BTI - Why I Still Don't Like Charlotte's Web Stock

2023-03-06 03:03:03 ET

Summary

• I have followed Charlotte's Web since it went public in 2018.
• The stock appears to be cheap, but I don't own it in my model portfolios.
• I explain here why the stock doesn't attract me.

Charlotte's Web ( OTCQX:CWBHF ), a leading CBD innovator, went public in Canada in September 2018, selling 13.3 million shares at C$7 and raising C$93.2 million. It also sold additional shares privately, increasing the gross proceeds to about C$99 million, which today would be $73 million in the United States. Today, the stock trades way lower, with a market cap for the entire company of about $59 million. The price has declined from C$7 to C$0.52 on the Toronto Stock Exchange, down 93% from the IPO.

While Charlotte's Web has declined a lot and appears cheap, I don't include it in either my Beat the Global Cannabis Stock Index or my Beat the American Cannabis Operator Index model portfolios. In this piece, I explain why I am not a fan of the stock.

Fundamentals

The CBD industry is struggling due to the lack of regulation by the FDA, which pushed the issue to Congress, which passed the 2018 Farm Act in late 2018 that legalized hemp growing and opened the door to CBD production. In the first three quarters of 2022, Charlotte's Web saw revenue fall 22% to $55.3 million. In Q3, they fell 28% from a year ago. Gross margin has compressed significantly to 54.2% for the year-to-date, down from 62.3% for the first three quarters in 2021. The year-to-date operating loss has expanded from $19.5 million to $24.1 million. The company used $2.6 million to fund its operations through September.

Revenue peaked under $100 million after surging initially following the IPO. Here is the history, including the estimate for 2022:

Looking ahead, analysts project revenue will increase just 4% in 2023 to $81 million. Operating income is expected to improve slightly to -$25 million, and adjusted EBITDA is expected to improve from -$16 million to -$7 million, still a loss. The outlook for 2024 is much stronger, with revenue projected at $126 million with adjusted EBITDA of $10 million.

One of the very interesting things recently was the convertible note bought by British American Tobacco ( BTI ) that was announced right after the company reported Q3 in November. BAT invested $56.8 million in the company through an out-of-the-money convertible note with a conversion price of C$2. Lots of folks were excited by this, but I saw it as a negative. BAT could have bought the stock, but it took debt instead.

Another recent announcement that excited the market but not me was the deal with Major League Baseball disclosed in October. The company will provide the "official CBD of Major League Baseball." I doubt that it will be very successful commercially, and the deal locked the company into a big up-front expense. Charlotte's Web issued MLB 6.12 million shares, 4% of the company, and it will pay rights fees to MLB through the end of 2025. An 8-K filed by the company revealed that the rights fee would be $30.5 million with a 10% royalty fee for sales above the first $18 million.

Valuation

The company has about 152 million shares outstanding, and its dilutive securities are way out-of-the-money. The market cap is $59 million, and the cash net debt now is about $16 million. This results in an enterprise value of just $43 million, which seems very low to revenue and to projected 2024 adjusted EBITDA of $10 million. The company went from no debt to a lot of debt with the convertible note with BAT, and this could become a problem. I also don't really have confidence that the company will achieve the estimates for 2024.

The cannabis industry has plenty of low valuations, but many of the companies with those low valuations are generating cash flow from their operations and/or trade below book value. Charlotte's Web isn't really generating cash, but it is trading well below its tangible book value of $107 million.

At year-end, the stock could trade at $100 million enterprise value, an EV/adjusted EBITDA for 2024 of 10X, which would suggest a market cap of about $115 million, or $0.76. This would still be near tangible book value and would represent a gain of 95% from where it recently closed, $0.39. That level doesn't seem that likely to me, though I would expect to raise my target if the FDA begins regulating the CBD industry. Another factor that could become positive in time is that the company could acquire the THC business of the Stanley Brothers. It holds an option to do so.

Chart

Charlotte's Web did well in its early days after going public, but it now trades well below its 2020 low:

Looking at the recent action in a chart, the stock is close to its all-time low:

The volume has gotten so low that it doesn't qualify at New Cannabis Ventures for inclusion in the Global Cannabis Stock Index or the American Cannabis Operator Index .

Conclusion

I find Charlotte's Web to be cheap and to have the potential to rally, but I don't include it in my model portfolios. The stock isn't in the indices that I am trying to outperform, and it doesn't seem extremely cheap like so many cannabis stocks. With a low price to tangible book value ratio and a strong brand, the stock could do well, especially if the FDA begins to regulate the CBD industry.

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