Cresco Labs Remains Strong Amidst Rescheduling Uncertainties (Hold)

seekingalpha08-29

Cresco Labs recently reported strong Q2-2024 financial results.The company is well positioned for growth in Florida and Pennsylvania where recreational cannabis legalization is soon expected.The ...

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The company reported earnings earlier this month and its stock price has been up 45% over the last twelve months. Financial performance remains strong for the company, but the US cannabis markets are volatile because of the uncertainty around rescheduling. News this week indicates that rescheduling has been delayed until December. Cresco Labs is poised for growth within its robust US operations and the company is already modeling its tax burden without the constraints of 280E. For now, I rate the company as a Hold and recommend that investor watch for developments form the company and the sector. Rescheduling of Cannabis Delayed Until December The DEA recently announced that the hearing to reschedule cannabis has been set for December 2nd, after the upcoming presidential elections. The move sheds much uncertainty over the final process and outcome. Cannabis stocks will remain volatile and down-trending until there are further developments. Once the event occurs, the cannabis market still awaits banking reform and federal legalization. When cannabis is rescheduled, US operators will be able to claim normal business deductions on their federal taxes. Cresco Labs is preparing for such a change. In its recent Q2-2024 earnings statement, it addresses its new potential tax position. Cresco Labs shares the following about 280E obligations: The Company, in consultation with its tax advisors, has determined that IRS Section 280E is not applicable to its business and intends to update its tax position going forward to file as a normal business. The company’s net loss of $51 million included a one-time payment of $61 million related to Cresco Lab’s new tax position. The company expects $65 million in cash savings for PY2024 and future years due to the new tax position. The company has prepared itself in case there is a challenge to their new tax model. The cash saving may set the company on track for reporting net income versus loss. Current Operations and Synergies Cresco Labs operates 72 cannabis dispensaries in 6 states and 13 production facilities over 8 states. Its Sunnyside dispensary breakdown is as follows: Ohio (5 stores), Pennsylvania (17 stores), Florida (33 stores), Illinois (10 stores), Massachusetts (4 stores), and New York (3 stores). Production facilities are also in these 6 states plus facilities in California and Michigan. The company operates in both retail and wholesale channels. It has its own set of brands as well. Cresco Labs is positioning itself for growth in Pennsylvania and Florida where recreational legalization is being considered in the Fall. The company is also increasing its position in Ohio because the state recently passed recreational legalization. Cresco Labs boasts the number one overall share in the cannabis markets in Illinois, Pennsylvania, and Florida. Q2-2024 Earnings Results Cresco Labs reported revenues of $181.2 million, representing a 6.4% decrease YoY ($193.6 million) and basically no change QoQ ($181.7 million). Net loss of $54.3 million has increased YoY (net loss of $36.5 million) and QoQ (net loss of $5.2 million). For the quarter, net loss increased because of a one-time payment of $61 million related to Cresco Lab’s new tax position. The company reported profit margins at around 50% of revenue. The company has maintained a high margin for many quarters and plans to increase it. It credits its core brand performance for the higher margins and feels it is beating price compressions in the market in this way. The company reports long-term debt of $498.7 million and short-term debt of $12.3 million. Cresco Labs makes semi-annual payments on its debt, which affects net income from quarter to quarter. Cresco Labs expects Q3 revenue to be about the same as Q2. The current market consensus for the company’s Q3 revenue report is $185.33 million, representing an increase QoQ and decrease YoY. The company expects Q4-2024 revenue to be higher when its Ohio operations are fully reported. Historical Performance and Valuation   Amounts in US$ Millions Q2-2024 Q1-2024 Q4-2024 Q3-2024 Q2-2024   Revenue 181.2 181.7 185.0 186.9 193.6   Cost of Revenue 89.6 92.1 92.1 96.9 111.2   Gross Profit 91.6 89.6 92.9 90.0 82.4   Margins (% of Revenues) 50.56% 49.32% 50.22% 48.15% 42.58%                 Operating Costs 58.7 60.0 65.8 68.3 71.1   Operating Income 32.9 29.6 27.1 21.7 11.3   Net Income (54.3) (5.2) 2.6 (115.6) (36.5)                 Cash & Short-Term Investments 112.3 123.2 103.4 107.1 73.2   Account Receivable 54.2 51.3 52.5 58.6 59.1   Total Assets 273.4 285.1 278.1 303.2 265.2   Long-Term Assets 1,358.0 1,360.1 1,358.5 1,399.2 1,511.2                 Accounts Payable 18.8 17.4 27.6 19.6 20.4   Total Current Liabilities 136.9 209.2 200.2 260.9 237.6   Total Liabilities 983.5 940.1 930.4 973.3 964.3                 Book Value Per Share $1.34 $1.47 $1.49 $1.50 $1.85     Current             NTM Total Enterprise Value / Revenues 