The two top dogs in the Hemp-derived CBD industry both released their results in May. Although neither saw significant quarter-on-quarter growth, they both still stand head and shoulders above their peers.
In 2018, the Farm Bill was signed into law, which redefined hemp as an agricultural commodity and is helping to move hemp-based CBD from a "grey market" product which is of questionable federal legality and turn it into a fully-legal product. To understand how valuable these companies could be, one needs to have a better understanding of the hemp industry, and more specifically, the hemp-derived CBD industry.
The CBD industry
There are many estimates regarding the potential size of the CBD industry. The Brightfield Group estimates that the value of the CBD market will be $22 billion by 2022.
"I've been doing market research for years and covered everything. This is definitely the craziest market I've ever covered."
Bethany Gomez, director of research for the Brightfield Group
Market Watch has the industry growing at 39.5% for the next 6 years, reach ing $3.8 billion by 2025. And finally, Cowen and Co. analysts projected the revenue of this market to reach $16 billion by 2025.
No matter which estimate you use, the undeniable fact is that the industry is set to see explosive growth in the coming couple of years, and these two companies are primed to take advantage of it.
Let's start with the undisputed market leader.
Charlotte's Web is the #1 player in the US market, by SKU range, retail outlets selling their products, and general brand recognition. The brand benefitted greatly from the story of young Charlotte Fiji – who had a very severe case of epilepsy namely the Dravatt syndrome – and was able to be seizure free on the propriety hemp-derived CBD trains that the Stanley Brothers produced.
The story (and the results) were picked up by Doctor Sanjay Gupta and covered in his 4-part series on CNN on the undeniable benefits of medicinal cannabis.
CWEB has been benefiting from the federal legalisation and increasing acceptance of CBD products. This was demonstrated when on March 20th, Curaleaf made waves by announcing that CVS would be carrying Curaleaf CBD products in 800 stores. It was always unlikely that a chain like CVS would only stock one brand (especially at the beginning of the industry and their customer awareness and acceptance of such products).
The photo from "imgur" clearly shows Charlotte's Web products on the CVS shelves. From there Walgreens announced they too were going to carry CBD wellness products, further enhancing the potential for the realisation of the CBD boom. And Charlotte's Web is currently in pole position in terms of market share and brand awareness.
As of May 2019, CWEB reported that over 6,000 retailers were now stocking CWEB products. This is a massive increase from the 3,680 they reported in the previous quarter (Q4 2018), with most of the retail outlets being health food and natural product stores. But that's just retail, as they also have their own e-commerce platform. They sell online through cwhemp.com but sales have been declining online. We saw the same issue with both Elixinol and CV Sciences.
However, it's important to note that although online sales have been declining as a percentage of revenue, the overall revenue is also getting larger leading to a natural declining percentage.
Being a vertically-integrated company, CWEB operates 300 acres of irrigated farmland including company-owned land in Colorado and contract farming in Kentucky and Oregon. Combined, this allowed CWEB to produce 675,000 lbs of hemp in Q4 2018, up more than ten-fold from the prior quarter.
Charlotte's Web is due to report their Q1 2019 Earnings later in the month, but have put out guidance with preliminary results. These include:
- Organic consolidated revenue of $21M – $22M ($21.5m in Q4 2018 means almost no quarter-on-quarter growth)
- 50% from e-commerce sales (down from 65% in Q4)
- Gross Margin in a range of 70% to 75% (which is in line with their 72% achieved in Q4)
- Adjusted EBITDA1 between $4.0M to $4.5M, or approximately 20% (18% in Q4)
- Retail doors have surpassed 6,000 at May 8, 2019 (making them the largest player in the US)
- Doubling hemp acreage planting for 2019 which should have a significant impact on their production capacity, given they already smashed 10x production in the previous quarter.
- They also maintained their 2019 revenue guidance of $120 – $170 million in revenue.
As can clearly be seen from the graph above, there is almost no quarter-on-quarter growth, with margins also maintained at their current levels. Good to see positive EBITDA again, which is one of the distinguishing features of the CBD focussed companies operating in the cannabis market.
Before analysing their results any further, let's consider CV Science's Q1 2019 results and from there we can compare the results.
Our final US play operates in the booming Hemp industry. CV Sciences, operates through two segments, Specialty Pharmaceuticals, and Consumer Products. The company focuses on developing and commercialising prescription drugs utilising synthetic cannabidiol (CBD) as the active pharmaceutical ingredient. Its initial drug candidate is CVSI-007 that combines CBD and nicotine for the treatment of smokeless tobacco use and addiction.
The company also engages in the development, manufacture, marketing, and sale of consumer products containing Hemp-based CBD under the PlusCBD Oil name in various market sectors, including nutraceutical, beauty care, specialty foods, and vape.
