Cresco Labs gets a big target raise from Echelon Capital

Core markets continue to be the growth drivers for US cannabis company Cresco Labs (Cresco Labs Stock Quote, Chart, News CSE:CL).

That’s according to Echelon Capital Markets analyst Andrew Semple, who reviewed Cresco’s latest quarter in a report to clients on Thursday.

Chicago-headquartered Cresco Labs is a vertically-integrated multi-state cannabis consumer packaged goods company with product manufacturing, branding and distribution to medical and recreational markets and a national chain of Sunnyside-branded dispensaries.

The company reported third quarter financials on Wednesday, featuring $153.3 million in revenue compared to $36.2 million a year earlier and $94.3 million just the quarter before, representing a 63-per-cent sequential growth rate. Adjusted EBITDA was $46.4 million compared to $3.1 million a year ago and $16.5 million for the second quarter. (All figures in US dollars except where noted otherwise.)

CEO Charles Bachtell said in the quarterly press release that Cresco entered the Q3 firing on all cylinders in terms of revenue, profitability and cash flow.

“We remain the number one operator in the industry focused on, and delivering results in, the wholesale distribution of branded products,” Bachtell said. “Our retail is outperforming and we are generating substantial operating leverage. The investments we made to support growth are paying off, and as a result our profitability has grown dollar for dollar with gross profit.”

Cresco’s cash flow from operations hit a record $17.8 million, while the company ended the quarter with cash and equivalents of $57.7 million.

Semple called Cresco’s third quarter a blowout, with beats on revenue ($153.3 million versus Semple’s estimate of $115.3 million and the consensus estimate $116.2 million) and on adjusted EBITDA ($46.4 million versus Semple’s $23.3 million and the consensus $19.6 million).

The analyst noted that wholesale revenues grew by 65 per cent sequentially to $90.5 million of the total Q3 revenue, putting Cresco as “the largest supplier of branded cannabis products in the industry.”

“This is the third consecutive quarter with sequential growth exceeding 40 per cent, and we note that growth accelerated in the third quarter. The principal contributors continue to be the core markets of Illinois, Pennsylvania, and California,” said Semple.

The analyst said Cresco’s wholesale and CPG operations benefitted from a nearly full quarter of contribution from increased capacity in Illinois and Pennsylvania along with strong growth from branded products in California, where they were up 66 per cent sequentially, although Semple predicted a more moderate growth rate in the upcoming fourth quarter.

“Cresco’s developing markets also have a bright outlook for the quarters ahead as new production comes online. In addition, there is the potential to see progress towards adult-use legalization in Cresco’s markets such as Pennsylvania and New York in 2021,” he wrote.

Semple said by turning free cash flow-positive at $17.7 million in CFO, Cresco’s operations are showing they’re capable of supporting the company’s organic growth, thus making it less reliant on the capital markets. Semple said Cresco should remain FCF-positive going forward aside from possible exceptions involving abnormally large working capital or capex investments.

Looking ahead, the analyst has revised his estimates on the back of the stronger than expected third quarter numbers. He is now calling for 2020 revenue and adjusted EBITDA of $478.2 million and $116.2 million, respectively, and for 2021 revenue and adjusted EBITDA of $838.8 million and $274.6 million, respectively.

With the new report, Semple has introduced 2022 figures, estimating revenue and adjusted EBITD of $998.8 million and $343.2 million, respectively.

“In 2021, on the retail side, we look for new store openings in Pennsylvania, a transition to adult-use retail sales in Massachusetts and Arizona and organic same-store-sales growth across the Company’s retail network to generate growth,” Semple wrote.

“Regarding our 2021 wholesale outlook (discussed in detail above), we expect new third- party dispensary openings, capacity expansion opportunities in PA, and capacity coming online in developing markets (MA, OH, MI, AZ) to support robust growth ahead. Our revisions to our 2021 EBITDA forecasts are particularly notable (up to $275 million from $172 million), as we recalibrate our model to account for the Company’s higher sales and margin profile,” Semple added.

Cresco has a good year in the markets, as well, with the stock currently up 34 per cent for 2020, but Semple thinks CL’s valuation is still “very reasonable.”

“We believe Cresco’s strengthened positioning in Illinois and Pennsylvania, which we would characterize as some of the most attractive cannabis markets in the world, deserves increased consideration from investors,” the analyst wrote.

The analyst estimates Cresco to be currently trading at 12.6x his 2021 EBITDA estimate (16.3x consensus 2021E EBITDA). With the update, Semple has reaffirmed his “Buy” rating and raised his target on Cresco from C$10.50 to C$14.50, which at press time represented a projected one-year return of 22.3 per cent.

“Though shares have experienced solid gains recently, our estimates have risen even faster, and the valuation multiple has compressed since we last published (previously 16.3x our 2021 EBITDA estimate). For a vertically integrated business that offers high-margin consumer staples/medical products, with non-cyclical demand characteristics and a long runway for growth, we continue to see ample room for upside to this multiple and our valuation parameters,” Semple said.