Cresco Labs Earnings release

The MDA does not discuss changes QoQ.  You get YoY comparisons and that is it. Makes it tough for investors to analyze operations.

What I said last Q

Boy howdy! A couple of items stand out

Pluses

• Sales increase of 42%.  Largest $ sales increase of all MSO’s this Q.
• Progress on GM% with a 5% increase but looks to be accounting related versus operational
• SGA reductions of $6 million

Minuses

• GM% below leading peers but that is a function of wholesale mix
• SGA > GM
• Report an Adjusted EBITDA of +$16 million.  I have them at -$1.5 million.  “Liberal” use of “adjustments” by management.
• OPEX Burn of $20 million
• Cash $71 million versus A/P and Accrued $67 million, $35 million income tax payable, and $11 million in current contingent consideration

This Q:

Ill add another “Boy howdy” right here!

Pluses:

• Sales increased +63% or USD 59 million QoQ
• Gross margin improved from 36% to 52% this Q.  Their GM% was a concern relative to their peers, but this is quite the improvement.
• Despite increase in sales SGA only increased $4 million

Minuses: And I am nitpicking a little here

• 280e taxes really take a bite out of US operators… NPBT was $18 million and after tax is $5 million
• Net income attributable to controlling interest is -$7 million out of the positive net income of $5 million. So, NCI hold $12 million in net income from these statements.
• They need to renegotiate a $89 million loan by July 2021.  This should not be a problem if they continue to generate the EBITDA that they have.

Income Statement Drivers & Breakeven: Trend

Sales Split and Deltas:

Footprint:

• Illinois: Cultivation 3, Dispensaries 11 (+2 for Q… MDA QoQ still says 9 but presser says +2 for Q. I went with the +2 from presser.)

• Penn: Cultivation 1, Dispensaries 3
• Ohio: Cultivation 1, Dispensaries 1

• Cali: Cultivation 3 Processing 1, Distribution 2
• Arizona: Cultivation 2, Dispensaries 1
• Maryland: Cultivation 1
• NY: Cultivation 1, Dispensaries 4
• Mass: Cultivation 1, Dispensaries 1

• 31 Nicotine vape stores in Canada

Total

• Cultivation 3
• Processing & Distribution 3
• Dispensary 21 (+2 for Q)

Their sales have increased $59 million to $153 million, good for sequential growth of 63% after +42% last Q.  Of the $59 million increase +$35 million in wholesale and +$24 million self-owned retail the same $ increase as the previous Q.  Illinois opened 2 more dispensaries in the Q and now have 11 in state, by far their greatest retail footprint.

Wholesale and Retail sales mix was consistent QoQoQoQ at 59-41.

Same store sales versus new stores would be a welcome metric, as would CL brands sold as a % of retail sales.  The metric I created shows per store revenue for the Q at $3.1 million a +44% increase QoQ. Illinois sales are likely the reason, as Illinois has been growing cannabis sales tremendously this year.

This was a stunning increase in sales.

Wholesale growth was driven by increased cultivation footprints in Illinois and Pennsylvania. Given that projected yield from Bio Assets is forecasting a 16% decline for next Q, it will be interesting to see if they can continue to fuel wholesale growth with cultivation taking a projected step backward in the upcoming Q.  Inventory grew from $100 million to $108 million QoQ after a rise the previous Q of $19 million.  Something to keep an eye on.

Annualized Sales per Property, Plant and Equipment and Goodwill + Intangibles

This is our attempt to try and compare the organic growth companies (eg. TRUL and LHS) with the companies that are going organic plus “roll up” route.  The idea is that when a company purchases another company and instead of getting lots of PPE they are instead paying G/I to get a head start in the market.  That head start should manifest itself in Sales and GM, not necessarily immediately (retail stores yes, a cultivator may take time to launch) but eventually. 

The above measure is Sales revenue annualized divided by (PPE + G + I).

• In Q1-Q4 F2019 CL loaded $105 million in PPE to $156 million and $155 million in G/I to $232 million.  The Q4 alone they loaded $69 million in PPE and $153 million in G/I via the Valley Ag and HHH acquisitions both added in October 2019.
• In Q1 F2020 they added $32 million in PPE and $418 million in G/I from Origin House

This Q they improved on the metric to $0.74 revenue per dollar of combined PPE and G/I from $0.46.   

