Seeking Alpha

Charlotte's Web: Buy The Dip

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About: Charlotte's Web Holdings, Inc. (CWBHF)
by: SKK Investments
SKK Investments
Long/short equity, Growth, momentum, event-driven
Summary

Charlotte's Web has experienced a sharp decline in share price due to weakness in the broader marijuana industry.

Shares have rallied from current levels in the past and we expect this to occur again in coming quarters.

The company remains the largest and fastest-growing company in the red-hot CBD space.

Introduction

Shares of Charlotte’s Web [TSX: CWEB] (OTCQX:CWBHF) have declined considerably since our last article on the company due to weakness in the marijuana sector, regulatory concerns, and intensifying competition.

In this article, we will argue that an investment in a CBD company is fundamentally different than an investment in a marijuana company and that the two sectors (CBD and marijuana) should not necessarily move in tandem. We also believe that recent share price weakness presents a compelling opportunity to become a part owner in the top publicly traded company in the red-hot CBD space.

Financial Snapshot as of September 7, 2019 (in millions USD)

Share Price (OTCQX:CWBHF)

11.83

Shares Outstanding

106.3

Market cap

1,257.5

Debt

4.2

Cash

69.1

Enterprise Value

1,192.6

(Source: Yahoo Finance)

(Source: thinkorswim)

As you can see from the above chart, shares have sold off sharply over the past two months - we believe this is partly because investors tend to bucket CBD and marijuana companies together. According to the WSJ, "The North American Marijuana Index, which tracks the leading cannabis stocks in Canada and the U.S., has fallen more than 52% in the past 12 months". The cannabis sector has struggled due to lack of debt financing for startups, a thriving black market (due to high taxes on legal cannabis sales), and growing competition.

Negative sentiment about cannabis companies has spilled over to CBD companies - both Charlotte's Web and CV Sciences (OTCQB:CVSI) has experienced downward pressure in recent months. In our view, CBD and cannabis stocks should not move together for the following reasons:

  • THC (the active ingredient in marijuana) and CBD are two entirely different substances from a practical point of view - THC is intoxicating and federally illegal whereas CBD is neither.
  • High taxes on cannabis sales do not apply to CBD since CBD sales are not yet tightly regulated.
  • CV Sciences and Charlotte's Web are profitable on an operating basis - most of the largest publicly-traded marijuana companies are not.
  • Marijuana stocks have struggled due to sky-high valuations and large losses - Charlotte's Web and CV Sciences have reasonable valuations and have not suffered large losses.

Even Google Trends data shows that demand for marijuana and CBD does not necessarily move in lockstep.

U.S. search interest for "CBD" and "marijuana" over the past five years:

(Source: Google Trends)

Worldwide search interest for "CBD" and "marijuana" over the past five years:

(Source: Google Trends)

Although overall search interest in CBD has slowed as of late, search interest for CBD is still outpacing that of marijuana. We do not believe that this slowdown is a major concern for investors, but will keep a close eye on it to see if it continues to decline.

Leading The Pack

As we've discussed in prior articles, there are a number of companies that are fiercely competing for a slice of the CBD industry. CV Sciences (the company behind PlusCBD products) is Charlotte's Web's largest competitor, along with the brands pictured below:

(Source: Brightfield Group)

Charlotte's Web remains the leader in the CBD industry by a wide margin, with a 6.3% market share. We believe that its leadership position within the space makes it a potential acquisition target by either a large cannabis company or consumer company looking to get involved in CBD.

Our confidence in Charlotte's Web's future is due in part to the excellent management team that has been assembled and management's stated intentions (voiced several times on past earnings calls) to become a full-fledged CPG (consumer packaged goods) company in the CBD space. The company also appointed Russell Hammer as CFO in August of this year, a retail veteran with experience as Chief Financial Officer of well-known retailers like Crocs Inc. (CROX), Motorola, and Orbitz.

Valuation

(Source: CapitalIQ)

We view this sell-off as a net positive for investors as it provides the opportunity to get involved in Charlotte's Web at a more reasonable valuation. Although CWBHF is currently trading at fairly high multiples (13.5x EV/Sales and 14.2x price/sales), we believe this is justified given the company's growth rates and future trajectory. Sales for the first six months of 2019 came in at $46.7 million, which was up 54% YoY.

In addition, the number of stores selling Charlotte's Web products is growing rapidly: The company announced that 7,871 stores (a sequential increase of 1,926 stores) now carry CWEB products in its Q2 earnings release (note that CV Sciences' retail distribution currently sits at 4,591 stores). Charlotte's Web also announced in late September that 738 Vitamin Shoppe locations across 45 states would start selling its CBD gummies, tinctures, and liquid capsules. This is an excellent move by the company to expand its retail presence and introduce CBD to a wide new range of customers.

Regulatory Concerns

There has been no material updates from the FDA since we wrote our our last article on the company. However, as we have described in previous articles, there are several ways that the FDA could move to regulate CBD:

  • Option 1: The FDA could impose a strict, hardline approach and prohibit the sale of all CBD products except for FDA-approved drugs such as Epidiolex that are used to treat rare forms of epilepsy. This would occur if the FDA came to regard CBD as a prescription drug that shouldn’t be legal for consumption as a wellness or dietary supplement.
  • Option 2: The FDA could permit the sale of certain CBD products such as tinctures, capsules, and pet products while prohibiting the sale of CBD-infused foods and beverages.
  • Option 3: The agency could permit the sale of all CBD products, given that it is generally recognized as safe for human consumption and there is little to no evidence of adverse side effects.

This transcript of a speech given by Lowell Schiller (Principal Associate Commissioner of the FDA) is worth reading for anyone looking to get involved in the industry. Schiller spoke at length about the ongoing efforts at the FDA to come up with a policy for CBD (including data collection and evaluation) and also referenced the growing popularity of CBD:

We recognize the need to provide clear answers regarding how specifically our authorities apply to different types of hemp products, particularly given the incredible amount of interest in these products.

This is especially true when it comes to CBD. Recently, we’ve seen an enormous surge of interest in this substance, and the level of excitement is palpable. At FDA, we’re excited too. We see significant potential in this substance, including potential clinical uses.

Risks

We believe that the primary risks to investing in CWBHF include the possibility that the FDA takes a hardline approach to CBD regulation and the possibility that competitive pressures will slow the company's growth rate. In addition, growth in commercial hemp production activity may lower prices for CBD products, which would negatively impact Charlotte's Web's pricing power and gross margins.

Conclusion

We view the recent sell-off in Charlotte's Web as a buying opportunity for investors looking to get involved in the CBD industry, given that CWBHF is the industry leader and is growing at a rapid pace. We will continue to keep readers updated via articles on the site. Thank you for reading and we welcome all comments and feedback!

Disclosure: I am/we are long CWBHF. 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.