Tobacco company 22nd Century Group (XXII -4.40%) has been one of the hottest stocks to buy this year. Its shares have already climbed more than 120%, dwarfing the S&P 500 and its 13% gains. There is an awful lot of bullishness behind a business that has generated losses that have nearly eclipsed its revenue over the past year.
The company has been working on some exciting things, but it still has a long way to go in proving it is the real deal. Is this just another high-risk meme stock, or could 22nd Century make for an incredible investment opportunity?
Its low-nicotine products could be game changers
There is a lot of excitement surrounding 22nd Century's very low nicotine content (VLNC) products. The U.S. Food and Drug Administration (FDA) approved the marketing of the company's tobacco products, which contain between just 0.2 and 0.7 milligrams of nicotine per cigarette, in December 2019. Conventional cigarettes, the FDA noted, average between 10 and 14 milligrams. And studies have found that reducing nicotine levels can lower the dependence levels of smokers and even help them to quit smoking.
But despite the green light from the FDA, the company isn't rolling in sales just yet. Revenue for the first three months of 2021 totaled just $6.8 million and was down 4% on lower volumes. The company is hoping that the FDA will approve its modified risk tobacco product (MRTP) application. If it does, 22nd Century would able to let consumers know that its products contain 95% less nicotine.
However, the company filed the MRTP application two years ago, and although 22nd Century says it is in the final stages of the review process, it hasn't offered a date as to when it might get the news from the FDA.
The company also has other businesses
VLNC products are a key area for 22nd Century, but the company is also targeting what it estimates to be a $1.3 trillion global opportunity that includes tobacco, hemp, and cannabis. 22nd Century conducts cannabis research and has partnered with multiple companies to develop intellectual property. Earlier this year, it reached a deal with Keygene, a company that specializes in molecular breeding and attempts to maximize crop yields. It also has an exclusive agreement with testing company CannaMetrix, which it believes can help it commercialize new products and bring them to market faster than competitors can.
The company has recently launched a subsidiary in Canada that will enable it to more easily penetrate the cannabis market there, where marijuana is fully legal. It is pursuing multiple revenue streams for hemp and cannabis in 2021, including monetizing some of its IP. One of the companies it is working with is Canadian producer Aurora Cannabis, and it expects to generate revenue related to the IP that they share (related to commercializing cannabinoid biosynthesis) later this year.
There's also another segment to 22nd Century's business, but no further details about this one have been announced. In a June letter to shareholders, CEO James Mish said the plant-based franchise represents a $500 billion market opportunity and relates to a plant species that is similar to hemp and cannabis but "is not as highly regulated and legislated as [those] two franchises."
Is the stock too expensive?
Any time shares of a company double or triple in value, it's worth asking whether the valuation has gotten out of control. And the numbers clearly suggest that in 22nd Century's case, it has. At 25 times its revenue, 22nd Century is trading at an extremely high premium to Aurora Cannabis, a risky but more established company that investors are paying just 7 times revenue for. Although the businesses are different, it's hard to suggest that 22nd Century should be worth a larger premium than Aurora. The average holding in the SPDR S&P 500 ETF Trust is even cheaper, trading at less than 3 times its sales.
Should you buy shares of 22nd Century?
There are many red flags here that make it easy for me to look past this stock.
For one, the company keeps dangling the carrot that it will obtain MRTP approval for its tobacco products even though there's no firm timeline investors can count on. And even if it does get the OK from the FDA, there's still no guarantee the products will be in high demand. Although they may be safer, consumers may not like them, and until the numbers are there to support the company's claims, they may struggle to gain widespread approval. The cannabis business may offer more potential, but here again, investors will need to wait to see how much it can actually bring in from that segment of its operations.
The part I dislike most about the business is the secrecy surrounding its third business. If it is such a great opportunity, surely the company could at least give investors more details about it. If management is going to hold back that information, then investors should also hold back their money.
And if all that wasn't reason enough to avoid the stock, there is also its hefty valuation, which is obscene for a business that is as unproven as 22nd Century is right now.
While the market opportunity may seem promising, investors should remember that with all that market size also comes lots of competition looking to fight for it; simply being in those markets doesn't mean 22nd Century will be a big player in them.