Charlotte's Web Is Spinning Quickly

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About: Charlotte's Web Holdings, Inc. (CWBHF)
by: SKK Investments
Summary

Charlotte's Web has established itself as the leading pure-play CBD company.

The company's sizable revenue growth, experienced management team, and brand name lead us to believe that shares in the company present an attractive investment opportunity.

Soaring public interest in CBD and its purported health benefits are also tailwinds for the company.

Introduction to Charlotte’s Web

Charlotte’s Web (TSX: CWEB; OTC: CWBHF) is a Colorado-based company that is involved in the production and sale of CBD-infused products. These products include topical ointments, gummies, tinctures (concentrated liquid herbal extracts), capsules, and pet products.

The company, formerly known as Stanley Brothers Inc., was started in 2008 by seven brothers who became interested in the medical benefits of marijuana after their uncle was diagnosed with cancer. In 2012, the company re-branded as Charlotte’s Web after the brothers cultivated a high-CBD, low-THC strain of CBD that helped stop the epileptic seizures of 5-year-old Charlotte Figi. The brothers (and CBD) gained nationwide recognition and were featured in a 2012 documentary by Sanjay Gupta (CNN’s chief medical correspondent).

This New York Times article provides an excellent account of the brothers’ humble rise from a small farm in Oklahoma to purveyors of the hottest wellness product in quite some time.

Financial Snapshot as of July 6, 2019 (in millions USD, except per share values)

Market cap

1,789.03

Debt

4.2

Cash

69.1

Enterprise Value

1,724.13

Share Price (CWBHF)

16.83

Shares Outstanding

106.3

Charlotte’s Web is Spinning Quickly

Charlotte’s Web has been on a tear over the past couple of years, achieving impressive top and bottom-line growth and positioning itself well competitively. Consider the following numbers:

  • Revenues have increased by 5x from $14 million in 2016 to $70 million in 2018, and 2019 sales are projected to be anywhere between $120 to $170 million, the midpoint of which represents a 100% growth rate year/year.
  • Operating margins skyrocketed from 6.7% to 21.6% over the same time period due to operating leverage and a decline in SG&A and R&D expenses as a percentage of sales.
  • The company IPO’d in August 2018 on the Canadian Stock Exchange and was listed on the Toronto Stock Exchange in late May. Shares are also available on the OTC markets under the ticker CWBHF.
  • CWEB tapped Deanie Elsner in April 2019 as CEO, a major step in legitimizing the company and positioning itself for continued growth. Elsner previously served as President of Kellogg’s Snack Foods Division.

Why The Hoopla?

Charlotte’s Web has benefited from the soaring popularity of cannabidiol (CBD), which has become the subject of intense public interest and scrutiny for its potential as a remedy for a wide range of ailments.

Just take a look at the following graph from Google Trends:

This rise in public interest is translating into a booming industry. Investment bank and financial services firm Cowen & Co. estimates that 2018 sales of CBD ranged between $600 million to $2 billion and forecasts this number to rise to $16 billion by 2025.

The Brightfield Group forecasts $22 billion in annual hemp-derived CBD sales by 2022. Note the following excerpt from the linked article:

“CBD is the next healthcare phenomenon. It is so effective for so many conditions, is natural, non-psychoactive and has no known serious side effects. It is the next hot, functional ingredient beauty ingredient, like collagen, shea butter or aloe. It can be grown domestically as a substitute for tobacco and provide a much-needed cash crop for American farmers”.

Fundamental Valuation

At first glance, shares of the company appear expensive. CWEB’s current enterprise value of $1.7 billion and 2018 sales of $69 million imply an EV/sales multiple of over 24x. However, looking at the company in this way provides an inaccurate picture given how quickly the company is growing its top-line.

Assuming that management can hit ~$150 million in sales in 2019 (slightly above the midpoint of its full-year guidance of $120 to $170 million) and grow sales by 75% annually over the next two years (representing net sales of $468 million), the company’s EV/sales multiple drops to 4x.

It is difficult to forecast sales for a quickly growing company like Charlotte’s Web, so we used historical numbers and allowed for a slowdown in sales after 2021 due to the difficulty of growing a larger sales base on a high percentage basis.

CWEB is one of just a few profitable CBD/cannabis companies: it generated $11.8 million of net income in 2018, or 12 cents a share. Gross margins are a healthy 75% which is attributable to CBD’s attractive pricing structure. A 100mL bottle of CBD oil retails for $189 on Charlotte’s Web’s website.

While increased future competition will likely negatively impact gross margins, we feel that CWEB will be able to maintain its pricing power to some extent due to its reputation and focus on quality. In addition, rapid expansion should provide the company with ample operating leverage to improve its bottom-line and further increase shareholder value.