They went from 5^th highest in this metric in the per group last Q to 3^rd, trailing only Cura (waiting on their Sedar filings to update) and Trulieve.  This is the biggest single Q increase since I have been keeping this metric.

BTW… I really like this metric as it focuses on operating efficiency.  Before you can get to positive Net Income to focus on ROI, Sales and GM must materialize.  This is a pre cursor to those events, assuming Opex is kept in check.

USA Retail Revenue: Peer & Trend

Retail wise Cresco is the fourth largest in the above peer set and show consistent growth over the period under review. 

The peer set does not include Harvest Health, MedMen and TerrAscend as they do not segment sales.

USA Wholesale Revenue: Peer & Trend

Wholesale wise Cresco is the largest in the above peer set and show growth over the last three Q’s in the period.  

I have been thinking about what end state US retail legislation might look like to try and determine where longer term value lays and where some pitfalls may exist.  If the US opened up state to state commerce, Retail might run into the same issues if online giants like Amazon get in on the cannabis sales trend.  (Very much a long-term future scenario).  This thought was provoked by Amazon announcing an increase in their pharmacy operations this week, and my CVS shares fell 8% in one day. Conversely, my Amazon shares barely budged on the news.  Considering the increased competition and pricing power in the organic food market with Amazon buying Whole Foods and distributing it online, this could be a scenario played out in cannabis retail.

As we have also seen in Canadian provinces, early retail sales volumes could well be eroded as new entrants come in and get established and saturation takes hold. As such, I am thinking more and more wholesale will come to dominate the US market as brands are sold in non-owned stores.

Does the retail network get devalued in a wide-open cannabis USA?

The peer set does not include Harvest Health, MedMen and TerrAscend as they do not segment sales.

Income Statement Drivers & Breakeven: Peer

Cresco has the 3rd highest sales in US trailing CURA (not updated above yet) and GTII and surpassing Trulieve.

Gross Margin: USA Peer & Trend

Gross Margin increased by $46 million to $79 million and from 36% of sales to 52%.  This was achieved despite sales mix for wholesale and retail remining at 59-41 QoQ.  As no narrative is given as to why, I have to think more of the retail sales were fueled from CL produced product, thereby capturing more GM per sale.

As mentioned above, Bio Assets are projected to produce less of a yield this upcoming Q.  It will be interesting to see if they can maintain the GM%.

Gross Margin Annualized per PPE and Goodwill and Intangibles

As per the Annualized Sales version of this graph we are seeing how effective at GM generation the peer set has been. 

Cresco is generating $0.38 of annualized GM for each $1 they have spent on PPE and G/I an increase of more than double from $0.16 last Q. This reduced considerably from $0.31 to $0.14 to $0.10 Sept/19-March/20 driven by the substantial decrease in the denominator each of the latter two Q’s, although the assets acquired did contribute for the majority of the quarters.

This Q the increase is a result of the increased Sales and better GM%.

They went from 7^th place of 10 in this metric by peer group last Q to tied for second with CWEB and trail only TRUL.  (Cura, when spread, will decline from $0.59 with the addition of the Grass Roots PPE and G/I this Q despite also showing a healthy increase in sales.)

This metric is becoming a favorite of mine, more so than the Sales metric above, as it shows efficiency of operations versus just the ability to increase sales.

Gross Margin: USA Peer

Last Q, Cresco has the 2nd worst GM% in the US MSO peer group at 35%, leading only MedMen.  While 52% is middle of the pack, it is impressive given their heavy wholesale lean.

Gross Margin: North American Peer Base

SGA & SBC as a % of Sales: Trend

Note: I moved impairment credit to Other Expenses to maintain the peer group protocol.

Selling expenses increased by $1.4 million to $4.1 million for the Q and stayed steady at 3% as a % of sales.   

Administration expenses increased by $3.9 million to $36 million and decreased 11% as % of sales to 24%. Notable changes:

• Professional fees decreased by $1.7 million to $3.9 million which lowest in seven Q’s.  
• Business expansion costs decreased by $1.4 million to virtually nil.
• Salaries and related increased by $2.4 million to $21 million
• Excise taxes increased by 2.0 million to $4.3 million
• Office expenses increased by $1.6 million to $4.8 million

Combined SGA is $41 million a QoQ increase of $5.3 million

SBC decreased $3.9 million to $2.8 million and represents 2% of sales.

Depreciation of $5.8 million rounds off Opex.

Total Opex was $53 million +$1 million QoQ and comes in at 34% of sales a decrease from 55% last Q. An excellent Q!

