Should You Buy KushCo Holdings, Inc. (KSHB)?

Peter Sayles |

The growth of cannabis is unprecedented. It’s really the new Gold Rush.

The world is recognizing it too.

Twenty countries have approved the use of medical cannabis – including Germany, Mexico, and Australia. Denmark and Luxembourg are right behind.

Canada and Uruguay have fully legalized it – including recreational.

All but 17 U.S. States have approved cannabis in one form or another.

Thousands of companies are rushing to become the dominant players. And Kushco (KSHB) has established itself as one of them.

But Kushco doesn’t produce cannabis like Canopy Growth Corp., Tilray, Cronos, or Aurora Cannabis.

These companies have tens – if not hundreds – of thousands of acres to produce cannabis.

Kushco isn’t competing with any of the companies that produce cannabis edibles or drinks either.

What Does Kushco Holdings, Inc. Do?

Kushco is the “picks and shovels” provider for the cannabis industry. They provide everything from packaging and supplies to hydrocarbon and solvents (which are used in the extraction process to make cannabis oil).

Their company structure is broken out as such:

Kushco’s Business Units Cover The Entire Cannabis Industry

Are Kushco’s Revenues Growing?

Kushco reported quarterly earnings January 8th for its first quarter of 2019.

Revenues grew 186% year-over-year (yr/yr) to $25.3 million. Revenues grew 27% quarter-over-quarter (qtr/qtr).

Kushco is experiencing hyper-growth. It’s a testament to how big of a trend the cannabis industry is becoming.

This massive growth comes from two things: growing its customer base. And increasing the revenue per customer.

Revenue is up 535% since 2016. Kushco grew revenue from $8.2 million in 2016 to $52.1 million in 2018.

They expect to double revenue in fiscal 2019 to $115 million.

Investors need to take note no matter which way they look at it. A company growing this fast comes with a couple risks though.

Four Kuscho Risks As An Investor

Investing in a hyper-growth company doesn’t mean the stock price goes up and to the right.

There are a lot of risks Kushco faces in the future. Here are X.

1) Kushco invites plenty of competition

Kushco faces plenty of competition. It’s intuitive, but needs to be stated.

Kushco is the supplier of products and packaging for companies.

They are the #1 player in the space with over 1,500 stock-keeping-units (SKUs).

But there’s nothing truly proprietary about any product or packaging.

Any company (or companies) could take note and try to do it “better.” There will be dozens who see Kushco’s 500+% revenue growth and at least try to take a slice of the pie.

2) Kushco Investors Price It For Perfection

Plenty of investors don’t mind looking at valuation metrics – like the P/E or EBITDA – when looking at hyper growth companies.

Why? Because the bet investors make is that companies will grow into the valuations.

Take Amazon for example. Value investors missed all of Amazon’s growth because Amazon was unprofitable for 15+ years.

Amazon didn’t have a price-to-earnings (P/E) ratio because the earnings (E) was negative. When Amazon did start squeaking out profitability, the P/E ratio was massive (100x).

(No “value investor” wouldn’t even look at Amazon for more than five seconds with a 100+ P/E ratio. Remember, the P/E ratio tells investors how much they’re paying per dollar of earnings.

So if investors bought Amazon at 100x P/E… investors would make their money back in 100 years if Amazon paid out all of its earnings each year – assuming no growth. Amazon doesn’t pay a dividend either.)

The same thing applies for Kushco.

It isn’t profitable. So there’s no P/E ratio. Value investors aren’t going to consider buying shares.

This leaves investors to look at other metrics to gauge its “value.”

Some might look at its price-to-sales (P/S) ratio.

Remember, Kushco forecasts revenue of $115 million for fiscal 2019. It’s P/S ratio is 4.55x with its current market capitalization at just over $500 million.

Grant and I (Peter) think a 4.55x P/S ratio is a great price for Kushco today.

For starters, tech darlings have much higher P/S ratios with less growth. have mu

Netflix has a 9x P/S ratio at $150 billion market cap – a very high price. One we think investors buying at today’s price will be very disappointed in.

Facebook trades at an 8x P/S ratio at $440 billion. Nvidia at a 7x P/S ratio at $90 billion.

We’d rather pay 4.6x sales on a $500 million company growing revenues 100+% yr/yr than 9x sales for a $150 billion company like Netflix growing revenues 35% yr/yr.

Of course, it’s not truly apples-to-apples. But it’s just context. We can look around the cannabis industry to give a little bit of a better picture.

