Cresco Labs has an upside of 56 per cent, Echelon says

A new acquisition by Cresco Labs (Cresco Labs Stock Quote, Chart, News CSE:CL) is a strategic fit for the US multi-state operator, says Echelon Wealth Partners analyst Matthew Pallotta, whose client update on Monday maintained his “Speculative Buy” rating and C$15.00 target price.

Chicago-based Cresco Labs announced on Monday a purchase agreement to buy the Nevada and Arizona assets of Tryke Companies, a vertically integrated seed-to-sale cannabis company, owners of Reef Dispensaries. The $227.5-million deal (in shares and $55.0 million in cash) will include four two Las Vegas dispensaries, two medical stores in Phoenix and cultivation and processing capabilities in both states as well as a cultivation license in Utah. (All figures in US dollars unless where noted otherwise.)

“Our thesis for success in establishing a normalized and professionalized cannabis industry as well as providing the greatest return on invested capital for our shareholders calls for us to leverage our existing operations in states of significance to rapidly attain material and meaningful market-leading positions,” said Cresco CEO and co-founder Charlie Bachtell in a press release.

“This Transaction meets every point in our ROIC framework. It accelerates top-line growth, enables efficiencies across our network through the addition of one of the most impressive operating teams in the country and brings a pipeline of high return projects that we expect to execute on at a measured pace over the next several years,” Bachtell writes.

The deal looks good from a strategy perspective, says Pallotta, who notes that it will significantly expand Cresco’s footprint in Nevada and the Southwestern United States where the analyst believes that the company could benefit from a deeper presence to better compete with its like-sized MSO peers. Pallotta says that Reef Dispensaries is a well-known name and that the deal includes a high-traffic flagship Reef location adjacent to the Las Vegas Strip.

The deal, which Pallotta predicts will close in Q2 of 2020, involves assets which generated revenues of about $70 million and EBITDA of about $25 million in 2018. Those assets are both highly accretive from the standpoint of Cresco’s pre-announcement valuation, according to Pallotta.

“In total the two Las Vegas locations generated $49 million of revenue last year, roughly ~$25 million per location. These would rank amongst the most productive retail assets we have seen sales data for in the US. Based on our discussions with management, we understand that wholesale revenues are fairly nominal at this point, however, we are forecasting growth in this segment once integrated with Cresco, consistent with the Company’s focus on the branded product manufacturing and distribution verticals,” said Pallotta.

“We expect that Cresco should be able to generate added synergies from the acquired assets by leveraging the production facilities to increase the wholesale distribution of its suite of brands throughout the state. The retail assets further add to the footprint of consumer touch points in key markets as well, though given that its licensed retail presence is fully built out in both states, we expect that future growth will be driven largely by the wholesale businesses, and the increased presence of its branded products on third party shelves in both markets,” he writes.

Cresco also announced at the same time a C$73.5-million bought deal which will likely be enough to cover the added capital needed to close the Tryke acquisition, says Pallotta, but that Cresco needs to muster up more cash to fulfill its longer term capital requirements — Pallotta figures that Cresco needs $200 million more to finance the closing of the Valley Agriceuticals (New York), VidaCann (Florida) and Hope Heal Health (Massachusetts) deals as well as planned capital expenditures.

Pallotta thinks that Cresco will generate 2019 revenue and adjusted EBITDA of $145.1 million and $9.6 million, respectively, and 2020 revenue and adjusted EBITDA of $658.1 million and $147.1 million, respectively. His C$15.00 target represents a projected 12-month return of 56 per cent at the time of publication.