The cannabis industry is going through some interesting times. It’s something we touched on in our recent piece on The Paradox of Marijuana Stocks. Sales are supposed to be going through the roof, yet not all companies will be around to take advantage of the “boom” as capital dries up. The end result is a cannabis industry that collectively stagnates.
We recently drove through the Pacific Northwest doing field research on what’s going on at dispensaries. The price of edibles has gone through the roof for some reason, and the “budtenders” refuse to acknowledge this. You won’t find 100 MG of edibles under $15 USD. That’s when we learned about Rick Simpson Oil. You gotta try this stuff. Essentially, it’s a syringe loaded with what appears to be black tar heroin, but is actually a cannabis plant extract that contains 1,000 MG of THC. At a price point of $15, it’s hard to comprehend why anyone would even buy edibles.
Anyways, today we’re here to talk about another emerging trend in the cannabis industry that’s undergoing some change – cannabidiol (CBD).
CBD as an Investment Thesis
Just to bring you all up to speed on the CBD investment thesis, it’s different from the larger cannabis theme in a number of ways. CBD products do not contain THC (the good stuff that gets you high), so it’s not regulated like cannabis is but instead falls into some sort of grey area. You’re not allowed to call it a supplement, so it’s this extract that’s supposed to have good properties for people. For example, pop a few CBD capsules every day and you may start sleeping better or feel less stressed. Or you might feel nothing at all. Most people who take the stuff can’t really tell if it’s working or not, so naturally real CBD is hardly distinguishable from fake CBD, and there’s plenty of snake oil out there. It’s difficult to say if CBD is just a passing fad or something that will continue to gain traction. A company called Charlotte’s Web Holdings Inc (CWEB:CN) really hopes that this isn’t a passing fad.
Why is Charlotte’s Web Stock Dropping?
Cannabis investors have been in a world of hurt as cannabis stocks like Canopy Growth have been crashing lately. It’s expected that the CBD companies would be correlated to these price movements, and for Charlotte’s Web that appears to be the case. Exactly one year ago we speculated that a fair price for Charlotte’s Web stock was $20 CAD per share based on the fact they sold a bunch of shares at that price to institutional investors. That investment didn’t age well. Today, shares are trading at $5.74, a drop of -71%. That gives CWEB a present-day market cap of around $620 million CAD.
Of course, experienced investors know that this number only has meaning when compared to a benchmark. Over the past 365 days, the cannabis sector as measured by the first pot stock ETF – HMMJ – has plummeted an astounding -70%. If the CBD space is correlated to the broader cannabis industry, then the Charlotte’s Web stock price drop is to be expected. However, we don’t want to leave it at that.
To help understand why Charlotte’s Web stock is dropping, we need to look at any company-specific events that may help explain the drop. From CWEB’s latest annual report, here are announcements that may have negative connotations.
- In August 2019, the CFO resigned, and two weeks later they changed their auditor from MNP LLP to Ernst and Young LLP.
- In December 2019, they sold 5 million shares of common stock at $13.25 to raise about $66 million CAD.
- A class action lawsuit was filed in January 2020 claiming that some of their topical products didn’t contain enough key ingredient.
Charlotte’s Web has a really great story which we were immediately attracted to, but like any firm there is what we call company-specific risk. Having your CFO resign, and your auditing firm replaced weeks after, isn’t a good look, but at least if there was a problem it’s been rectified. The shares they issued would have increased outstanding shares by about 5% so not a huge impact to existing shareholders. As for the class action lawsuit, sounds rubbish but they’ll still need to dedicate loads of time and money towards the problem. What we’re far more concerned about is a piece issued by the FDA titled “What You Need to Know (And What We’re Working to Find Out) About Products Containing Cannabis or Cannabis-derived Compounds, Including CBD.” It says things like “CBD has the potential to harm you, and harm can happen even before you become aware of it,” and “CBD can cause liver injury.” More importantly, it says “It is currently illegal to market CBD by adding it to a food or labeling it as a dietary supplement.”
These comments from the FDA are likely to error on the side of caution as they do some due diligence, but they’re hardly helpful when your business is to sell CBD products in various forms. The good news is that the FDA is actively working towards establishing some regulation around CBD, and CBD companies are certainly helping to drive that forward. We previously wrote about how CWEB stacked up against an Australian CBD company called Elixinol. That stock has been an utter disaster, losing more than -90% of its value over the past year.
The Latest Earnings From Charlotte’s Web
This morning Charlotte’s Web released Q1-2020 earnings which saw revenue for this quarter largely unchanged from the same quarter in 2019. Earnings went into the red though, as their admin costs doubled since the first quarter of 2019. This led to an adjusted EBITDA loss of $5.7 million CAD. Their CBD product can be found in over 11,000 retail locations, but the majority of their sales are direct-to-consumer. They have around $53 million CAD in cash to hold them over until income turns positive again.
In regards to the yearly numbers, growth continues, but operating expenses have increased sharply leading them into the red.
You don’t want to be burning cash right now given that the entire cannabis space is starting to realize funding is drying up. Having a bunch of added legal costs won’t help the situation much either. Could Charlotte’s Web stock be a buy at the current price? If we’ve learned anything from our last piece on Charlotte’s Web, it’s that you don’t try to call the bottom for a stock, no matter what price they’re selling shares at.
We’ve always been wary about investing in the cannabis industry because there are far too many regulatory risks right now. While every cannabis stock out there soared to new heights as investors piled in, we warned about the excessive number of scams being perpetrated. Expert investors see the opportunity to be in the “ancillary cannabis sector” which is businesses that can benefit from the growth of cannabis without incurring any regulatory risk.
As for the CBD market specifically, CWEB may have majority market share, but that hardly matters if CBD falls out of favor for any number of reasons. We need to know more about beneficial hemp compounds so that they can be regulated and marketed for what they are. While we continue to think that Charlotte’s Web is a great company with a great story, we’re on the sidelines for both CBD and THC investment themes.