Cannabis producer Canopy Growth Corp. (CGC) is trading over a 160x P/S ratio – trailing twelve months. E-commerce company Namaste Technologies (NXTTF) is trading at 14.5x P/S ratio – even after a lot of sketchy and allegedly fraudulent activity surfaced.

Kushco is trading at a very good price based on a P/S ratio.

3) Kushco’s Margins Will Continue Fluctuate

Companies go through growing pains when they grow at the pace Kushco has.

This recent quarter saw 186% revenue growth. But it also saw its gross margins decrease – from 34.8% to 12.6%.

This is a huge decrease that might make a few investors nervous. It was a huge decline.

But it’s also normal to see gross margins pull back as a company grows bigger. Here’s a graph of Kushco’s rising revenues but falling margins.

Source: Seeking Alpha Contributor Jonathan Cooper

Kushco attributed the decrease to “the utilization of air freight and additional cost incurring quality control measures at our receiving warehouse to meet demand.”

Will Kushco need to pay more for air freight if they continue to see growing demand for their products? Maybe. Probably.

Will they need to pay more for “quality control” if they continue to see growing demand for their products? Maybe. Probably.

Will they continue to have “supply chain inefficiencies” as a hyper growth company? Maybe. Probably.

Investors need to factor this in before buying the stock.

So Kushco says it’ll be able to get back to 30% gross margins… but investors shouldn’t take it as gospel. It comes with the territory of growing so fast.

Investors will need to update their models to adjust (and prepare) for lower gross margins moving forward.

3) Kushco Is Diluting Shareholders To Fuel Its Growth

Kushco doesn’t earn any money.

It reported a loss of $8 million from operations last quarter. Its cash balance fell from $13 million to $3 million. And it has just an $8 million line of credit.

It continues to lose money qtr/qtr in order to fuel its growth. Again, this isn’t always a bad thing. Think Amazon or Netflix.

But remember, a business can’t stay open if it just loses money. This means Kushco will need to tap the equity or debt market to stay open.

And that’s just what’s happened.

It listed a direct offering of shares and warrants to raise around $34 million this past January at $5.25 – lower than its previous closing price of $5.96. Shares fell 13% on the day to $5.20.

Meanwhile its share count rose 19% yr/yr. This means investors get a smaller slice of the earnings pie at the end of the day.

Not really what you want to see. But something we expect from companies that burn through millions per year… and need to raise money through share issuance.

4) Kushco’s Acquisition Strategy Isn’t A Given

Kushco acquired multiple companies last year.

It acquired Summit – a distributor of hydrocarbon gases in May 2018. It then acquired special design agency Hybrid in July 2018.

Kushco’s balance sheet is now inflated with goodwill.

Total assets amounted to $113 million this past quarter. Goodwill accounted for 44% – at $49.5 million.

Goodwill is an intangible asset. It fluctuates based on some subjective accounting measures.

You really don’t want goodwill making up the majority of one’s assets. You’d rather have tangible assets like cash or property, plants, and equipment. And sometimes inventory.

Even accounts receivable shows that it is waiting to be paid.

But goodwill can be written down to $0. Which means that Kushco’s balance sheet could decrease by almost 50% with the snap of a finger.

Take Microsoft for example. It wrote down its $7+ billion acquisition of phone maker Nokia to $0. It also wrote down its $6.3 billion acquisition of aQuantive to $0 as well.

And one of the worst write-downs of all time was AOL and Time Warner. It bought Time Warner for $165 billion in 2000 at the height of the dot-com bubble.

Three years later it took a $98.7 billion write-down after the bubble burst.

Acquisitions are a huge road to revenue growth. But there’s a lot of execution risk here with Kushco.

The acquisitions could be big for Kushco. But it doesn’t mean Kushco paid the “best” price for them.

We’d like to see Kushco continue to shift its balance sheet away from being goodwill heavy. And more towards tangible assets.

Conclusion

Kushco is one of the better companies to invest in during this cannabis boom.

Its revenues have grown over 530% over the past two years. And it expects to double revenues again in 2019.

It’s also trading at a very reasonable 4.6x P/S ratio. But there’s a lot of execution risk too. This includes shareholder dilution to help fuel growth.

Unfortunately, Kushco doesn’t have any options available to trade. We’d prefer this method to bet on the growing cannabis boom.

Either way, Kushco is at the top of our cannabis watchlist.

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