The market
The explosion in demand for CBD (Cannabidiol) products has been widely described as the “CBD Craze”, a description that implies CBD could be a fad that will wane over time. Evidence suggests, however, that interest in CBD is strong and deep-seated due to benefits experienced by consumers as will be further discussed. For readers wanting an overview of CBD, a video titled “The Booming CBD Craze, Explained” illustrates some of the benefits and key issues in the CBD industry.
A ubiquitous source of information and data on consumer demand and preferences today is readily attainable with online reviews. Reviews have not only provided a great deal of leverage to consumers, but have also provided marketers a valuable source of data on consumer preferences. In search of a wide base of consumer responses to CBD products, the author has accessed multiple review sources to view hundreds of consumer responses to CBD. While unscientific in the method of ascertaining demand characteristics, the overwhelming positive response to CBD products is unmistakable. Further, while CBD may not have achieved full mainstream status, a major portion of the population has heard of it. And the explosion of interest in CBD has occurred mostly in a period of months.
In considering a contrarian view, it is noteworthy to read negative responses which focus overwhelmingly on particular products or services, but rarely on CBD itself. Among the benefits expressed most often from CBD products are relief from pain and anxiety, as well as increases in the quality of sleep. It must be noted that since CBD is technically illegal, ingestible CBD is not sold by most large retailers including Amazon, which sells hemp oils and other products, but not CBD. The distinction between hemp and CBD is clearly explained by Consumer Labs, a respected source for consumers on supplements. In addition, there are hundreds of online sources describing the benefits of CBD.
Considering the magnitude of products on the market to remedy pain, anxiety, and insomnia provides a sense of the huge potential magnitude of the CBD market. In addition to human use, CBD has grown into the huge pet care space that is likely to extend the market further. Accordingly, analysts are projecting huge growth in CBD sales over the next five years, from $1.9 billion in 2018 to a projected $20 billion by 2024 in the U.S.
Regulation
While the projected growth in CBD is likely to occur, it will undoubtedly be accompanied by increased federal and state regulation. Near the end of his tenure at the FDA, former commissioner Scott Gottlieb issued a statement on CBD following the passage of the Farm Bill of 2018, which removed hemp-based cannabis products as a controlled substance.
A notable industry response to Mr. Gottlieb’s statement can be seen in a statement taken from a prospectus issued by Charlotte’s Web (OTCQX:CWBHF) May 13, quoted as saying “The Former Commissioner restated the FDA’s concerns over drug claims being made about products that contain CBD or other cannabis-derived compounds, as well as the agency’s position that under the Food, Drug and Cosmetic Act (“FD&C Act”) CBD cannot be marketed in a dietary supplement because a product containing CBD was approved as a drug and substantial clinical trials studying CBD as a new drug were made public prior to the marketing of any food or dietary supplements containing CBD, and therefore dietary supplements or food are precluded from containing this ingredient (the “IND Preclusion”). The Company believes there are significant arguments against this position in that all conditions of the applicable statute must be met before the IND Preclusion applies.” Then on May 31 an FDA hearing was conducted that included input from the public, science/medical advocates, and industry participants. While the purpose of the hearing was to gather information, the FDA followed up with a statement detailing the agency’s current position on CBD, which summarized four key concerns (quoted from the statement):
- How much CBD is safe to consume in a day? How does it vary depending on what form it’s taken?
- Are there drug interactions that need to be monitored?
- What are the impacts to special populations, like children, the elderly, and pregnant or lactating women?
- What are the risks of long-term exposure?
A common thread in the CBD discussion is that very little is known about the long term effects of CBD on overall health. However, likely much more is known about CBD than may be widely realized. For example, Cannabidiol (or CBD as commonly known) has been around since 1940 although not on the scale it is being used today. Also, CBD epilepsy drug Epidiolex, a synthetic form of CBD, was approved by the FDA in 2018. The data formulated in the FDA approval process provided a great deal of information on the safety aspects and potential side effects of the CBD-based drug. Accordingly, the Epidiolex trials revealed significant side effects of “sleepiness, sedation and lethargy; elevated liver enzymes; decreased appetite; diarrhea; rash; fatigue, malaise and weakness; insomnia, sleep disorder and poor quality sleep; and infections.”
In comparison with the prescription drug, however, it should be noted that the synthetic epilepsy drug is dosed at higher levels than CBD supplements being marketed directly to consumers. Further, an NCBI abstract provided overall favorable ratings on safety and efficacy of CBD at lower doses. Concerning dosage, a crucial factor in dosing is in knowing the exact CBD content of products. Due to the lack of labeling standards, supplement product labels can be confusing, even deceptive. Top brands make available a Certificate of Analysis that details content which can assist in dosing and product comparisons.