SGA & SBC as a % of Sales: Peer

Last Q, Cresco was in the middle of the pack on combined SGA SBC. This Q they vaulted to third best at 28%.

+Net Operating Profit Quarterly Breakeven Sales: USA Peer

NOP before IFRS Voodoo was negative $18 million last Q and improved to +$27 million last Q.  The entire improvement can be traced to increase in GM$’s and GM%.

At current GM% and OPEX$, Cresco requires 66% of existing sales to be +NOP.

Other expenses totaled $14 million versus expenses of $6 million the Q prior, a $8 million negative swing.

• Interest expense increase from $9.6 million to $11.3 million.  Now only 13% of GM.
• Other Expenses of $3.0 million increased from $0.7 million last Q.  Loss on IFRS derivative instruments of $4.1 million was the main driver, offset by a gain on fair value of contingent consideration.

Taxes were $13 million (an effective tax rate of 72%) versus previous Q of $13 million.  280e at work.

That NOP including IFRS voodoo of +$17 million is the driver. 280e relief would be welcomed.

Net Income Was +$5 million versus negative $5 million last Q.  Interestingly, Net income attributable to CL was negative $7 million while Non-Controlling Interest had a +$12 million.

+Net Operating Profit Quarterly Breakeven Sales: North American Peer

EBITDA Trend and Peer:

I note that Cresco does not follow industry peer reporting with Adj EBITDA.  I have their adj EBITDA as $40 million.  They have it at $46 million.   They take some liberties that others do not in their “adjustments”.  I have normalized to our peer group.

This is an impressive improvement of $41 million QoQ, all traced to GM$.

If you look at their Opex Burn for the Q they are at $23 million of source of cash, flipping from -$20 million last Q.   Interest and Taxes paid make up most of the difference from my Adj EBITDA.

+EBITDA Quarterly Breakeven Sales: USA Peer

At current GM% and OPEX$’s, Cresco requires 49% of existing sales to generate +EBITDA.

+EBITDA Quarterly Breakeven Sales: North American Peer

“Waterfall” – Trend

Cresco’s inventory increased $8 million to $108 million with FG increasing QoQ by $6 million to $32 million.   

Bio Assets decreased by $5.6 million to $53 million.  Their projected yield decreased to 21,000 KGs a decrease of 16% QoQ.  

“Waterfall” Peer

Cresco has 3rd highest inventory level of its peer group at $108 million trailing only Trulieve at $205 million (they cannot rely on purchasing wholesale) and CuraLeaf at $130 million. Cresco had the highest sales increase of the peer set this past Q.

Cresco has $57 million in cash, a decrease of $13 million from last Q.  The problem is they have A/P of $62 million, taxes due of $35 million and current contingent consideration due of $10 million. That aggregates $107 million, double their cash position.  They have $111 million under the credit facility that migrated into current liabilities, as it matures in July 2021.  They are in negotiations with the lender to extend maturity and access the remaining $100 million accordion feature.  I would expect both of these events to be taken care of in an amendment over the next six months.

Share capital increase $56 million in the Q.

No other material changes were noted on the balance sheet.

What I said last Q:

Sales growth was fueled by Illinois and Pennsylvania. GM% rebounded but is very low compared to peers as Cresco is heavily tilted to wholesaling versus retailing.

They reigned in SGA for the Q, but it is still greater than GM.

Their EBITDA is improving but they are still burning $20 million in the Q on Opex. 

Interest remains 1/3^rd of GM generated, and taxes are eating up most gains. 

I am getting put off by their management judgement on adjustments to EBITDA and the aggressive Gain on Biologicals pull forward.

Their cash position relative to short term liabilities is worrisome.  They need a raise.  More debt will mean more interest which can become a millstone.  I think they need equity and $75-100 million to clean up the balance sheet.

This Q:

This is one of the most impressive QoQ’s I have seen in the industry.  Sales increases of +20% on organic growth are difficult to achieve, 63% are unheard of.  They grew more in sales in one Q than Aurora generates per Q.

The Gross Margin improvement has me extremely interested, as they are now very peer comparable despite a tilt toward wholesale.

Opex control was also very commendable. 

They do need to address liquidity and they might well get there via the $100 million accordion.  With SP remaining strong a raise is not out of the question. 

That’s all I got.

The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author does not have a position in Cresco Labs and will not start one in the next five days.