During a well-received earnings report, Curaleaf (OTC: CURLF) told investors that annual revenue could reach a 10-figure sum next year, thanks to big acquisitions planned for later this year. That would make Curaleaf the first cannabis company to reach the $1 billion threshold, and that's not even the boldest part. Management also expects wide profit margins on all that new revenue.
Before running out to buy this or any other marijuana stocks in the hope it can meet some big expectations, you should know that Curaleaf's latest guidance update contains some asterisks and caveats. Let's examine the fine print to see shares of this market leader can move your portfolio in the right direction.
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Reasons to buy
Curaleaf is currently the largest multistate operator, with 48 dispensaries in 12 states. To become the cannabis industry's undisputed leader, Curaleaf wants to acquire Grassroots, a privately held business with 17 cultivation and processing licenses that feed 20 dispensaries in operation.
Curaleaf is mainly an East Coast operator, while Grassroots holds a whopping 61 dispensary licenses mostly in Midwest states with high barriers to entry that could limit competition to a manageable level. Unlike its Canadian peers that are still bleeding money, Curaleaf has already started recording a trickle of cash flowing into its pockets. Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) rose to $3.4 million in the second quarter of 2019, from a loss of $3.7 million three months earlier.
Total revenue generated from Curaleaf's businesses grew $48.5 million in the second quarter, which was 38% higher than the previous three-month period. We can probably expect it to more than double again when the company reports third-quarter results. If it had started the second quarter with all of the revenue streams that began flowing during the period, total revenue would have reached $110.9 million.
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Reasons to remain cautious
Curaleaf's nearly halfway to reaching $1 billion in annual revenue, but producing a profit will be a lot more challenging. Adjusted EBITDA turned positive in the second quarter but the "I" and the "T" components require more attention. The company's already swimming in debt and interest expenses in the second quarter reached $6.4 million.
Sales, general, and administrative expenses reached $28 million in the second quarter but the company isn't allowed to deduct most normal business expenses thanks to Internal Revenue Code 280E. Instead, Curaleaf's tax expense soared to $8.2 million in the second quarter, which worked out to 30% of its reported gross profit.
Taxes, interest, and operating expenses climbed to a dizzying 197% of the gross profit generated during the period and it could get worse. If Curaleaf is allowed to acquire the Select brand for a planned $950 million, and Grassroots for $875 million later this year, operating expenses that the company can't deduct from income reported to the IRS will soar again.
Curaleaf was able to raise some capital through a sale-leaseback agreement, at an enormous expense. To raise just $28.3 million the company will make lease payments that add up to $49.5 million between now and the end of 2023, then another $33.4 million in subsequent years.
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You really should wait
The U.S. cannabis industry is extremely interested in the CBD space because operating expenses associated with its production, and sales aren't subject to 280E rules. Investors want to remain patient because Curaleaf's losses could widen significantly in the second half of the year thanks to more employees and a lack of high-margin CBD revenue.
Unfortunately for the cannabis industry, a CBD tincture called Epidiolex earned approval for the treatment of severe childhood epilepsy in 2018, which means any ingestible consumer product that contains CBD is considered an unapproved new drug. Under the Federal Food, Drug, and Cosmetic Act, it's illegal to sell any unapproved drugs. This is why on Curaleaf Hemp's website now, you'll find nothing but a collection of uningested massage oils and lotions that contain CBD in packaging that says nothing about its possible health benefits.
Losing high-margin CBD revenue after investing heavily to launch its suite of unapproved new drugs is going to hurt Curaleaf's already dismal bottom line. Remember, the company still plans to complete a $950 million acquisition of Cura Partners and an $875 million acquisition of Grassroots before the end of 2019. Adding these businesses will lead to a spike in revenue that will be taxed before subtracting soaring operating expenses that can't be deducted from taxable income.
We don't know if Grassroots was a loss-making venture before Curaleaf decided to buy it. That said, if Grassroots is making money, Curaleaf almost certainly would have boasted about it in its announcement.
Not a buy now
At recent prices, Curaleaf's a $3.3 billion company with cash flows that aren't nearly as positive as the company's adjusted earnings results would suggest. Until we see signs that it can curtail soaring operating expenses, pay suffocating taxes, and service its debts without needing to tap shareholders for more capital, it's better to watch this story play out from a safe distance.
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This article was originally published on Fool.com