Relevant to potential restrictions on CBD use, the FDA hearing and statement recognized the strong consumer interest in CBD and that any actions taken by the agency will be based purely on science. Accordingly, there is a strong implication that the agency will show restraint in action on current use of CBD products in the absence of supporting scientific data that would warrant restrictions. And without scientific data to provide evidence of negative effects on health, it is unclear what restrictions on use could be implemented. The vast majority of supplements are not prescribed but dosed at will by consumers. Furthermore, health and quality of life benefits emphasized by consumers may far outweigh potential side effects. In the absence of potential negatives, CBD represents a dietary supplement that is not psychoactive, non-habit forming, with miniscule risk for abuse.
Beyond health concerns, the FDA sent a clear message that the agency will take action against CBD sellers that make false or unfounded claims on the benefits of CBD. Accordingly, the FDA cited claims by some sellers that CBD can cure cancer. The statement included strong assurances that the agency will take actions to protect consumers from deceptive practices employed by sellers. Consumer protection actually appeared to be the most actionable response by the FDA in the near term. Precluding regulatory action pending at the FDA, California has acted to allow sales in the state, which was a huge win for CBD and removes some of the uncertainty surrounding the segment near term. The bottom line for leading, quality CBD suppliers is that they welcome FDA scrutiny and regulation of the market that would purge the industry of unscrupulous, marginal players. In fact, top-rated Charlotte’s Web Holdings (OTCQX:CWBHF) stated on the company’s Q1 conference call “Finally, we’re encouraged by the most recent positive regulatory developments we’ve seen in the United States. On Friday, May 31, the U.S. Food and Drug Administration will hold its first public hearing on the regulatory status of CBD. While this is simply the beginning of a process, we remain optimistic as the FDA has signaled plans to share its findings as early as this summer.”
In view of the foregoing discussion, it is reasonable to assume that CBD will continue its strong growth trajectory upward. And since the Farm Bill of 2018 provided nationwide legalization to grow hemp, CBD is clearly differentiated from marijuana legalization issues-and much more investable. When considering hemp and CBD as a pure play, three public companies lead the market both in the U.S and, to some extent, globally. As illustrated in the chart below, Charlotte’s Web (OTCQX:CWBHF), CV Sciences (OTCQB:CVSI), and Elixonol (OTCQX:ELLXF) dominate the hemp and CBD markets both in presence and revenue which will be covered more fully below. As noted in the charts, all three stocks have been under pressure since April and have only recently begun to recover. The market action is likely due to several factors. Cannabis stocks overall have been in correction mode for quite some time as revenue and earnings have lagged expectations. Then on May 31, the FDA held hearings on CBD, which the market likely viewed as a negative to CBD stocks. Also, Charlotte’s Web reported lower than expected earnings on May 28, which as the leader, exerted downward pressure on the group.
(Courtesy: Stockcharts.com)
Below is an illustration of selected metrics for the three companies. Since Elixinol (OTCQX:ELLXF) is an Australian company and actual numbers are reported in Australian dollars A$, some adjustments were made to make the numbers comparable (comparison data in the illustration may not be exact).
(Source: Wallmine.com and company reports)
Charlotte’s Web
Charlotte’s Web Holdings (OTCQX:CWBHF) is the best known of the CBD players formerly operating as the Stanley Brothers and publicly as Charlotte’s Web since 2018. Some key attributes of the company are listed on the company website including a claim of being the number one brand serving 6000 retail locations. CWBHF reported full-year 2018 revenue of $69.5 million, a 74% YOY increase, with gross margin of 76%. Earnings were $11.8 million with EPS of .12 per diluted share. For Q1 2019, the company reported revenue of $21.7 million, a 66% YOY increase with earnings of $2.3 million or .02 per diluted share. During the Q 1 conference call, management cautioned that performance can vary significantly by quarter due to business patterns and the early development stage of the business. For full-year 2019 management has provided revenue guidance of $120 to $170 million, which would represent a 73% to 145% increase YOY.
CWBHF stock pulled back after the Q1 earnings report, then much more when selling insiders sold shares on the Canadian market at $15 a share. From that point on, shares traded down to about $11 before recovering to near $16 today. Since no new shares were issued, the sale had no dilution in share count with 89.3 million shares outstanding at the end of 2018. According to a July 10 annual meeting/proxy notice, insiders owned about 9 million or 9.2% of outstanding shares. It should be noted that the Stanley brothers in total own significantly more shares in the company, although five brothers are not considered insiders.
On the Q1 earnings conference call, CWBHF management stated that the company currently has deals with four national chains to market the company’s products, two grocery and two drug chains. Management further stipulated that three of the retailers would initially sell topicals only while one would sell both topicals and ingestible CBD products. Further, management indicated that the company has pilot programs running with both Amazon and Google on topicals.