A well-run business with great management, and a solid track record, they are one of the best placed to take advantage of the massive Hemp market currently opening up across the US. The Farm Bill of 2018 has, without doubt, lifted the tides for all companies operating in the hemp-derived CBD space, and CV Sciences is primed to take advantage of this.
Just like Charlotte's Web, CV Sciences had only 5% quarter-on-quarter revenue growth. However, their gross margins did improve, which is something we were hoping to see. But in a balancing act to that good news, their operating costs blew out to almost $20 million from $6.6 million in the previous quarter.
However, on closer inspection, $8.8 million of this was as a result of Michael Mona Jr exiting the company. The founder and former-CEO was removed from office ("retired" they called it) in January 2019 as a result of SEC charges against him relating to 2013. He had previously stepped down from his role as president and CEO in mid-2018, in a move that was likely forced by the SEC. And this exit (albeit very good for the company) was not cheap.
CVSI had to accelerate the vesting of his restricted stock units and took $934,000 in accrued payroll and benefits associated with Mona Jr. All in all, the exit cost the company $8.8 million.
Undoubtedly, the biggest news of the quarter was the announcement that CVS was adding PlusCBD to 800 of its stores. This led to a 48% increase in retail store count, from 2,238 on Dec 31st to 3,308 on Mar 31st.
Given this occurred late in the quarter, the sales result of the nearly 50% increase in retail footprint hasn't really moved the dial in this quarter. Investors should definitely look out for increases in the coming quarters (and big ones at that).
And finally, once again, CV Sciences management suggested that it remains in dialogue with the NASDAQ about a potential up-listing. We've been hearing this for almost 12 months now. Make no mistake though, an up-listing to the NASDAQ would be huge for the company in allowing US investors to really jump on board the story.
"The first quarter was a milestone for CV Sciences' as we shipped our first order to the national drug retailer, CVS marking the beginning of what we believe will be broad expansion of CBD products across national food, drug and mass merchandiser accounts."
Joseph Dowling, CEO, First Quarter Earnings Call
Revenue and margins
As mentioned above, revenue grew by 5% QoQ to $14.9 million. Ordinarily, we would not be impressed with 5% for the quarter, however, the retail store count for the quarter increased by 48%. Gross margins increased this quarter to 71% (up from 65% gross margins last quarter).
Operating costs for the quarter came in at $19.9 million, a huge increase over the $6.6m in the previous quarter. Even after removing the one-one-time charge to remove Mona Jr, their operating costs would have come in at $11.1 which is still a significant increase on the previous quarter. The company put this down to investments in "additional management resources and business systems."
Even without that charge, however, operating costs would still have increased from $6.6 million to $11.1 million – a very sizeable increase. During their earnings call, management explained that their headcount had doubled in the past year, including the addition of more management resources and business systems. This may explain some of this increase as CVSI prepares for a new world for CBD, where their products are sold in CVS and potentially other national chains.
This increase in operating costs is a negative for CV Sciences and will hinder their ability to generate operating leverage in the short-term. Over the coming quarters, I want to see revenue growth without accompanying operating cost increases as CVSI gains operating leverage. This quarter, we saw the opposite – flat revenue with a big jump in operating costs.
CV Sciences was not profitable this quarter with EBITDA losses of $9.2 million. However, it would be fair to remove the $8.8 million paid to Mona Jr as that would not be a recurring payment. CVSI thus makes a minimal loss, and with the additional 800 stores coming onboard via CVS, we expect this small loss to turn into a significant gain in the coming quarters.
As of Dec 31st, CVSI had $13.6 million in cash, up from $12.7 million last quarter. This is partly offset by $273,000 in debt, resulting in a net cash position of $13.4 million. Over the past year, CVSI has increased its cash position each quarter, from a base of $3.1 million a year ago.
So how do the two compare?
Charlotte's Web, which has the edge on CV Sciences on virtually every metric, but you are paying a lot more for Charlotte's Web. To be fair, given they are the market leader, and the #1 most recognisable brand, they deserve a premium. The real question is though…just how big?
CWEB beats CVSI on all metrics, including revenue (43%) and retail store count (82%), but the stock price is over 4 times greater, with a market cap nearly three times bigger. This is the main reason why we are so bullish omg CVSI. It has nearly the same margins as CWEB, and with their new CVS contract, they are very well positioned to capitalise on the booming CBD wellness market.
But we must add that we like both companies and have both in our Paper Portfolio.
If investors believe that the CBD market will grow as rapidly as forecast – or more rapidly – both companies may offer attractive values moving forward given projected revenue growth. Make no mistake though, this market is only going to become more and more competitive. Both companies are going to have to keep raising the bar, and most importantly start delivering on both revenue and EBITDA.
For the moment, however, it certainly looks like CWEB is winning the battle of the big green giants!
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