Cannabis stocks have been underperforming for the last two years due to a lack of progress toward federal legalization in the U.S. Given the high risk involved, cannabis investing is not for the faint of heart. However, it is an evolving sector with a lot of room to grow. Savvy investors understand that it may take some time, but cannabis stocks have the potential to transform your portfolio if you are willing to take the risk and hold them for the long term.
Curaleaf Holdings (CURLF 5.26%), a multi-state operator (MSO), has been a dominant player in the U.S. cannabis industry, with stellar revenue growth. However, industry headwinds are beginning to have an impact on the company. Will it be able to continue its growth streak and become a major player in the cannabis industry? Let's take a closer look to see if it's worthwhile to invest in Curaleaf right now.
The bull case for Curaleaf
Curaleaf has long held the top revenue contender title in the U.S. cannabis industry. The company earned $1.3 billion in revenue in 2022. Curaleaf retains its leadership position, despite competition from Trulieve Cannabis, which has 181 stores nationwide and $1.2 billion in revenue over the same period.
Curaleaf's growth has been aided by smart and timely acquisitions between 2019 and 2021. Among them are the acquisitions of cannabis operators and brands such as Curaleaf NJ, Blue Kudu, Select, Remedy, and Grassroots.
While most cannabis companies continue to struggle with revenue growth, Curaleaf's revenue grew 14% year on year to $336 million in the first quarter of 2023. Upcoming states' cannabis legalization could further boost sales. For example, when recreational cannabis is legalized in Florida, it could be a significant market. Florida is a limited-license market, which means that only a few cannabis companies are permitted to operate there. Curaleaf operates 60 stores in the state, giving it a competitive advantage when the recreational market opens.
Experts predict that a few more states will legalize cannabis this year, providing more opportunities for Curaleaf. The MSO now has 152 locations in 19 states.
Aside from the domestic market, Curaleaf's management is optimistic about international growth in the coming years as legalization spreads across more European countries. In Europe, the company operates as Curaleaf International, and revenue increased 53% year over year to $12.5 million in the quarter.
The European cannabis market is currently a highly profitable opportunity, expected to grow at a compound annual rate of 61% to reach a value of $14 billion by 2028.
The bear case for Curaleaf
Curaleaf's revenue may have increased as a result of the acquisitions, but the company's bottom line has yet to improve. The cannabis oversupply situation is delaying the company's ability to turn a profit. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) fell 4% year over year to $71 million. In fact, its net loss deepened to $54 million in the first quarter from $36 million the previous year.
Curaleaf is still not profitable but is making all efforts to make that possible soon. To cut costs, it recently closed down underperforming facilities in California, Colorado, and Oregon.
Furthermore, acquisitions have weighed heavily on the company's balance sheet due to its rapid expansion. The company is shutting down unprofitable operations but is also opening more stores to take advantage of the new markets. Investors will have to monitor future earnings reports to see whether this proves to be a boon or bane for the company.
So far this year, it has opened 26 new stores. Cannabis operators face challenges in raising capital because the drug is still illegal on a federal level. As a result, raising capital through secondary stock offerings becomes a last resort that dilutes stockholder positions.
New cannabis markets could bring in more sales for the company. However, if management isn't cautious, rapid expansion could devastate the company's balance sheet and undo all of its hard work to date.
The company ended the quarter with $116 million in cash, and $593.8 million in outstanding debt after deducting unamortized debt discounts in Q1. Considering debt management and its waning cash position, it seems that "last resort" could become a likely option.
CURLF Debt to Equity Ratio data by YCharts
As depicted in the chart above, Curaleaf's debt-to-equity ratio is 0.49, indicating that it is heavily reliant on debt compared to its peers, to fund its growth strategies. It will be difficult for the company to reduce its debt until it generates profits.
Curaleaf anticipates generating $50 million to $60 million in free cash flow in 2023, which would help clear some debt. However, the company has yet to generate positive free cash flow in its history.
Wall Street says there's potential, but the bears may be right
Curaleaf is currently trading at a low price-to-sales ratio of 1.5. Wall Street analysts see a potential upside of 185% for Curaleaf's stock in the next 12 months. The estimate could be based on the potential of the industry.
This is not impossible in a rapidly evolving industry like cannabis. Any incremental progress toward legalization could boost the stock in the short term. However, for its financials to support future growth, the company must be profitable and reduce its debt. Given this, I believe Curaleaf is a risky stock to invest in right now. Only investors with a high-risk tolerance and a willingness to wait for Curaleaf to reach its full potential should consider investing in this cannabis stock now.
