Sales growth rates play a huge role in determining the value of a cannabis investment. However, growth analysis is rarely a clean or simple task.
The goal of thorough due diligence is to differentiate core, organic growth of a business from all other transient, nonrecurring or exogenous factors.
Why do we need to differentiate? Because we may want to assign a different valuation multiple to core, organic growth versus growth from other sources.
Reported sales growth rates can be impacted by acquisitions, divestitures, new product launches, net store openings, the start of new customer contracts, entrance into new markets, price changes, customer inventory changes, retail square footage growth, harvest timing, prior period growth, etc.
Core, organic growth analysis is made even more complex when multiple factors need adjustment simultaneously.
Take, for example, GW Pharmaceuticals, which recently began selling Epidiolex, the first drug approved by the U.S. Food and Drug Administration that contains a purified substance derived from natural cannabis.
The drug had a transformative impact on GW Pharmaceuticals’ sales. Since the drug launched two quarters ago, GW has posted spectacular year-over-year sales growth rates of 639% and 1,999%.
| 1Q18 | 2Q18 | 3Q18 | 4Q18 | 1Q19 | 2Q19 | |
| Sales ($US million) | 5.4 | 3.4 | 2.4 | 6.2 | 39.7 | 71.7 |
| Y/Y % Growth | 110% | 69% | -22% | 122% | 639% | 1999% |
| Q/Q $ Growth | 2.6 | -2.0 | -1.0 | 3.8 | 33.4 | 32.0 |
Sales increased quarter-over-quarter by $33 million and $32 million for the past two quarters – and some investors may assume it’s plausible to forecast several more quarters of $25 million-$30 million sequential sales growth.
However, multiple factors will positively and negatively impact short-term sales and growth rates:
- There could be a positive boost from rising dosage rates. Doctors typically start their patients on lower doses to assess efficacy and ability to tolerate the drug. If the drug is effective and has manageable side effects, doctors will likely raise dosage amounts by 50% to 100%.
- The drug may receive approval for use in the European Union late in 2019. If so, we could see a large sales spike similar to the U.S. launch.
- Sales of the drug have been frontloaded because of rapid adoption of the drug by patients and doctors who were involved in the drug’s clinical trial programs and prelaunch awareness campaigns.
Once the early surge passes, there could be a much slower pace of new patients using the drug.
With those multiple puts and takes, GW may post impressive growth rates for several more quarters as they capture share of the patient market. However, the addressable patient market size for Epidiolex is relatively limited; the drug is approved to treat just two of more than 30 epilepsy conditions.
Once GW has deeply penetrated its patient base and is at full dosage rates, the London-based company’s sales growth rates aren’t likely to remain in the stratosphere unless it receives regulatory approval to treat other conditions.
Accurately measuring current growth and, more importantly, assessing future growth prospects can be a complex endeavor.
As part of our expanded product, we will analyze and report on core, organic growth and scores of financial and operating metrics such as:
- Same-store sales and sales per square foot.
- Fixed versus variable expenses.
- Gross, EBITDA and operating margin analysis.
- Accounting red flags (such as rising days sales outstanding or days of inventory on hand, factoring of accounts receivable, changes in revenue recognition or deferral policy, etc.)
Our goal is to provide you with valuable insight that will help you identify investment opportunities in the cannabis industry and how to capitalize on them.
Craig Behnke can be reached at craigb@mjbizdaily.com.