Future of CBD in the United States

Continued growth in the United States is still uncertain given regulatory concerns and questions about CBD’s efficacy, but we are optimistic on CBD’s potential for a number of reasons.

First, CBD is considered safe by the World Health Organization. According to a report published by the WHO in November 2017, "there is no evidence of recreational use of CBD or any public health related problems associated with the use of pure CBD".

In addition, there is an immense amount of public interest in CBD. The WSJ, Bloomberg, New York Times, and a bevy of other major news organizations have recently published pieces on the compound. Part of the reason why CBD is generating so much buzz is because it does not have any of the intoxicating properties of its cousin THC, rendering it (mostly) free of the stigma associated with cannabis.

The industry will also benefit a great deal from the Agricultural Improvements Act of 2018, which we’ll describe below.

2018 Farm Bill

The Agricultural Improvements Act of 2018 (also known as the 2018 farm bill) was signedinto law on December 20, 2018. The parts of the bill that are most relevant to CBD are as follows:

  • Industrial hemp cultivation is now legal nationally. Hemp is a strain of the Cannabis sativa plant that can be refined into textiles, plastics, clothing, paint, animal feed, etc.
  • Legalized hemp is restricted to 0.3% THC; any hemp that contains more than this amount of THC is still illegal at the federal level.
  • This legislation also explicitly allows for the interstate movement and commercial sale of hemp-derived products.

The act also expands the research efforts enacted by the Agricultural Act of 2014 by re-extending protections for hemp research and including hemp under the Critical Agricultural Materials Act.

This is a major step forward for Charlotte’s Web in terms of legitimizing cannabidiol in the eyes of American consumers and allowing commercial activity in the space to flourish. In addition, this brings the company one step closer to listing on a major U.S. stock exchange, a move that was discussed during the last earnings call. This would pave the way for institutional investors to get involved in CBD and would likely generate significant interest in the company.

Analyzing Charlotte Web’s Management Team

We feel that a close analysis of management is necessary to thoroughly understand Charlotte’s Web. A company selling a relatively unknown substance such as CBD likely does not have the easiest time attracting the most-qualified personnel. The following is an overview of recent additions to Charlotte’s Web’s senior management team, which we feel is a bullish indicator of the company’s future prospects.

  • Deannie Elsner – Deannie Elsner joined Charlotte’s Web as CEO in April 2019. She was formerly president of Kellogg’s $3 billion Snack Foods Division and Chief Marketing Officer at Kraft Foods.
  • Eugenio Mendez – Eugenio Mendez joined Charlotte’s Web in January 2019 as Chief Growth Officer – his prior experience includes roles at Barcardi and Coca-Cola, most recently as Coca-Cola’s Vice President of Global Marketing – Water, Enhanced Water, and Sports Drinks.
  • Stephen Lermer – Stephen Lermer joined Charlotte’s Web in January 2019 as Chief Operating Officer – he has previously held senior leadership and executive positions at DuPont, Johnson & Johnson, Burroughs Wellcome (now GlaxoSmithKline), Rhone Poulenc (now Sanofi), Orion Oyj and Akela Pharma.

It’s instructive to analyze these recent additions because they provide a glimpse into the perspective of people with far more experience in the consumer goods industry than we do. Although one might argue that these individuals may have joined solely for the prestige offered by a C-suite position at a publicly-traded company, we believe it is equally likely that they believe in CBD’s long-term potential.

Leaving senior positions at large, reputable companies to join a relatively unknown startup (let alone one peddling a product whose legal and regulatory future is still uncertain) is a bold move, and one that requires (in our view) some degree of conviction as to the product’s future viability.

Final Thoughts

Charlotte’s Web has cemented itself as the leading pure play cannabidiol company – it is growing revenues at a rapid pace, is profitable, and has organized a highly-qualified and competent management team. The company is also benefiting from growing nationwide interest in CBD, which has shown promise as a way to treat anxiety, pain, soreness, and other common ailments (as well as serious conditions such as epilepsy).

Although some have voiced concerns that CBD is a fad, there is considerable evidence that the compound can be beneficial for a variety of ailments. In addition, just 64 million people (20% of the US population) have tried CBD, according to a January 2019 survey by Consumer Reports.

We believe that this number is likely to increase quickly in coming months/years since CBD does not have any negative side effects (per currently available research) and a growing wellness industry. In our view, these factors (as well as those mentioned above) will help CWEB outperform and continue to grow its top-line.

While the company’s share price has experienced significant volatility since the IPO, we are enthusiastic about the company’s long-term prospects and believe that it deserves the attention of investors eyeing the CBD industry. However, shares have spiked sharply over the past week and it may be prudent to wait until a pullback occurs (of course, at the risk that shares will continue to appreciate). We will continue publishing articles on companies in the CBD/cannabis space (as well as other industries) and welcome comments and feedback from readers!

Disclosure: I am/we are long CWEB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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.