Likely the most significant indication of prospects for Charlotte’s Web is in recent management additions. On April 29 the company announced the appointment of Adrienne “Deanie” Elsner. Ms Elsner is a former President of U.S. Snacks division at Kellogg Company and has more than 25 years of experience in consumer packaged goods in both business and marketing leadership roles encompassing domestic and international markets. As stated in the news release, Ms. Elsner is described as a “talented marketer…widely recognized for driving business results.” The decision of a key leader from a company like Kellogg to join Charlotte’s Web confirms confidence in the growth opportunity in CBD and in the company.
In addition to CEO Deanie Elsner, the company announced two additional key appointments during the Q1 conference call linked above, including a new Chief Operating Officer and Chief Growth Officer, both with extensive packaged goods experience marketing household-name brands. Beyond management, Charlotte’s Web is also planning major expansions of its facilities. Lastly, management stated on the Q1 conference call that the company is planning expansion into international markets, primarily in Europe and South America.
CV Sciences
Although not having the name recognition of Charlotte’s Web, CV Sciences (OTCQB:CVSI) is a major player with the second largest market share and equally impressive revenue growth. The company operates in two distinct business segments: drug development which focuses on developing and commercializing synthetic CBD therapies, and consumer products which are marketed under the PlusCBD brand, both direct and through over 4500 retail locations. It should be noted that the company is not deriving revenue from the drug development segment of the business and does not foresee revenue in the foreseeable future. For full-year 2018 CVSI increased revenue 133% YOY to $48 million, net income of $10 million, and EPS of .11 (source: Form 10K). For Q1 2019, revenue increased 85% YOY to $14.9 million, with a loss of $9.4 million and EPS of -.10 (source: Form 10Q). The Q1 loss was due to increased R & D spending of $1.3 million and SG & A expenses of $18.6 million. The extraordinary SG & A expense reported was due mainly to stock based compensation and retirement of the company’s former CEO and founder. CV Sciences has reported agreements in place to market through 4591 retail stores that include CVS Pharmacy (CVS) and 945 Kroger Company (KR) stores.
Like Charlotte’s Web, CV Science firmly backs regulation of CBD by the FDA and states, and also sent a delegate to the FDA hearing May 31 to represent the interests of industry suppliers. Incidentally, CV Sciences is the only supplier that has achieved a GRAS designation for its products by the FDA, which acronym stands for “Generally Recognized As Safe”. To validate the safety and efficacy aspects of CBD, and specifically the company’s products, CVSI outsourced a clinical trial as a testimony for its PlusCBD Oil product.
Though now settled, CV Sciences stock continues to be plagued by negativity concerning an SEC legal action filed in 2017 against former CEO and cofounder, Michael J. Mona, Jr., for alleged securities fraud, which included inflating the balance sheet of CV Sciences. Settled in May of 2018, the action resulted in Mr. Mona being barred from serving as an officer or director of a public company for five years. Concurrent with the settlement, Joseph Dowling was appointed CEO and currently holds the position. Even though now in the past, prospective investors should consider the action when evaluating the suitability of the stock.
In spite of missteps in the past, CV Sciences was an early entrant in CBD and pioneered the retail market in the U.S. And based on positive execution and surging revenue, it does not appear that the debacle has negatively impacted growth in the business and future prospects. At a market cap near $400 million, CVSI appears to offer significant value relative to its peers. As reported on its Q1 2019 conference call the company is in discussions with multiple additional retailers and expects to report significant wins, with pilot programs already running with some. Without the drag of extraordinary expenses in Q1 2019, CV Sciences could be set to report an extraordinary Q2.
Elixinol Global
Elixinol Global Ltd (OTCQX:ELLXF) is an Australia-based company with U.S. operations in Colorado and California. The stock is listed on the Australian Stock Exchange and trades in the U.S. on the OTC with a current stock price near $3.85. The company operates in two business segments, consumer products and pharmaceutical, with three brands: Ellixinol (supplements), Hemp Foods Australia (hemp foods), and Nunyara (medicinal cannabis pharmaceutical). An investor presentation includes a graphic that provides a comprehensive overview of the business.
The Elixinol brand is produced and marketed in the U.S. and is focused on CBD sales in North America. The company reported 2018 Elixinol revenue of $32.5 million (USD) which represented 87% of worldwide sales. Consolidated revenue increased 121% in 2018 as U.S. revenue for Elixinol increased 141% YOY. While not reflecting on the prospects for the company, financial reports are stated in Australian dollars (A$) which may require additional efforts to evaluate the merits of the stock. Also, reporting may be less robust than with peers, since Q1 2019 quarterly results were not available for this article. An additional resource for investors is provided in an audio presentation for an investor conference held May 14.
