There's little doubt that cannabis could be one of the fastest growing industries over the next decade. After more than tripling global sales between 2014 and 2018, Wall Street has called for worldwide weed sales to grow fivefold to 18-fold by 2030.
But believe it or not, there's an even faster-growing niche surrounding the marijuana industry and pot stocks. Sales of cannabidiol (CBD), the nonpsychoactive cannabinoid found in cannabis and hemp that's best known for its perceived medical benefits, are expected to grow by more than 100% per year through 2023, according to the Brightfield Group, a market research firm for the CBD and cannabis industries. That's put market share leader Charlotte's Web (CWBHF -5.11%) at the center of this high-growth trend.
Yet, this popular CBD stock has shed 24% of its value in 2019, and lost nearly two-thirds of its share price since hitting its yearly highs in early April. Does this decline represent a buying opportunity for investors, or is it a classic value trap? Let's weigh both arguments, then circle back and answer the question at hand.
The buy thesis
Let's start with the basics, such as Charlotte's Web being the market share leader in a very diverse CBD space. It has done an excellent job of building up its brand in a competitive marketplace. After beginning the year with access to 3,680 retail doors, the company ended September with access to more than 9,000 retailers. In 2019, Charlotte's Web has secured national deals with Kroger in 1,350 stores across 22 states, as well as Vitamin Shoppe. Put simply, it wouldn't be landing these deals if its CBD products didn't stand out from a very crowded field.
Although it took a step back with its bottom line in the most recent quarter, it's important to note that Charlotte's Web has had numerous quarters of operating profitability (without the aid of one-time benefits). In essence, the company has shown that its CBD sales model works. Now it's simply a matter of demonstrating to Wall Street that the model can be scaled nationally without losing its brand appeal.
Another selling point for Charlotte's Web is CBD itself. You see, CBD is being added to or infused into derivative products, such as topicals, and derivatives are a considerably higher-margin product than dried cannabis flower. This places Charlotte's Web at the center of this high-margin niche movement.
Lastly, keep in mind that Charlotte's Web's CBD products are focused on a U.S. market that's opened its doors to industrial hemp production and hemp-derived CBD following the signing of the Farm Bill a year ago. No longer are CBD products only sold in dispensaries. With consumers now finding them in pharmacies, grocery stores, and even general stores, access is growing by the day. And since CBD doesn't get users high, the consumer pool willing to try the products could be bigger than most folks realize.
The avoid thesis
Sounds like a great investment idea, right? Well, there are also reasons behind Charlotte's Web's fall from grace.
Arguably the biggest concern for the company is a recent consumer update from the Food and Drug Administration about CBD. In that update, the agency, which is still reviewing CBD as a possible additive to food, beverages, and dietary supplements, proclaimed that CBD can cause harm, and that the agency still doesn't know a lot about it.
This has some investors clearly concerned that the FDA could crack down on CBD products, and makes it increasingly likely that CBD-infused edibles and beverages are a long way from reaching retail shelves in the United States.
Make no mistake about it: The FDA hasn't been shy about going after CBD companies that make unsubstantiated medical claims. In July, Curaleaf (CURLF 3.83%) received a warning letter from the FDA regarding claims made by some of its CBD-infused products. Curaleaf was quick to address these deficiencies, but it still wound up costing the largest multistate operator in the U.S. a distribution deal with CVS Health.
Charlotte's Web has also been freely spending to expand its production capacity, which has meant adding new employees and relocating into larger offices. In short, operating expenses have been on the rise, which during the third quarter pushed Charlotte's Web to a modest loss per share of $0.01. When combined with the FDA's cautious take on CBD's early stage safety profile, perhaps it's no surprise that sales and profit forecasts for Charlotte's Web on Wall Street have fallen notably in recent months.
Now that you've had a brief taste of both sides of the aisle, we can return to the original question: After a 24% year-to-date decline, is now a good time to buy into Charlotte's Web?
My answer is that, yes, it wouldn't be a bad time to consider opening a new position or nibbling on an existing one.
While there's no question that the FDA's CBD consumer update was a disappointment, there are a few important factors that Wall Street has overlooked. First of all, the FDA's primary focus is on CBD as an additive to food and beverages, and ensuring that no unsubstantiated medical claims are made. Charlotte's Web's labeling hasn't been an issue with the FDA thus far, and the company has primarily thrived with topicals and oils, which don't seem to be in any danger of declining sales following the FDA update.
Charlotte's Web is also one of a rare handful of companies in the cannabis/hemp niche that have been able to produce a no-nonsense operating profit. Again, while there's no sugarcoating that the company's Q3 report disappointed investors, capacity upgrades are more of a short-term expense than a long-term recurring cost. I'd look for the company's profitability to once again improve in the latter half of the upcoming year.
As long as Charlotte's Web is able to continue expanding its retail presence and remains mindful of how it labels its products, I see no reason why its stock can't head higher from here.