1.31x 1.37x 1.62x 1.32x 1.62x 1.32x   Total Enterprise Value 1,340.80 1,411.28 1,628.81 1,292.57 1,616.80 1,400.53   Market Cap 688.38 752.46 966.25 609.44 932.53 676.95   Price $1.48 1.58 2.07 1.36 2.03 1.51   Median Target Price $2.50     NAV per share $1.07   Click to enlarge *Data from Seeking Alpha and TIKR Cresco Labs has reported consistent revenues over the last five quarters. Gross profit has increased while costs of revenues have decreased. Operating costs have also decreased. This trend has increased the company’s cash positions and sets them closer to quarterly free cash flow. If Cresco Labs’ tax strategy works, then financial numbers will improve even more. The company’s assets outweigh its liabilities. NAV per share is $1.07 and book value per share is $1.34. The company’s stock price of $1.50 is trading a little above its current value per share. The price per share is undervalued overall compared to its 52-week high. Regardless of undervaluation, there is not enough momentum nor sentiment to move the price above $2.50-$2.70 per share. The valuation does not accurately reflect the company’s excellent performance and positioning, but rather it mirrors the volatility in the cannabis market and with cannabis stocks overall. A variety of negative factors are affecting the US and Canadian cannabis markets. For the US, rescheduling will not likely solve these issues. Stock Price Movements   www.StockCharts.com Although the stock price is up 45% over twelve months, it is still down 14.85% over six months, down 18.50% over three months, and down 17% over the last five days. It is trading below its 20/50/200 moving-day averages. The price has fluctuated greatly since its 52-week high of $2.77 per share last September. The stock price has undergone volatility for most of the last year and now sits at $1.50 per share, more than a dollar less than its 52-week high. Low momentum and low investor sentiment are part of the issue and are affecting all cannabis stocks. Comparison to Peers   Numbers reflect last quarterly report per company in US$ millions* Cresco Labs (CRLBF)  Curaleaf Holdings (OTCPK:CURLF)   Green Thumb Industries (OTCQX:GTBIF)   Trulieve Cannabis (OTCQX:TCNNF)   Verano Holdings (OTCQX:VRNOF)    Revenue 181.2 342.3 280.1 303.4 222.4   Cash and ST Investments 112.3 89.4 196.1 355.2 130.1   Total Assets 1,358.0 3,083.0 2,540.6 2,864.9 2,239.1   Total Liabilities 983.5 1,975.8 786.6 1,488.5 1,017.7   Net Income or (Loss) (54.3) (48.9) 20.7 (12.0) (21.8)                 Book Value per Share $1.34 $1.34 $7.45 $7.37 $3.53   Current Price Per Share $1.50 $2.80 $9.40 $8.54 $3.25   Median Price Target $2.50 $7.65 $20.43 $23.93 $10.04   1 year stock price change Up 45% Up 1% Up 38.44% Up 147.54% Up 23.11%   Click to enlarge *Data from Seeking Alpha. Cresco Labs is performing in-line with its peers. Overall the top-tier US MSOs above are all somewhat undervalued and underperforming. Curaleaf is lagging behind the rest of its peers in terms of performance. Green Thumbs Industries and Trulieve are currently leading the pack. It remains unclear which MSO has the best advantage in the current conditions. The market will be volatile until endemic issues like lack of regulations are cleared up on a national level. I would rate each of these companies as a Hold for now. Risk and Investment Strategy Cresco Labs is at low risk of poor financial performance. The company has an abundance of assets and resources to continue is current business strategy. Cresco Labs plans to increase its geographical and market footprint while also increasing its profit margins. Assets outweigh the liabilities and debt is in proportion to performance. The company expects higher revenues in 2025 and has a lot to gain if legislation changes over the next year. A long-hold strategy comes at a high risk to the investor. Trading volume for cannabis OTC stocks are low and thus stock price can and will fluctuate greatly. Cannabis stocks are suffering sector volatility and greater stock market volatility. Investor sentiment remains low on the sector because of long-term uncertainty. At best, investors might want to hold these stocks and see what happens in six months. There is a risk of the stock price falling further, even if business performance continues to improve. Conclusion Cresco Labs enjoys a top share in US cannabis markets, The cannabis MSO operates dispensaries in six states and grow facilities in eight states. The company is well-positioned to increase its foot print and market share. Cresco Labs is focused on states where recreational cannabis is about to become legalized. This strategy puts them in a profitable position. The company reports strong financial performance for Q2-2024 and has consistently reported such performance over the last five quarters. The company expects even better financial numbers, if its new tax strategy is successful. There are delays in the US government’s attempt at rescheduling cannabis. The US cannabis markets are suffering from a lack of regulation amidst long-term uncertainty. Investor sentiment in cannabis stocks remains low. I rate Cresco Labs at a Hold for now.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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