recreational and medicinal use. Investors are hoping cannabis will be decriminalized so they can start using the US banking system. However, as things stand, the SAFE Banking Act seems like the best bet for investors, even if cannabis is not fully legalized. For Cresco Labs, its merger with Columbia Care appears more useful to the latter in this transaction. Still, there are many additions such as new markets for the business which are seen as expedient in revenue growth. Yet the company must change its pricing strategy to ensure not only increasing revenue, but also maximizing profit margins. For these reasons, we offer a holding rating for the title.

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