Investing In Legal Cannabis: Part 1 CBD

U.S. Background



Public opinion towards legalizing cannabis has evolved over the past twenty years. According to a Pew Research report on the U.S. public opinion on legalizing marijuana, 63% of respondents thought the use of marijuana should be illegal in 2000. However, public opinion gradually changed over the next 10 years, and by 2010 public opinion was split on whether marijuana use should be legal. Since 2010, legalizing cannabis has gained significant popularity led by the millennial and Gen X generations. At the end of 2018, six-in-ten Americans said marijuana use should be legal.

There are currently ten states and the District of Columbia that legalized small amounts of marijuana for adult recreational use, and thirty-three states that allow medical use.

There are a growing number of state lawmakers and governors getting behind efforts to legalize marijuana as public support strengthens.

Twenty-one states considered bills that would legalize adult-use marijuana in 2018, and there are an additional nine states that are likely to legalize recreational marijuana use in 2019.

I expect to see more states across the U.S. gradually legalize recreational cannabis use over the next five years.




U.S. 2018 Farm Bill Legalizes Hemp Unlocking CBD Potential

What is hemp? Hemp and marijuana are two species of plants within the Cannabis family of plants. Marijuana has levels of THC, the component that induces psychoactive effects, exceeding 15%. Hemp has THC levels of .03% or less, which is too low to create a psychoactive effect.

Outside of the United States, hemp has been cultivated for a variety of industrial purposes and, increasingly, to produce CBD, a natural health and wellness product. CBD products are used to provide the following effects: a sense of calm and focus; relief from everyday stresses; help in recovery from exercise-induced inflammation; and support for healthy sleep cycles.

You may have recently seen a number of athletes and sports figures using and promoting CBD products on Instagram due to the post-exercise recovery benefits. You may have also seen CBD added in beauty products, which Kim Kardashian loves (a strong sign of a product’s potential).

Why are you seeing a rise in CBD products?

First, CBD have been growing in popularity in states that legalized recreational and medicinal marijuana use since it attracts a broad group of consumers who wouldn’t normally purchase marijuana products to get high. Instead, these consumers are more interested in the wellness benefits of CBD.

Second, on December 20, 2018, President Donald Trump signed the 2018 Farm Bill that drastically transformed the federal policy on hemp. The bill clarified that hemp and hemp products are legal, as long as they produced in accordance with the bill’s strict regulations. The USDA and FDA will be monitoring and enforcing the production of hemp and CBD products.

Hemp CBD oil can be shipped to people in all 50 states as long as it is extracted correctly from industrial hemp in accordance with the 2018 Farm Bill.

CBD Key Players


A few stocks that primarily focus on CBD products are: Charlotte’s Web Holdings (CWBHF), GW Pharmaceuticals (GWPH), and CV Sciences (CVSI). The chart below shows the percentage change of each stock’s price from December 2018 to April 2019.


Chart
Data by YCharts

These CBD stocks performed better than the S&P 500 since December 2018, and Charlotte’s Web Holdings increased 66%.

Charlotte’s Web Holdings: The Retail Play


I currently own Charlotte’s Web, and  entered my position in January 2019. The company’s business model is vertically integrated so the cultivation, manufacturing, and distribution are all monitored in-house. This model ensures their products are high quality and consistent. Charlotte’s Web recently released their Q4 2018 results, and they reported an increase in revenues of 70.6% year over year. Revenues also increased 21% from Q3 2018 to Q4 2018.

The growth in revenues was organic, and revenue from human nutrition products, topicals and animal nutrition products grew by 73%, 373% and 126% respectively.

The company sells their CBD products online, which accounts for 57% of sales, as well as through retailers. Charlotte’s Web is the number one brand by market share, and the company’s products are sold in 6,000 retail locations.

There are several national retailers embracing CBD products including Walgreens, CVS, and Rite Aid. Charlotte’s Web has the potential for even more significant growth if the company is able to expand their business with these national retailers.

The Hemp Industry Daily published the below chart, and they expect annual U.S. CBD retail sales to grow at a CAGR of approximately 50% from 2019-2023. Charlotte’s Web and their retail business is my preferred option to invest in CBD.



GW Pharmaceuticals: The Prescription Drug Play

GW Pharmaceuticals is a biopharmaceutical company headquartered in Cambridge, United Kingdom. The company’s primary product is Epidiolex, a pharmaceutical formulation of CBD, that was approved by the FDA on June 25, 2018 for the treatment of seizures associated with Lennox-Gastaut syndrome (“LGS”) and Dravet syndrome (“DS”), in patients two years of age and older. Epidiolex became commercially available in the U.S. on November 1, 2018.

