Cresco Labs Could Do Well After Rescheduling Takes Place

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Cresco Labs stock is rated a Hold due to its volatile stock performance, uncertain rescheduling of cannabis by the DEA and better alternatives.Q2 results showed mixed performance, with revenue ...

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Darren415 I last wrote about Cresco Labs (OTCQX:CRLBF) in June, explaining why I liked it. I rated it as a Hold and did not include any in my model portfolio that I shared with subscribers to my investing group at that time. I have been following the company since it went public in 2018, and it is one of the 23 cannabis stocks that I currently include on my Cannabis Focus List. CRLBF is up 17% in 2024, doing better than most of its Tier 1 MSO peers and the New Cannabis Ventures Global Cannabis Stock Index (up 7.3% year-to-date), but the stock has dropped since the June article by more than 12%. The stock is 59% higher than its all-time low set in August 2023. Of course, it is down over 90% from its all-time high in early 2021 at the peak of the market for cannabis stocks. While the stock has pulled back from when I last wrote about it and also from the peak, I do not include it in my model portfolio at this time. For those looking at cannabis stocks, I have gotten a lot more bullish on the sector recently. The DEA has proposed rescheduling cannabis from Schedule 1 to Schedule 3, and this is on track to happen it seems. The next issue is a hearing by the DEA in December. There is no exact timeline, and it is not certain that the DEA will make this change. I expect it could happen in early 2025. Rescheduling cannabis will end 280E taxation, which kicked in when Ronald Reagan was President. It forces any company that produces or sells federally illegal cannabis to pay taxes on gross profits rather than net income, and this has weighed heavily on MSOs like Cresco Labs. In this piece, I review the stock charts of CRLBF, look at the company's fundamentals, assess its valuation and share my thinking on why it is still a Hold. I think that the stock will do very well ahead if rescheduling goes through. Cresco's Chart Is Beaten Up But Solid Cresco has been all over the place in the past 6 years: YCharts After making an all-time high in February 2021, the stock has dropped over 90% and now trades well below where it was trading when it went public in Canada in 2018. Looking at the returns of the Tier 1 MSOs since the rescheduling rumor hit last year (8/29/23), it has done well: Ycharts Looking now at the returns since 4/30, when the DEA reported that it was in the process of rescheduling through its recommendation, all of these stocks have declined: YCharts (YCharts) The chart of CRLBF seems to show support in this area. In that June piece, I suggested that $1.60 to $1.70 could provide support. While we are right there now, it did trade lower in early August: Schwab Cresco Labs faces resistance right now at $1.80, its falling 150-day moving average, in my view. I kind of like it here, but a loss in Florida for adult-use legalization in a few weeks could weigh on it. Further, if rescheduling of cannabis becomes unlikely, that will depress the price too. The $1.35 low in August matched its price at the end of 2023, and is important to watch. Q2 Was Rough for Cresco Labs Cresco reported its Q2 on August 8th. The company had been expected to generate revenue of $185 million with adjusted EBITDA of $49 million. Sales came in slightly below what analysts had projected at $184.4 million, flat to Q1 but down 7% from a year ago and down 16% from two years ago. Operating income increased sequentially due to a better gross margin. Compared to a year ago, operating income expanded due to a much better gross margin and lower operating expenses. Adjusted EBITDA was better than expected, rising 1% sequentially to $53.9 million. This was a big improvement from a year earlier at $40.5 million. Looking at the revenue, wholesale fell 20% and represented 36% of overall sales. Dispensary revenue grew 2% to $118.5 million. The company cited price pressure in Illinois and Massachusetts and its decreased California operations as the reasons for revenue pressure. Tangible equity at the end of Q2 was -$116 million, which is a challenge. The cash decreased to $112 million, with net debt up slightly at $399 million. The current ratio at 2.0X suggests that there is no imminent liquidity issue. Most of its debt is due in 2026. YTD cash flow from operations improved from Q1 and was $53.6 million, up from $21.2 million in the first half of 2023. Capital spending fell, and the company generated free cash flow. After the report, the company announced that CFO Dennis Olis is retiring. I applauded the