As stated in the audio presentation linked above, Elixinol has several advantages that differentiates it from other CBD players. Although Elixinol was founded in 2014 and went public in 2018, its predecessor Hemp Foods Australia has been in the hemp business since 1999, maintaining a management staff that encompasses decades of experience in hemp. Management indicated that the company controls the complete process of growing, production, R & D, and marketing– all the way from water rights to enable consistent supply to marketing the final product. The company also has an international footprint with operations in Australia, New Zealand, Europe, Brazil, Japan, and the U.S. However, with 2018 revenue near $37.3 million including $32.5 million in the U.S., it is apparent that recent traction in the business has been in the U.S. with 87% of revenue. With international operations already in place, the company could gain major traction in those markets much quicker than competitors. And while the CBD market expanded at a breakneck pace following the passage of the Farm Bill of 2018 in the U.S., international markets could experience a breakout as CBD momentum builds.
Comparison takeaway
While all three CBD players discussed above should continue outsized growth, successful branding will likely be the main determinant of ongoing industry leadership, in which case Charlotte’s Web currently has a clear lead and is positioning itself for further gains. The CW brand has a story behind it and the company is taking quick action to build further momentum in the brand. Hiring high-profile packaged goods leaders like CEO Deanie Elsner and other key executives was a crucial next step for an industry in formative development. And after reviewing presentations, earnings conference calls, news releases, and other available resources, Charlotte’s Web appears to have the greatest momentum, energy, and management excellence. On the other hand, CV Sciences, with a market cap near $400 million, appears to provide the best choice on a valuation basis.
It is likely that both CV Sciences and Charlotte’s Web will be up-listed to either Nasdaq or the NYSE. CV Sciences has a pending application with Nasdaq (source: Q1 2019 earnings conference call) that could receive approval at any time. Charlotte’s Web management has stated that the company’s board of directors is reviewing potential up-listing on either Nasdaq or the NYSE. The prospect for up-listing Elixinol is currently unknown.
Future of CBD
A key aspect of the CBD market is that it consists mostly of producing and marketing a product derived from an agricultural commodity, hemp. Similar to other packaged goods derived from commodities, successful branding will be crucial to long term gains. As revenue and scale continues to build, margin compression will undoubtedly occur. Gross margins of over 70% will dwindle as new players enter the market. However, due to regulation and scale, there will be barriers to entry in the market and opportunities to lower costs. And similar to other consumer goods companies like Constellation Brands (STZ) with gross margins near 50%, it is likely that leading CBD brands will command attractive margins.
Another trend in CBD is the development of synthetic versions of CBD for use in the pharmaceutical segment of the business. Synthetic versions provide exact dosing standards necessary for drug approval. Some analysts have suggested that synthetic CBD could likely be the future of the overall CBD market, including supplements marketed as consumer brands. However, with the overwhelming and growing preference of consumers for natural, non-GMO, and environmentally friendly products, it appears highly likely that farm-grown hemp will dominate the CBD market for the foreseeable future.
Risks
Investors should realize that, even though CBD is likely to provide a high-growth opportunity in the early stage of development, investing in CBD carries a high level of risk, both in terms of potential regulation or other unforeseen developments. In addition, none of the CBD players discussed are listed on U.S. exchanges, adding volatility and the potential for stock manipulation. Additionally, cannabis-related stocks have been extremely volatile and, as noted earlier, CBD stocks plunged over 50% from near-term highs. Readers should not invest in the CBD stocks based solely on the content of this article, and do so only after evaluating risk profiles provided in financial statements and disclosures.
Conclusion
Both consumers and CBD suppliers are set to become winners in the huge growth ahead for CBD that could occur in high double-digits or even triple-digits. Due to wide consumer acceptance and broad evidence that CBD is benefiting the lives of people worldwide, as documented in hundreds of reviews and consumer testimonies, CBD is quickly going mainstream. Based on the FDA statement that followed the May 31 hearing, it is clear that the FDA has a full awareness of the moving parts, including a strong and growing consumer preference for a product that clearly provides benefits. In the Charlotte’s Web Q2 conference call, management cited that 80% of consumers have an awareness of CBD and are open to try it, while CBD has a household penetration of only 7%.
While the industry will be subject to regulation, further clarification of the FDA position on CBD could prove to be a bonanza for major CBD players, paving the way for much wider adoption at the largest retailers. At the same time, regulation will purge the market of unscrupulous players that have been detrimental to consumer interests. Few industries offer potential growth prospects comparable to CBD. As the industry matures, there will undoubtedly be gross margin compression, but at much larger revenue and scale.
Disclosure: I am/we are long CWBHF, CVSI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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