Curaleaf Crashes On Worries About Russian Ties (OTCMKTS:CURLF)

Medical cannabis

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I have referred to Curaleaf (OTCPK:CURLF) as the “biggest and baddest operator in the room.” The US cannabis operator has a strong track record of building a wide reach, and appears set to begin improving profit margins across its coast-to-coast footprint. The stock has fallen more than peers on concerns of Russian ties, but the allegations appear hard to support and the company has firmly denied any wrongdoing. The stock trades at some premium to peers, but is still priced very attractively considering the long-term growth runway of the cannabis sector. I rate shares a strong buy and traders might consider taking advantage of the Russian-inspired selloff to build positions.

CURLF Stock Price

After trading as high as $17 per share in early 2021, CURLF has fallen down all the way to levels not seen since its IPO.

Curaleaf price chart

YCharts

At around $6 per share, the stock is clearly misvalued considering the company’s strong forward growth prospects.

What is Curaleaf?

CURLF has historically been the largest company in the US cannabis sector. While it now has stiff competition for that title, the company remains the only US operator with a coast-to-coast footprint.

curaleaf coast to coast footprint

Curaleaf November 2021 Presentation

Investors new to the cannabis space might be wondering why one should care about cannabis at all. Do you wish that you had invested in the growth of the Internet two decades ago? Cannabis is similar. Cannabis remains illegal on the federal level, but many states have already legalized cannabis themselves either for medical or recreational sales. Companies like CURLF have sought to take advantage of the federal overhang by taking market share ahead of federal legalization. We can see below that cannabis is projected to grow at a rapid rate over the next several years and end up with a $100 billion total addressable market.

cannabis market size

Curaleaf November 2021 Presentation

For reference, CURLF trades at just above a $4 billion market cap. With such a wide footprint, CURLF has exposure to a wide range of assets. In particular, investors should focus on the near to medium term catalysts in New Jersey and New York. As discussed on the earnings call, New Jersey is expected to begin recreational sales this year in May and New York is expected to come online next year. These states have minimal medical programs in the meantime, which have led investors to pay little attention to them. However we can see below that the illicit market is very large and suggests that legal sales will be very strong out of the gate.

cannabis illicit vs legal markets

Curaleaf November 2021 Presentation

Being the historically largest operator, CURLF deserves credit for having the vision to have conviction in the sector ever since early on. The company continues to differentiate itself from peers in this respect, as evidenced by its investment in Europe through its acquisition of EMMAC last year:

curaleaf in europe

Curaleaf November 2021 Presentation

CURLF Stock Earnings

The latest quarter saw CURLF deliver typically strong year over year growth of 93% to $320 million. Sequentially, revenue has been flat for many quarters, as the sector has struggled with pricing pressures and the lack of newly legalized states coming online.

Revenue comparisons

Cannabis Growth Portfolio

Looking forward, management stated on the conference call that they expect “the recent trend of softer industry growth, which began in quarter 3 of last year, will continue through the first quarter of ’22, followed by a resumption of growth in the second quarter and through the remainder of the year.”

Because of its emphasis on a wide footprint, CURLF has historically maintained among the weakest adjusted EBITDA margins in the sector. Adjusted EBITDA margin came in at 25% in the latest quarter.

Cannabis EBITDA margins

Cannabis Growth Portfolio

CURLF notes that its overall adjusted EBITDA margin is depressed largely in part due to its investment in Europe, which accounted for a 700 basis point drag. The US operations in isolation generated an approximate 32% adjusted EBITDA margin, which would put the company in-line with top tier operator Green Thumb Industries (OTCQX:GTBIF).

In 2022, CURLF has guided for adjusted EBITDA margin to expand to 28% – a positive development which is a result of continued operating leverage. However, due to ongoing regulatory delays and some sector-wide pressures, CURLF expects revenue growth to come in at only 20% to up to $1.5 billion.

If New Jersey comes online before May, then it may be able to outperform that guidance.

