Curaleaf: Former Leader In U.S. Cannabis Remains Buyable

Curaleaf (OTCPK:CURLF) was once considered a clear leader in the US cannabis market. But the current stock price makes it look more like a penny stock as the entire sector has been going through a vicious crash ever since it became clear in 2021 that hopes for federal legalization were premature. While CURLF no longer has the same size gap ahead of peers as it had in the past, it remains the only multi-state operator (‘MSO’) to invest meaningfully in Europe. The fundamental picture for US cannabis operators has deteriorated meaningfully over the past several quarters as price compression from supply-demand imbalances have coincided with a recessionary environment. CURLF has a highly leveraged balance sheet which may be a source of weakness amidst rising interest rates. The stock is still cheap here, though one must question if the stock is worth buying ahead of similar quality peers.

CURLF Stock Price

CURLF has fallen so much that it is now trading nearly where it was during the pandemic crash. That is surprising considering that cannabis sales boomed following the pandemic.

I last covered CURLF in October where I discussed the company’s prospects following Biden’s announced intentions for cannabis reform. The stock has since dipped 23% as further legalization progress has not materialized. Is the stock still worth buying even without imminent legalization?

CURLF Stock Key Metrics

With peers like Trulieve (OTCQX:TCNNF), Verano (OTCQX:VRNOF), and Cresco (OTCQX:CRLBF) now possessing wide footprints, CURLF is no longer the only “king” in US cannabis. Yet the company still retains a wide 21 state presence.

CURLF is also the only MSO to have made meaningful investments in Europe, as it has exposure to the U.K, Germany, Italy, Switzerland, and Portugal. Whether or not that exposure is a positive is unclear as it remains a loss-generating business segment.

The latest quarter saw revenues grow 7% YOY to $340 million. That number reflected anemic 0.6% sequential growth. Gross margin was 49%, higher than 46% in the third quarter of 2021 but lower than 52% in the sequential quarter as the company faced a great deal of price compression. Adjusted EBITDA of $84 million reflected a 25% margin, lower 1% sequentially but 2% higher YOY.

CURLF has historically been a “scale-up” kind of story, so the lack of sequential improvement is a clear negative.

On the conference call, management noted that it continues to show strength in New Jersey, with “close to a 30% market share” that looks set to increase with its third store (this one located in Bordentown) having come online on November 1st subsequent to the quarter end. CURLF maintains a strong position in New York as a medical cannabis operator ahead of the launch of adult-use sales. Sentiment toward the state has soured ever since recent developments have shown preferential treatment for social equity licensees at the expense of the MSOs. Management nonetheless believes that the final roll-out will be one in which the MSOs play a meaningful role in adult-use sales.

Looking ahead, management expects up to $355 million of revenue in the fourth quarter, reflecting continued pressure from price compression. With such a wide footprint, profit margins vary greatly across core and investment markets. Whereas management touts 30% EBITDA margins in its core markets, they note that investment markets have a 750 basis point drag on overall margins, with their European investments representing about a third of that impact. Given the rising interest rate environment, I question whether the company should be investing so heavily in loss-generating markets at the current time.

The company ended the quarter with $198 million of cash versus $599 million of debt for a 1.9x debt to EBITDA ratio.

While 1.9x debt to EBITDA might not sound unreasonable for what is arguably a consumer staples company, I must note that due to cannabis being federally illegal in the United States, CURLF pays far higher tax rates and interest rates than the typical consumer staples company, making that leverage figure rather understated.

Cannabis stocks have been hit hard in part due to the realization that legislative reform will not happen that quickly. I have positioned the portfolio without any expectation for legislative reform, with a focus on operators capable of generating positive cash flow even under current market conditions. I define free cash flow as being adjusted EBITDA minus interest and tax expenses. CURLF generated $15.7 million of free cash flow in the latest quarter, though it is unclear how that number will be affected once CURLF completes its transition to GAAP accounting standards.

Is CURLF Stock A Buy, Sell, or Hold?

While the cannabis sector has been hit hard over the past year, the future remains promising. The legal market is expected to be one of the few sectors to sustain a double-digit growth rate over the next several years.

That growth is understandable considering the wide ranging medical applications of the plant, as well as the numerous states which have yet to come online for medical or adult-use sales. CURLF offers one way to invest in the US cannabis sector ahead of full-blown legalization.

Yet is CURLF the best buy in the sector? I continue to view the answer to that question as a resounding “no.” CURLF trades at a material premium to Tier 1 peers like Green Thumb (OTCQX:GTBIF), Trulieve (OTCQX:TCNNF), and Cresco Labs (OTCQX:CRLBF).

The sector-wide pricing pressures have prevented CURLF from making further progress on margin expansion, making one wonder why the large premium exists. Further, GTBIF maintains a cleaner balance sheet and is GAAP profitable – if anything GTBIF should be the one maintaining a wide premium. I suspect that CURLF may be retaining a premium due to historical reasons, as it was the first big MSO after it acquired Select in 2019. Yet a wide footprint is not necessarily justification for a premium, especially if the company is unable to drive higher margins. One could even make an argument that its exposure to loss-generating markets is actually a negative and not something that people should be willing to pay a premium for. Further, as stated earlier, other Tier 1 operators now have businesses highly comparable in size to CURLF. I note that in late-January, the company announced that it was exiting loss-generating states of California, Oregon, and Colorado. I am hopeful that such actions may help bolster the bottom line.

I can see upside here. Assuming CURLF can sustain 15% net margins over the long term, sustain 12% topline growth, and trade at a 1.5x price to earnings growth ratio, I could see the stock trading at around 2.7x sales, presenting around 30% potential upside.

Yet there are considerable risks. CURLF has received media coverage for its connections with Russian investors, including most recently the announcement that the company had received hundreds of millions in financing from billionaire Roman Abramovich. CURLF is exhibiting many of the troubling signs seen at the Canadian operators in terms of pursuing growth at any cost – in particular I wonder why the company has not more aggressively exited loss-generating markets in the current environment given the elevated risks. With the balance sheet now highly levered, such a strategy may pose great financial risk to shareholders. Cannabis stocks have already fallen a great deal, but the presence of 280e taxes and high debt interest rates have held back free cash flow. This means that these companies lack the cash flow capacity to take advantage of low stock prices through share repurchases even if they were willing to do so. Without that tool at their disposal, it is possible that these stocks remain highly volatile in spite of what looks like very cheap valuations. I continue to view higher quality MSOs and certain ancillary stocks to be the best way to position long term. While I continue to rate CURLF as being buyable, I emphasize my preference for cheaper and potentially higher quality peers.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.