Source: Author based on company filings.
Charlotte’s Web (OTCQX:CWBHF) (“CWEB”) is the largest and most valuable cannabidiol (“CBD”) company. Their brand is likely the best-known CBD brand, and their products tend to command premium prices over competitors. CBD is a cannabinoid which does not get users high, but may offer medical benefits. After the 2019 Farm Bill, CBD is de-scheduled, but the FDA has not approved any medical claims of CBD aside from Epidiolex for seizures. Notably, the dosage of Epidiolex is much higher than for over-the-counter CBD users:
Lack of FDA clarity: One year ago, CBD companies were all the rage, and CWEB stock traded for as much as $24 in April 2019. However, share prices have been hurt by waning investor enthusiasm for CBD, inconsistent financial performance, and continued FDA inaction on allowing oral CBD over the counter. The latter factor has meant that, while major retailers like CVS (NYSE: CVS) and Walgreens (NASDAQ: WBA) have dabbled in selling CBD products, they have avoided selling ingestible CBD products – the best-selling type of CBD products – and have only sold topical CBD products like lip balm and skin rubs. There is limited scientific evidence that CBD has any therapeutic effect applied topically at over-the-counter dosage levels.
CVS sells Charlotte’s Web products, but only topical products like skin balms. Source: CVS.com on March 24, 2020.
Choppy financial results: Charlotte’s Web share prices have declined more than 80% from the 2019 peak due largely to choppy financial results including slowing growth and worsening margins and profitability.
Charlotte’s Web had choppy revenue growth and declining EBITDA margins in 2019. Source: Author based on company filings.
On March 24, 2020, Charlotte’s Web reported its results for the fourth quarter. Those results missed analyst estimates on revenue and EPS and showed CWEB’s first decline in revenue in at least 12 quarters. Among other results in this earnings release:
- Revenue declined sequentially for the first time in at least 12 quarters. Revenue fell 9% to $22.8 million.
- Revenue is forecast to decline next quarter, with CWEB forecasting $20 million of revenue. Annual revenue should rise 10-20% for the year, partly driven by the move into topical products with the purchase of Abacus Health Products (OTCPK:ABAHF).
- Gross margins slipped to -9%, driven by $14 million of impairments. Even without impairments, gross margins fell to 54%, down 17 percentage points from last quarter.
- Adjusted EBITDA fell to a ($10.2) million loss. This loss excludes the $14 million of impairment, or it would be much worse. This is CWEB’s first Adjusted EBITDA loss in at least 12 quarters.
Charlotte’s Web is forecasting a weak first quarter, with their first ever year-over-year revenue decline as a public company. After that quarter, results should improve, driven by a stronger move into consumer packaged goods and topical products with the purchase of Abacus Health Products.
Purchasing Abacus & Moving Towards The Mainstream
On March 23, 2020, Charlotte’s Web announced a C$99 million all-stock acquisition of Abacus Health Products. Under the terms of the transaction, Abacus shareholders will receive 0.85 CWBHF shares for each ABAHF share they own. At the time the deal was announced, this was a value of C$4.39 per Abacus share and a 38% premium over Abacus’s market price.
As of this writing, CWEB shares trade for $4.06, so Abacus investors will receive $3.45 in compensation for each share they own. Rather than narrowing, the merger premium had widened to 45%. This widening premium may reflect investor disbelief that the deal will close as it was announced, as several major cannabis mergers have fallen through, including MedMen’s (OTCQB:MMNFF) acquisition of PharmaCann.
Source: Abacus Health on March 24, 2020.
Abacus makes a wide range of CBD topical products under the CBD Clinic and CBD Medic brand names. They have an endorsement deal with former New England Patriots tight end Rob Gronkowski.
Charlotte’s Web will seek to leverage Abacus’s strengths in topical products and distribution while reducing their operating costs. Through three quarters of 2019, Abacus has generated sales of $11.1 million with 62% gross margins but is unprofitable due to high operating costs.
Charlotte’s Web sold $95 million of products in 2019 and expects a 10-20% sales increase in 2020 to perhaps $110 million at midpoint (excluding Abacus). Prior to fourth quarter earnings, analysts were forecasting forward revenue of $214 million. Excluding Abacus, this implies that CWEB trades for ~3.4x forward sales.
Charlotte’s Web costs were too high and were hurt by $14 million in impairments, reflected here in their gross costs. Source: Author based on company filings.
Given $110 million in revenue, it will be difficult for CWEB to make meaningful profit this year. CWEB has historically generated about 70% gross margins, although that fell hard this quarter, but spent $26 million on operating costs in the fourth quarter. If those operating costs are maintained, CWEB may generate $77 million in gross profits but spend $104 million in operating costs – resulting in $27 million in annual operating losses.
Despite the likelihood of losses, CWEB will have the relative security of a commercial banking relationship and line of credit with JPMorgan Chase, announced on March 23, 2020.
More bullish investors will look to CWEB’s strong brand, historic profitability, and the prospects of FDA regulatory oversight on CBD as reasons to remain invested in CWEB.
However, given low prospects for near-term profitability and limited growth in 2020, I believe Charlotte’s Web is fully valued at its current price, and there are better investment opportunities elsewhere in the cannabis sector.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.