The thing with cannabis stocks is that growth can be lumpy because it’s largely driven by newly legalized states coming online (especially for recreational sales). Management discussed its forward growth catalysts below:

Looking beyond this year, we see several powerful tailwinds to our growth in 2023 and 2024 that we are really excited about. First, we continue to expect New York to launch its adult-use program in 2023. As a reminder, New York is expected to ultimately be the second largest U.S. cannabis market at more than $5 billion in annual sales. We believe Connecticut’s adult-use program could also begin in either late ’22 or early ’23, representing a $570 million plus market. And we expect that Pennsylvania and Maryland may be next major states in our footprint to approve adult-use, potentially launching their programs sometime in 2024. With a combined population of 19 million, Pennsylvania and Maryland represent an estimated additional $4 billion annual market opportunity. We have never been more ready to capitalize on the massive potential revenue opportunity coming in New York, New Jersey, Connecticut, Pennsylvania and Maryland. These states represent in aggregate an opportunity of $12 billion market, and we continue to believe Curaleaf will benefit disproportionately as we are one of the largest if not the largest operator in each one of these states.

Is Curaleaf Stock A Buy, Sell, or Hold?

It’s curious that in recent days CURLF has greatly underperformed peers due to the deeply unfortunate state of events in Ukraine and Russia. Certain individuals raised questions about investor connections to Russia on Twitter, which got so much traction that the company had to formally release a letter clearing up the air.

Curaleaf rebuttal of Russian ties

Curaleaf Investor Relations

This press release appears to convincingly dispel any concerns about the Russian concerns, but it was not enough to prevent the stock to underperform Tier 1 peers by double digits.

Curaleaf vs peers in price % change

YCharts

Does the recent relative underperformance present a buying opportunity? Possibly. CURLF has typically maintained a large premium to peers. However, as we can see below, that premium has all but disappeared on a price to sales basis:

cannabis valuations

Cannabis Growth Portfolio

That said, based on 2023 estimates, CURLF still trades at around 2.8x 2023e sales and 9.3x 2023e adjusted EBITDA, which would place it richer than all Tier 1 operators besides GTBIF. If one believes that CURLF can regain a premium to the pack, then perhaps there is some trading opportunity. That said, my personal opinion is that any such premium is difficult to justify. Verano (OTCQX:VRNOF) and Trulieve (OTCQX:TCNNF) trade at huge discounts but arguably should trade at premiums due to their higher profit margins.

For CURLF itself, the stock is still objectively cheap. The company is well capitalized with $299 million in cash versus $436 million of debt. The company expects to generate positive operating cash flow next year, and as one of the most reputable names in the sector, I have no concerns regarding access to capital.

Let’s talk about valuations. CURLF is trading at only 2.8x 2023e sales. For a company that can grow at a 25+% clip for many years after 2023, that multiple is too low. As compared to the tech stocks in my coverage universe, I could see CURLF trading up to at least 8x sales, equating to a stock price of $17, representing 185% upside in less than two years. Longer term, I expect cannabis to be one of the stronger secular growth stories. Right now, most of the growth is mainly coming from conversion of the illicit to legal market. Only 20% or less of American adults regularly use cannabis. In contrast, nearly 70% of American adults regularly consume alcohol. I expect cannabis use to continue to grow as society becomes more aware of the medical benefits.

Why does CURLF trade so cheaply relative to tech stocks? Most institutions are not investing in US cannabis stocks due to cannabis still being federally illegal. The lack of institutional capital has created this prolonged buying opportunity. You can see this phenomenon very clearly when we compare the valuation of CURLF with Canadian cannabis operators, which have institutional investment:

cannabis valuations

Cannabis Growth Portfolio

As we can see above, CURLF trades at a significant discount to Canadian peers on a growth-adjusted basis in spite of having significantly stronger profit margins.

I expect US cannabis stocks like CURLF to soar rapidly in the event of federal decriminalization of cannabis and in the meantime for the stocks to deliver strong compounded returns as they continue to grow year after year. A key risk to watch out for is pricing pressure. This can occur both in the near term and long term. Because cannabis is still illegal on the federal level, the legal markets still remain very small even in states where recreational sales are online. This means that until my projected normalization occurs, legal operators are often competing against themselves in an artificially small market, which can cause price compression over time. Pricing pressures also can occur if there are regulatory changes for the worse. Many of these cannabis operators are able to generate strong profit margins due to states using a limited license structure, which naturally keeps competition low and provides support to prices. If these states decide to adopt an unlimited license structure, then prices will inevitably face pressures.

These risks are likely to matter more when the stock valuations are much higher. The current valuation is not factoring in the long-term growth opportunity from cannabis first becoming legal nationwide, and finally becoming a household item. I rate CURLF a strong buy but note my preference for cheaper peers in the sector.


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