KushCo Holdings (KSHB) just went from bad to worse. Shares of the provider of ancillary products and services to the cannabis and hemp industries had lost half of their value so far this year as of Wednesday. But KushCo stock plunged more than 36% on Thursday after the company announced the pricing of a direct offering of shares.
Is KushCo now a smart pick to buy after this massive meltdown? Or should investors follow the old adage of not trying to catch a falling knife?
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At the root of the carnage
KushCo's latest share-price free fall wasn't surprising at all when you consider the details of the company's direct stock offering. The cannabis industry supplier is selling nearly 17.2 million units, with each unit including one KushCo share and one warrant to buy half of a share, at a price of $1.75 per unit.
There are two key things to note with this offering. First, the 17.2 million shares being sold represent more than 19% of KushCo's total outstanding shares. If we add in another 8.6 million shares if the warrants are exercised, it brings the total of the stock offering to 29% of outstanding shares. That's a lot of dilution.
The other critical aspect of the offering is the price tag. KushCo's shares closed at $2.69 on Wednesday. The pricing of its stock offering represented a 35% discount to that prior-day closing price.
However, the real underlying cause of KushCo's steep declines this week and earlier in 2019 is that the company continues to lose money -- lots of money. And its bottom line is headed in the wrong direction.
Thanks to the just-announced stock offering, KushCo will have another $30 million or so to fund operations. But if the company doesn't become profitable, it's just a matter of time before KushCo will have to go to the well again -- and probably experience a similar outcome to what we saw on Thursday.
KushCo's path to profitability
That leads to the obvious question: How long will it take for KushCo to achieve profitability?
The good news is that KushCo is delivering strong revenue growth. In the second quarter, for example, the company posted a year-over-year revenue increase of 221%. Much of this revenue growth stems from acquisitions. However, these acquisitions -- particularly KushCo's purchase of Summit Innovations in a deal that put the company front and center in supplying hydrocarbons and solvents for cannabis extraction -- could potentially help smooth the way for KushCo to become profitable.
A big part of the problem, though, is that selling ancillary products and services like packaging solutions isn't a very high-margin business. Although KushCo reported net revenue of nearly $41.5 million in its latest quarter, the company's gross profit was only $7.4 million. A gross margin of less than 18% will require KushCo to more than double its current sales to cover its current operating costs.
But KushCo thinks that it will be able to increase its gross margin to around 30%, possibly in fiscal year 2020, which ends on Aug. 31, 2020. More importantly, the company predicts that it will achieve profitability in fiscal 2020 as well.
There is something to keep in mind with KushCo's path to profitability, however. Vaping-related products make up close to two-thirds of the company's business. Anyone who has been keeping up with the news knows about the health scare related to vaping in the U.S. It's uncertain how health concerns could impact KushCo's business.
To buy or not to buy?
I have been bullish about KushCo's long-term prospects for a long time. My view was that the continued expansion of the U.S. cannabis industry would fuel the company's growth. The legalization of hemp in the U.S. added another significant market opportunity for KushCo as well.
However, the dynamics for marijuana stocks are constantly changing. Worries about the health impacts from vaping could materially affect KushCo's business. My hunch is that KushCo will be fine over the long term, but I'm not sure how long it will take for vaping concerns to be addressed.
The cash raised from KushCo's latest stock offering should carry the company into next year. But I fully expect it will have to bring in more capital even if it stays on track to hit its goal of profitability in fiscal 2020. If I'm right, even more dilution could be on the way.
I still think that KushCo could be a big winner over the long run. However, the short-term uncertainties lead me to believe that now isn't the right time to buy this cannabis stock.