According to GW Pharmaceuticals latest presentation, there are approximately 30-50K people with LGS and 15-20K people with DS that could be treated with Epidiolex. The projected weighted average gross price of Epidiolex treatment in the first year is $32,500, and the company could see $1.5B to $2.3B in revenues in 2019.

GW Pharmaceuticals needs a significant amount of revenue from Epidiolex since the company has an accumulated deficit of over $800M mainly due to high operating costs and research and development costs while they were getting the product ready for commercialization.

The company has three other cannabinoid prescription drugs that are in various stages of testing before they can be submitted for FDA approval shown below. The drug approval process is robust and timely, but the company could see significant upside in the next few years if these drugs reach commercialization. There is a risk that GW Pharmaceuticals could continue to incur development costs for these drugs without ever getting FDA approval.
Source

CV Sciences Inc: The Hybrid Play

CV Sciences Inc. operates a retail business under the brand name PlusCBD™ and a specialty pharmaceutical business after purchasing several drug development assets through the acquisition of CanX.

Retail Business

According to the company’s latest 10-K, the company’s twelve months ended revenue grew 133% in fiscal year 2018 compared to 2017, which was all due to the retail business.

The PlusCBD™ oil branded products sold in 2,200 and 38 stores nationwide that is a 45% increase over the prior year and a 7% increase over the third quarter of 2018.

CV Sciences Inc. had significant growth similar to Charlotte’s Web, and the company benefited from rising consumer demand and further expansion of distribution channels.

CV Sciences Inc. has a strong retail business that makes it an attractive option in the CBD industry. I think GW Pharmaceuticals has the best pharmaceutical (already approved by the FDA), and Charlotte’s Web has a larger retail business.

CV Sciences’ management are splitting their focus between the retail and the specialty pharmaceutical which is an issue for me. It will be difficult for the company to effectively compete against the companies that are primarily focused on either retail or pharmaceutical.

In addition, CV Sciences Inc. has some past issues with management, and according to the company’s 10-K, there are a number of class action complaints alleging securities fraud, breach of fiduciary duty, and gross management against certain officers and directors. The SEC filed an enforcement action against CV Sciences and its then-CEO, Michael Mona Jr.  

The SEC alleged that the company and Mr. Mona violated federal securities laws through misrepresentations made in certain SEC reports regarding the value of the company’s assets acquired from PhytoSphere Systems, LLC. The company and Mr. Mona settled all claims, and without admitting or denying anything, the company paid a penalty, and Mr. Mona resigned from the President, CEO, and Board of Director positions.

Although Mr. Mona has left the company, the above mentioned legal proceedings raise concerns for me about the leadership culture at CV Sciences Inc.

Specialty Pharmaceutical Business

CV Sciences is developing a drug named CVSI-007 that combines CBD and nicotine in treatment of smokeless tobacco use in addiction. The company is currently progressing through a preclinical program for this drug, which is a necessary step before submitting to the FDA for approval.

Management believes in the potential of this drug, and they believe this is a multibillion dollar opportunity to address the treatment of smokeless tobacco use and addition. The company expects to have additional data to present in the coming quarters.

The company’s patent on CVSI-007 is still pending, and with the amount of information provided on this drug, I consider this aspect of the business to be highly speculative since it’s uncertain whether it will be approved by the FDA.

Valuation:

The below chart shows the quarterly revenues, operating expenses, and operating income for Charlotte’s Web Holdings, GW Pharmaceuticals, and CV Sciences for the past three years.
Chart

Charlotte’s Web and CV Sciences Inc. had steady increases in revenue as previously mentioned due to rising consumer demand and further expansion of distribution channels. As CBD gains more awareness, and hemp products penetrate national retailers; such as CVS, Walgreens, and Rite Aid, I expect these companies to see significant growth in the next five years.

GW Pharmaceuticals has seen operating losses over the past three years since the company incurred significant research and development costs for the development of their leading product Epidiolex and three other drugs. Epidiolex launched in the U.S. in November 2018, and I expect the company to see significant revenues in the next five years as the drug is commercialized.

The below chart shows the price-to-sales ratio for these companies from December 2018 to April 2019.
Chart
Data by YCharts

CV Sciences Inc. and Charlotte’s Web are selling at similar price-to-sales ratios, which seem reasonable considering the growth potential. GW Pharmaceuticals is trading with a much higher price-to-sales ratio as the stock price has already captured the significant revenues from Epidiolex.  

Takeaway

The market for CBD has grown rapidly since the passing of the 2018 Farm Bill. I expect to see significant growth in the next five years as CBD gains more awareness, and hemp products penetrate national retailers. My preferred CBD stock play is Charlotte’s Web due to the company’s strong retail business.


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Disclosure: I am/we are long CWBHF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a financial advisor, and this article is for informational purposes only. Please use your own due diligence and consult a financial professional before making any investment decision.

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