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What's Wrong With Charlotte's Web?

Charlotte's Web (OTC: CWBHF) was supposed to be a safe bet. Its hemp-based products are federally legal (unlike their cousin, marijuana), and consumers can buy them at more than 21,000 retail locations across the country. Charlotte's Web also sells products directly to consumers through its website. However, the company's share price is down more than 60% this year, nowhere near the Horizons Marijuana Life Sciences ETF (OTC: HMLSF), which is down 8.5%, or the S&P 500, up about 3%.

Investors are trying to figure out what's going wrong for this once-profitable company. It was a stock that -- once upon a time -- I saw as one of the safer plays in cannabis. But after the company posted a fourth straight loss in the recent quarter, it's become clear that this is no longer the case. Let's take a closer look at the company's results to see what's happening with the business and whether you should consider buying shares of Charlotte's Web during its dive.

Online sales are not strong enough to generate top-line growth

One of the reasons I was optimistic about the company's recent quarterly report was Charlotte's Web's strong direct-to-consumer (DTC) segment. The business segment seemed set to thrive as people turned to online shopping in the face of stay-at-home orders and lockdowns when the coronavirus pandemic hit. After all, many retailers have benefitted because they offer robust online options for customers. In their most recent quarterly earnings results, Walmart reported 97% e-commerce growth, Target's online sales were up by 195%, and Lowe's reported online revenue which rose 135% from the prior-year period.

However, when Charlotte's Web released its second-quarter results on Sept. 14 for the period ending June 30, sales of $21.6 million were down 13.6% year over year. DTC sales accounted for 71.8% of revenue and rose by 33.6% year over year. Unfortunately, that just wasn't nearly enough to offset lower in-store sales and less foot traffic at retail locations.

Image source: Getty Images.

While lockdowns are a legitimate reason for a decline in sales, it's not a reason to invest that stock pickers should readily act on. Despite shutdowns, the cannabis industry has fared well, with many states posting record sales numbers in recent months. Colorado sales came in over $200 million in July, the first time it's hit that mark in the summer month. Illinois set a new record in August with almost $64 million in revenue, and Ohio set a record in July with $21 million in medical marijuana sales.

Charlotte's Web's poor numbers could be a sign that people are turning from hemp to marijuana for its higher potency. Hemp is limited to 0.3% tetrahydrocannabinol (THC) content. If the material is comprised of more than 0.3%, it's considered marijuana, and therefore, illegal. THC is the psychoactive component in cannabis. Customers who use Charlotte's Web's hemp-based products do so for medicinal purposes, but plenty of cannabis-users continue to seek products with higher THC levels.

This is a concerning sign for investors. And even before the pandemic, there were growth problems for Charlotte's Web. Although more stores are carrying its products, increased product exposure hasn't translated into revenue growth. Investors noted the issue when the company released its fourth-quarter results, and it still remains a problem. In June, the company announced that it closed the acquisition of hemp company Abacus Health, which would allow it to distribute products in over 21,000 locations. That's up from over 8,000 retail locations as of the end of Q2 last year, when Charlotte's Web's sales topped $25 million.

Did the company make a big mistake in expanding too soon?

Charlotte's Web incurred a loss of $14.4 million in Q2, down from a profit of $2.2 million in the prior-year period. The glaring difference: A sharp increase in general and administrative costs. At $21.1 million, Charlotte's Web's expenditures in this category alone were nearly as much as its total revenue. Its personnel costs of $9 million are now more than triple the $2.9 million it spent a year ago. Legal and professional services cost $7 million and rose by 122% year over year.

When the company released its third-quarter earnings on Nov. 13, 2019, one of the key announcements was its move into a new 136,610 square feet facility, which would increase capacity by 10 times and result in cost savings by the third quarter of 2020. As of this past quarter, Charlotte's Web stated that it has moved its warehousing and fulfillment operations to the new location but it won't be fully operational until early 2021.

But with all of that expected growth and expansion comes more staff. This past quarter, Charlotte's Web reported a headcount of 318 -- up 42.6% from the 223 people it employed in the same period last year.

In its earnings release, the company did say that management was "initiating an expense optimization program targeting a 10% reduction in consolidated expense run rate by the end of 2020." However, that may not be nearly enough to get the company back to breakeven -- certainly not if sales continue to struggle.

In retrospect, the company's rapid expansion and focus on growth may prove to be its undoing, as its losses are undoubtedly keeping many investors away.

Why you shouldn't invest in Charlotte's Web today

If a company isn't generating sales growth amid the pandemic, it should be tearing down costs wherever it can. With the company's bloated headcount, a 10% reduction in costs isn't going to accomplish much. The company's general and admin costs shouldn't be anywhere near its total revenue. Until Charlotte's Web makes some serious, deep cuts, investors should stay far away from this stock.

More and more companies are getting into the U.S. hemp market, with Canopy Growth, Tilray, and Aurora Cannabis among some of the big-name competition that Charlotte's Web will have to fend off -- and that's just from Canada. The field is going to get even more crowded, making market capture even more difficult in the future. If Charlotte's Web can no longer turn a profit at around $20 million in revenue, then there's little hope that future periods will be any better.

Unfortunately, this once safe cannabis stock is no longer a conservative bet. Until the company gets its expenses significantly down, investors should expect shares of Charlotte's Web to continue declining.

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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Charlotte's Web. The Motley Fool has a disclosure policy.


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