company for bring Olis in, and he did a decent job since 2020 in my view. The company named a recent member of the company to be CFO, Sharon Schuler, who was most recently part of the management team at BJ's Wholesale Club. The Updated Outlook for Cresco Labs Is Better Ahead of the Q2 report, analysts, according to AlphaSense, were projecting 2024 revenue of $744 million with adjusted EBITDA of $199 million. Now, they expect revenue to fall 3% to $745 million. Adjusted EBITDA is projected to increase 1% to $213 million. For 2025, analysts had expected revenue of $809 million with adjusted EBITDA of $208 million. Now, the analysts project that revenue will increase 5% to $779 million. Adjusted EBITDA is expected to grow 6% to $226 million, a margin of 28.9%. This margin is below the other large MSOs except for Curaleaf (OTCPK:CURLF). The revenue growth isn't that exciting, but it could be higher than currently expected if Florida legalizes for adult-use. The adjusted EBITDA outlook has improved. The expectations look good for a company that has been shrinking on the revenue front. Potential investors should be aware that Illinois, where Cresco Labs is headquartered and quite active, declined in September for cannabis sales for the first time ever. The company doesn't break down its by state, but it faces a risk in Florida if adult-use fails to pass, as the medical cannabis program has shown all sorts of warning flags about that market becoming more competitive as patient growth slows significantly. I think another negative aspect of Cresco Labs is that it doesn't yet file with the SEC like most of its peers and most smaller MSOs too. Neither does Curaleaf, as both file with SEDAR in Canada still. Cresco Labs Is Cheap to Its Peers Looking at historical and expected adjusted EBITDA relative to the enterprise value, Cresco looks relatively cheap to the other Tier 1 MSOs: Alan Brochstein using AlphaSense Compared to the current expectations for 2024, the valuation is the lowest, and the 5.0X based on projected 2025 numbers is also the lowest. Investors need to be concerned about rescheduling not taking place, as 280E remaining intact would create a big challenge for all of these companies with their debts. Green Thumb Industries (OTCQX:GTBIF) trades at a higher valuation, but it has a better balance sheet with respect to the amount of debt as well as the tangible book value. Curaleaf seems very expensive, as I have suggested (currently a Sell rating by me). Trulieve (OTCQX:TCNNF) trades at a higher valuation, as investors seem overly excited by the prospects for adult-use in Florida, and I explained earlier this month why it should be sold by investors. Verano (OTCQX:VRNOF), which has declined a lot, is just as cheap as CRLBF and much cheaper than TCNNF, and it has a big opportunity in Florida too. I have been sharing a target with members of my investing group. Ahead of the Q2 report, my target was $2.80 for year-end, based on 8X projected adjusted EBITDA for 2025. While the EBITDA outlook has improved, the potential and likely rescheduling was delayed due to the upcoming hearing. I still believe that 8X is a good estimate for where the company will be valued, but it's not likely to happen at year-end. I am not yet using the projected 2026 numbers to get a year-end target for 2025, but I believe the projected adjusted EBITDA for Cresco will be higher then than in 2025. So, my target, while not for year-end 2024 and likely higher for year-end 2025, works out to $3.05 based on 8X the projected adjusted EBITDA for 2025. I think that CRLBF could almost double in less than a year. Conclusion As I disclosed above, I currently do not hold any Cresco Labs in my model portfolio that aims to outperform the Global Cannabis Stock Index. I do own 5 MSOs, including recently repurchased Verano Holdings, and total about 32% of the portfolio's holdings, which compares to index exposure of 27%. I described recently why I like Verano, and I believe that some of the other MSOs look much better than Cresco Labs. While I am overweight MSOs, I am more overweight two Canadian LPs that trade below tangible book value and appear to have reasonable valuations relative to their projected adjusted EBITDA. Of course, these stocks have no direct impact from rescheduling. I am currently underweight ancillaries, which are the largest part of the Global Cannabis Stock Index, but this includes a very large position in a debt-free company that trades at just 3.2X my projected adjusted EBITDA for 2025. Cresco Labs will likely do much better ahead, but I am waiting for a better time to add it to my model portfolio. Readers may just want to consider it 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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