One of the best ways to play the ancillary cannabis industry, KushCo Holdings continues to grow its market share.
Founded in 2010, KushCo Holdings (which started life as Kush Bottles) is probably the largest and most recognised supplier to the cannabis industry today. The name change, which happened last year, was done in order to better reflect the broader offering and expanding product lines that KushCo was developing.
KushCo has three business units. Their main unit is Kush Supply Co. which supplies packaging and containers, design and compliance, and other turnkey solutions to cannabis companies and retailers. The primary market for the company is the recreationally legal markets, as is in these markets, the volume of product sold is far higher, and the complexity of different State-Specific laws plays right into the hands of KushCo.
The company stocks and sells over 1500 different SKUs, which cover nearly all forms of cannabis including flower, oils, vape cartridges and edibles.
A unique selling proposition for the company is that the regulations and packaging requirements from State to State can vary greatly. This is good for KushCo as they are able to create bespoke lines that cover the relevant State's legislative requirements.
A very large revenue item for the company is the all-in-one vape cartridges and pen kits, and the all-in-one disposable kits. Vaping has emerged as the most dominant (and fastest-growing) cannabis form factor. However, the recent deaths related to black market vape cartridges, and President Trump's announcement of wanting to ban all vaping, has had an impact on the stock price.
KushCo have just released a presentation that addresses the current issues and provides guidance on how the company is handling this. You can find the presentation here.
Oils and extracts are the fastest growing sector of the market. The process of cannabis extraction utilises solvents and hydrocarbons depending on the extraction method, and Kush Energy distributes these solvents and hydrocarbons, which is projected to be a very big division moving forward.
The oils and extracts market is one of the fastest growing sectors of the industry, and Kush Energy sits at the epicentre of this.
The Koleto Packaging and Hybrid Creative business units are the innovation side of the business. This arm is the one that brings new and innovative products to the market. It is these products that provide the company with the opportunity to patent and protect their products. Again, creating a unique selling proposition with protectable, and commercially valuable IP.
And finally, Hybrid Creative is the creative agency arm of the business. This agency allows KushCo to be able to offer both the supply and custom design of products. This in-house turnkey solution could also end up becoming a unique selling proposition that creates market differentiation.
Q3 2019 Financial Results
In July, the company released its Q3 2019 results for the quarter ending 31 May 2019.
As has been the trend for a while now, KushCo showed superb quarter on quarter growth of 18% to deliver top-line revenue of $42 million. To put this into perspective, this places them number two on the US cannabis industry revenue list, just behind Trulieve (CSE:TRUL) on $45 million.
Just like the various divisions of the company, KushCo divides their revenue into product segments: vaporisers, packaging, papers and supplies, and energy and natural products. The vape segment is by far the largest contributor to revenue, and more than that, is also the fastest-growing segment of total revenue. The emerging dominance of vape products is a trend we are seeing across the cannabis industry.
The company has also given forward guidance of $145-150 million in sales for the FY2019. Including this third quarter, KushCo has reported revenue of $102 million, suggested fourth-quarter revenue of around $45 million.
However, given KushCo's low gross margins, they will need significantly more revenue before they are profitable with their current gross margins.Gross Margins
KushCo's revenue has never been an issue. Quite the contrary it has been steadily increasing for the past couple of quarters. Gross margin, however, is another story altogether. And once again, KushCo delivered very weak margins. Although an improvement over the last quarter (13%) the company was unable to get that into the 20's and ended on 18% for the quarter.
There is some positive news. The company was affected by the raging tariff war that President Trump is waging through Twitter and decided not to pass on the additional costs to its clients. Should they have done so, then the margin would have been a much healthier 23%.
It's a dual-edged sword, in that the growth of the vape category has also contributed to the lower margins. The vape category, albeit the fastest-growing category, is also extremely competitive and is associated with very low margins. As KushCo continues to grow this product segment, it is going to continue to put downward pressure on margin.
During the May quarter, KushCo generated a $13 million EBITDA loss and a $23 million operating cash flow deficit. The reason for the larger operating cash flows is as a result of a dramatic increase in inventory in order to better service the current growth.
To put this in perspective, in the last twelve months, KushCo has increased their inventory levels from $12 million in Q3 2018 to $53 million in this quarter. The company pays cash for the inventory, which is yet to be sold, and hence the operating cash flow deficit is more than EBITDA.
KushCo ended the quarter with only $12 million in the bank. In addition to the operating cash flow deficit, the company also has $18 million in debt. Given the company spends lots of cash in working capital and is still trading at a cash flow deficit, a capital raise is certainly on the horizon. This would be on the back of a $20 million raise in May this year.
For some time now, KushCo has been positioning itself for an uplisting to the NASDAQ. The listing is yet to be approved, but if (and when) they get to the NASDAQ, we expect the share price to really move, as US investors are able to buy stock in one of the strongest ways to play the ancillary industry. The company continues to believe this is going to happen, given they do not touch the plant, and another ancillary company – Greenlane – recently listed on the NASDAQ.
Disclaimer: Past performance is not an indicator of future performance.
Disclaimer: past performance is not an indicator of future performance.
We really like KushCo as they have developed outstanding relationships with most of the cannabis industry. They have patented childproof packaging, and offer cannabis retailers a turnkey solution that assists them with packaging requirements, and compliance with the various state regulations governing cannabis and its packaging.
However, the great growth story is overshadowed by very poor margins and a significant cash burn. This quarter was very encouraging in that margin was up 38% on the previous quarter. The company has stated that they intend to bring gross margins up to 30% "sometime during fiscal 2020". If they were to get to that figure, then they would require somewhere in the region of $65 million in revenue to break even.
We believe that as the US opens up, KushCo is very well positioned to supply the packaging and services in order to facilitate this growth. There will undoubtedly come a time when the world's biggest packaging companies enter the cannabis market, but while it remains federally illegal and has a Schedule 1 status, this competition is not likely.
Investors should definitely keep an eye on the gross margins, as they are currently far too low.
With the quarterly cash burn and current margins, KushCo is going to have to continuously come back to the market for cash. However, if they can improve these margins and continue the top-line growth, then they may well end up becoming the Nestle of the industry.
More and more states will legalise for recreational use, and with each stroke of the legislative pen, KushCo's market expands. They have existing relationships with some of the biggest cannabis companies in the industry. They deliver a turnkey solution creating value for clients from conception to production.
At these prices, we are buying the dip, and see a bright future for KushCo. Holdings.
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