Kush Bottles (NASDAQOTH:KSHB) is one of the market's best performing U.S. marijuana stocks, rising more than 120% in the past year as investors look for ways to profit on a boom in pot. As a wholesaler of supplies for marijuana dispensaries, investors view it as a way to profit from a general increase in retail marijuana sales as more states legalize the plant for recreational and medicinal use.
But there is more to the story you should know about before diving in. Here's an introduction to Kush Bottles as a potential investment.
More packaging than marijuana
Kush Bottles derives its revenue primarily from the sale of marijuana packaging and ancillary products like vaporizers, rather than the sale of marijuana. The company's main customers are marijuana dispensaries and distributors, who purchase its products in bulk for retail sale. The company currently sells products in four major categories: bags, tubes, containers, and vaporizers.
Its premier product appears to be the pre-rolled joint tube, a plastic container that holds a pre-rolled marijuana joint for retail consumption. Kush Bottles' tubes are inexpensive, costing as little as $0.11 each, or no more than 1-2% of the product's price at retail.
According to commentary from a July 2017 presentation, Kush Bottles was selling more than one million pre-rolled tubes each month. The company has a patent on the child-resistant mechanism on its tubes, a potential point of differentiation in the marketplace, though there are currently several different types of child-resistant tubes competing for market share.
To expand its offerings and footprint, the company has completed three major acquisitions over its history.
- Dank Bottles -- Acquired on April 10, 2015, Dank Bottles was the exclusive distributor of Kush Bottles' products in Colorado. Kush Bottles paid for the acquisition with $373,725 in cash and 3.5 million shares of stock.
- CMP Wellness -- Kush Bottles acquired CMP Wellness on May 1, 2017. CMP Wellness' primary products are portable vaporizers, cartridges, and accessories. Kush Bottles paid for the acquisition with $2.3 million of cash and promissory notes, plus 7.8 million shares of restricted stock. The deal also included earn-outs of $1.9 million in cash and up to 4.74 million more shares of Kush Bottles to be paid out based on the company's performance.
- Roll-Uh-Bowl -- On May 3, 2017, Kush Bottles acquired Roll-Uh-Bowl, which sells portable, silicone water pipes. Kush paid for the acquisition with $150,000 of cash and 200,000 shares of stock.
A cursory review of its website reveals that many of its core products are out of stock for reasons that aren't immediately clear. In the company's annual report, it discloses that its top two suppliers accounted for approximately 22% of its inventory purchased over the year ended Aug. 31, 2017. One wonders if its sales would be more robust if not for the fact many of its SKUs are out of stock.
Kush Bottles reported having more than 4,000 different customers in its recent earnings report, with a "local sales presence in every major U.S. cannabis market." No customer made up more than 10% of its revenue in the most-recent fiscal year.
Virtually all marijuana stocks have their red flags, given the industry is generally made up of new, barely profitable entities. For Kush Bottles, potential problems include recent executive departures.
On Aug. 1, 2017, one month prior to the company's fiscal year end, its chief financial officer, Chris Martin, resigned from the company. In a press release, the company highlighted quotes from the company's chief executive officer and new CFO, but Martin was not quoted.
This is a significant development given that the company's annual report cites several material weaknesses in control over financial reporting, including:
- Inadequate segregation of duties consistent with control objectives.
- Lack of a code of ethics.
- Lack of a whistleblower policy.
- Lack of an independent board of directors or board committees related to financial reporting.
- Lack of multiple levels of supervision and review.
Importantly, Martin would have signed off on this annual report if not for the fact he stepped down as the company's CFO.
The company contends that its small size (65 full-time employees as of November 2017) means that "segregation of all conflicting duties has not always been possible and may not be economically feasible." However, management noted that it intends to fix several issues in fiscal 2018. Most importantly, it expects to appoint an independent board of directors, including board committees related to financial controls and reporting in 2018.
Somewhat offsetting these risks is the fact that management and the company's board own a significant stake in Kush Bottles. Insiders owned approximately 42.9% of the company as of Nov. 21, 2017, which stands as a strong indicator of alignment between shareholders, company executives, and board members. Given its willingness to acquire companies with stock, significant insider ownership is good to see.
A "blue sky" valuation
Kush Bottles' valuation implies a rosy forecast. When the full-year results of CMP Wellness (acquired in May 2017) are included, Kush Bottles trades for approximately 15 times proforma sales for fiscal 2017 on a fully diluted basis, quite rich for a business-to-business wholesaler.
Of course, investors are looking forward rather than backward. With gross margin of 33%, the company's profits should grow at a faster clip than sales, as it scales out its fixed costs across a larger revenue base. Pre-tax margins have increased markedly over the past year, rising to 5.1% in the most-recent quarter, likely driven by increased scale from a spate of acquisitions.
Kush Bottles shares look priced for perfection, however. If we generously assume proforma sales can grow five times over, and its net profit margin expands to 10% (no easy task given gross margins of just 33%), the business would still trade at about 30 times net earnings.
Investors appear to be high on the potential, coming to the conclusion that Kush Bottles is almost certain to become as important to marijuana dispensaries as Sysco is to the restaurant industry. Barring a long list of large acquisitions (paid for with stock, not cash), it seems unlikely that investors will eke out a market-beating return from this richly valued marijuana stock.