Cresco Labs has target cut by Echelon, still a Buy

A proposed blockbuster deal and disappointing quarterly numbers have left Echelon Capital Markets analyst Andrew Semple with some questions in regards to US cannabis play Cresco Labs (Cresco Labs Stock Quote, Chart, News, Analysts, Financials CSE:CL). Semple reviewed Cresco’s current state of affairs in a report to clients on Thursday where he maintained his “Buy” rating while dropping his target price from C$18/share to C$15/share.

Chicago-based multi-state operator Cresco Labs cultivates, manufactures and sells retail and medical cannabis products across the United States. The company houses a number of cannabis brands including Cresco, High Supply, Good News, Wonder Wellness Co., Remedi, Reserve, FloraCal and Mindy’s Edibles while also licensing the Kiva brand of cannabis-infused edibles.

Semple’s latest analysis comes after Cresco Labs announced its intent to acquire Columbia Care, a deal which would be the second largest transaction in the American cannabis industry history while setting the pro forma company up to be a top-three entity within the United States.

“The proposed merger with Columbia Care could redraw the map in the US cannabis industry,” said Semple, who at this point views the transaction as being marginally accretive to Cresco. “The merger would offer Cresco Labs entry to the attractive New Jersey and Virginia markets, deepen its scale in several other states and optimize assets in states where there are overlapping operations.”

The proposed transaction, which carries a stated value of $2 billion (all report figures are in US dollars unless otherwise noted), would be paid out entirely in stock, with Cresco set to pay 0.5579 shares for every Columbia Care share. The $4.57/share valuation would represent a 16 per cent premium to the prior closing price and a 19 premium to CCHW’s 20-day VWAP.

However, Semple believes that prior to management’s expected closing of late 2022 or early 2023, a number of divestitures will need to be made to make the deal official, including in high-profile states like Florida, Illinois, Massachusetts, New York and Ohio, with the new entity being over the acceptable threshold of licenses awarded in some states.

“Given the potential magnitude of these divestitures, the success of these asset sales will be important to assess the attractiveness of this acquisition,” Semple said. “We believe there will be ample demand for these operations, though the significant uncertainties associated with both the timing and amount of potential proceeds may weigh on investor sentiment for this transaction until the plans for divestitures are better crystalized.”

Upon completion of the merger, the new company would have operations in 17 states and Washington, D.C. to account for approximately 55 per cent of the population of the United States, while also having the second-largest retail footprint with 130 stores spread over 18 states.

“This acquisition brings together two of the leading operators in the industry, pairing a leading footprint with proven operational, brand and competitive excellence. The combination is highly complementary and provides unmatched scale, depth, diversification and long-term growth,” said Charles Bachtell, CEO of Cresco Labs in the company’s March 23 press release. “The combination of Cresco Labs and Columbia Care accelerates our journey to become the leader in cannabis in a way no other potential transaction could. We look forward to welcoming the incredible Columbia Care team to the Cresco Labs family. I couldn’t be more excited about this enhanced platform and how it furthers the Cresco Labs Vision – to be the most important and impactful company in cannabis.”

News of the acquisition may have taken heat off the company’s fourth quarter financial results, which Semple said were underwhelming as they were headlined by $217.8 million in revenue for 1.1 per cent sequential growth. The figure was a significant miss in relation to management’s guidance of between $235 million and $245 million, the Echelon estimate of $239 million, and the consensus projection of $235 million, with Semple attributing the miss to the industry-wide slowdown on normalizing demand and price conditions.

Recent acquisitions in Pennslyvania and Massachusetts produced sequential growth for the company in the quarter, though revenue was lower than expected in California on account of its decision to pivot its business model to focus on its own brand distribution.

Meanwhile, the company produced adjusted EBITDA of $57 million for a 26.2 per cent margin in the quarter, which was also off in relation to the Echelon projection of $69.7 million and a 29.2 per cent margin, as well as the consensus projection of $66.9 million for a 28.5 per cent margin.

Cresco Labs’ stock price has fallen in the last 12 months at a 55.4 per cent loss, punctuated by a 10.9 per cent loss since the start of 2022. April 5 saw the stock hit a 52-week high of $16.71/share, but it has been consistently dropping ever since, hitting a 52-week low of $6.97/share on March 7. At press time, Semple’s new C$15.00 target represented a projected 97.6 per cent return.