The cannabis industry appears to have lost steam in recent years. The industry's enthusiasm is low because there has been little progress toward federal legalization. However, the industry as a whole is rapidly expanding. Marijuana is becoming legal in an increasing number of U.S. states and countries.
Multi-state retailer Cresco Labs (CRLBF -4.76%) did not expand as rapidly as its competitors. Yet, it is now one of the top five cannabis companies in the U.S. in terms of trailing-12-month revenue. However, industry headwinds appear to be weighing on this marijuana grower. Let's look at the Illinois-based company's most recent results to see whether it's a good buy right now.
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The bull case for Cresco Labs
Cresco Labs does not have a stronghold on the American cannabis market yet, but it is giving its peers stiff competition. In 2022, the company earned $843 million in revenue despite having only 61 dispensaries.
For context, peer Trulieve Cannabis has 181 dispensaries and earned a little over $1.2 billion in 2022, and Curaleaf Holdings, which operates 152 dispensaries, made $1.3 billion in revenue in 2022.
However, the company has not had a good start in 2023. Revenue fell 9% year over year to $194 million in the company's most recent first quarter. Management attributed the decline to a 5.6% drop in sales in Illinois as the new recreational market in Missouri put pressure on border states. Cresco does not have any stores in Missouri yet.
The revenue dip caused adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to fall to $29 million from $51 million in the previous year's quarter. Cresco is not yet profitable but is working hard to get there soon.
It closed down underutilized and unprofitable facilities in California and Arizona, which management considers the "lowest margin states." The company anticipates these strategies will help it improve its margins by the end of the second quarter. According to management, the company's most important goal for this year is to generate free cash flow. Obtaining positive free cash flow will help the company reduce its debt burden.
Cresco opened its 29th Sunnyside dispensary in Florida in April, bringing its total to 64 across the country. Cresco's hold on the American market could grow if regulators approve the acquisition of Columbia Care. The $2 billion deal that both companies agreed on last year was supposed to be completed by June, but management announced alongside the earnings release that the completion date has not been finalized yet. Cresco's portfolio will grow by 130 dispensaries once the deal seals.
The bear case for Cresco Labs
Though the company is doing well despite having fewer stores, the Columbia acquisition (when completed) will place it in a stronger position in the cannabis space as the industry expands. As more states legalize cannabis, Ohio, Pennsylvania, and Florida may present good opportunities.
However, a greater number of stores does not always imply greater revenue. Trulieve and Curaleaf are still struggling to grow revenue, as evidenced by their recent quarterly results. Oversupply and pricing issues currently impact all cannabis companies, regardless of market share.
CRLBF Debt to Equity Ratio data by YCharts.
Furthermore, the Columbia acquisition increased Cresco's debt load. It has a sizable debt-to-equity ratio of 0.76. A higher ratio indicates the company relies heavily on debt to survive and expand. The company had $90 million in cash, cash equivalents, and restricted cash at the end of the quarter. Cresco will struggle to reduce its debt burden unless it begins to generate profits.
Cannabis remains illegal on a U.S. federal level. As a result, acquiring capital for marijuana growers remains challenging. Raising capital through stock dilution will be the last resort in such a case, affecting shareholders' positions.
Cresco's long-term prospects remain bright if or when the merger is complete. As a bigger business, it may decide to expand internationally since European markets are rapidly expanding. Allied Market Research shows the global cannabis market could be worth $149 billion by 2031. However, cannabis investors must have a strong appetite for risk as well as patience.
If you have the fortitude to wait for Cresco to reach its full potential over the next few years, the stock is currently undervalued with a price-to-sales ratio of just 0.6, making now an excellent time to invest.
