What's better than selling a copious amount of marijuana? Selling an even more copious amount of marijuana, more efficiently than before, and to an everwidening audience. Assuming you're a cannabis cultivation company, that is.
Currently, marijuana wholesaler Cresco Labs (CRLBF -1.64%) is living the dream. But, despite its favorable growth trajectory, its appeal to investors may not be as sky-high as it is to its customers. Competition within the industry is rising, and Cresco still isn't listed on any U.S. stock exchange. Likewise, for all its strengths, it still hasn't proven that its business model is viable in the long term. Let's examine where the company is at right now to see if these issues should cause investors to steer clear.
Why you should buy it
In my mind, there are several strong reasons to buy this stock. First, Cresco's quarterly revenue is growing explosively at a rate of 326.6% year over year. Growth like that could ebb over the next year and easily remain in the triple-digits.
It's growing so rapidly because it's already the largest cannabis wholesaler in the American market. The company derives 59% of its revenue from wholesale transactions, which is significantly more than its primary competitors like Curaleaf. As the rest of the industry expands market penetration in the form of retail locations, Cresco keeps pace by benefiting from economies of scale. Management is committed to maintaining its lead in wholesaling in the long term because that's where they think margins will be the highest. It's clear that the strategy is working -- so far.
Speaking of margins, management has also pushed forward with selling, general, and administrative (SG&A) cost cuts and other helpful improvements. In particular, its cultivation facilities in Illinois and Pennsylvania are becoming more efficient quite rapidly. Management credits the efficiency improvements at these facilities in particular for an improvement in operational gross profit as a percentage of revenue coming in at 53% in the quarter, compared to 47% in the previous quarter.
Most importantly, thanks to falling costs and rising revenue, the company's most recent adjusted earnings before interest, taxes, amortization, and depreciation (EBITDA) of $46.4 million are the largest it has ever reported. Its $17.8 million in cash flow from operations is also a company record.
Why it might be better to wait
Even though its core financial metrics are improving rapidly, Cresco is still unprofitable, with a negative profit margin of 17.88%. But compared to companies like Aurora Cannabis, it's much closer to consistently profitable operations. Unfortunately, management hasn't provided any explicit estimates for when profitability might occur. My estimate, based on the last few quarters of data, is that it might be profitable by the end of 2021, which is a bit far in the future for conservative investors looking to make a decision today.
Furthermore, Cresco competes in the medicinal and recreational cannabis markets, but its portfolio of adult use brands is far larger than its medicinal holdings. As the marijuana industry experiences rising business competition from a wave of legalization in the U.S., it may not be able to defend its medicinal market share against others as a result. This is especially concerning because it enjoys a higher price point with its Remedi medicinal brand in comparison to its adult-use brands like Good News and its newest brand, High Supply. If the price is right for medicinal cannabis, why does management continue to advance with lower-price and less-differentiated brands?
That last question isn't a dealbreaker for me. The overall strategy -- wholesaling and focusing on the recreational market -- appears to be working. Management has shown that it is effective at lowering costs, increasing sales revenue, and scaling production capacity keenly with demand. As far as cannabis stocks go, Cresco is a winner, even if it hasn't proven that its operations are sustainable in the long run yet. I'd be comfortable with buying this stock today, and I expect that waiting a year would make the decision even easier.