GrowGeneration: Preparing for a strong 2023 (NASDAQ: GRWG)

Investment thesis

Grow Generation Corp. (NASDAQ: GRWG) has surged a whopping 83% in the past 52 weeks and more than 44% since the start of the year. One of the main reasons for the stock’s fall is the drop in forecasts for 2022 due to problems with the cannabis industry, a large user of hydroponic systems, more precisely “a huge oversupply of outdoor cannabis.“These issues will likely dent the company’s performance for the year, but provide a good entry point for an otherwise thriving emerging industry.

The United States House of Representatives recently passed the Marijuana Opportunity Reinvestment and Clearance Act ((MORE)), which will end federal prohibition of cannabis by removing it from the list of prohibited controlled substances . It will help further to help cannabis-related businesses in the United States, such as authorizing loans and SBA services, etc. Even though the bill has yet to pass the Senate, it bodes well for the industry moving in the right direction, resulting in the best interests of the hydroponics industry.

The hydroponics industry has not yet reached a mature stage and is full of opportunities in emerging markets. Even though hydroponics is not going to trample on traditional farming methods anytime soon, the segment of the industry is gaining momentum due to its long list of benefits.

GRWG is taking advantage of this fragmented market to acquire and expand its retail garden centers across North America, with 23 acquisitions in 2021. It has identified new market opportunities in Connecticut, Ohio, Illinois, Pennsylvania, New York, New Jersey, Mississippi, Missouri, and Virginia. It plans to open 15 to 20 new locations in 2022 and increase the total number of stores to 100 by 2023 to guide its operational performance.

I’m bullish on the stock due to the company’s growth strategy to thrive alongside the growing U.S. cannabis industry over the next few years.

Market overview

Simply put, hydroponics is a method of growing plants without soil. It is typically used for indoor growing, giving growers the ability to regulate and control better nutrient supply, light, air, water, humidity, pests and temperature, allowing agricultural production throughout the year. Plants in the hydroponic system can achieve 20-25% higher yields than in a soil-based system with 2-5 times higher productivity.

Hydroponic equipment is primarily used by vertical farms producing organic fruits and vegetables and the cannabis and hemp market. Vertical farms have increased due to an increasing scarcity of agricultural land, environmental vulnerabilities such as drought, other extreme weather conditions and pests. The Associated Press estimates that $32 billion worth of food was produced by hydroponic technology in 2019, and is expected to grow at a CAGR of 5% through 2025.

Additionally, with the skyrocketing legalization of herbal medicines, primarily cannabis and hemp, and the growing number of licensed grow facilities in North America, the demand for hydroponic products is increasing. Sales in the global cannabis market are expected to reach $61 billion, with the hydroponics market expected to reach $17.9 billion at a CAGR of 11.3% by 2026.

As these two industries grow hand-in-hand, a unique market opportunity arises for GrowGeneration due to its vast network across the states that offers end-to-end solutions for both commercial and artisanal growers.

In states with a mature cannabis market, such as California, the largest cannabis market in the United States, where 36.5% of the company’s stores are located, the company is well positioned to generate sustainable and recurring income through the sale of consumables. . In contrast, with the recent legalization of herbal medicines in emerging markets, growers are stepping up operations and purchasing non-consumable CapEx items for constructions.

Company presentation

GrowGeneration is “North America’s Largest Hydroponic Garden Center Chain”. It is a market leader in the marketing and distribution of “nutrients, growing media, advanced indoor and greenhouse lighting, vertical benches, environmental control systems” and growing accessories. hydroponic gardening.

The company “owns and operates 63 retail stores specializing in hydroponic and organic gardening” in 13 U.S. states, selling more than ten thousand products, including organic nutrients and soils, advanced lighting, and hydroponic equipment to commercial growers on the herbal medicine market. , artisanal producers and vertical farms.

Financial performance and position

GrowGeneration recorded 118.5% annual revenue growth, from $193.4 million in 2020 to $422.5 million in 2021, including 24.4% annual same store revenue growth. Comparatively, cost of sales increased 113.8% year-over-year, resulting in a 160 basis point year-over-year increase in gross margin to 28%.

Operating expenses increased by 142.3% compared to 2020, mainly due to the addition of 23 new stores, which increased depreciation expenses fivefold. Therefore, the 82% year-over-year increase in EBITDA is a much better indicator to measure the company’s operating performance than the marginal growth in net income of 25 basis points.

In 2022, the company expects revenue to peak at $445 million, representing a best-case scenario year-on-year growth rate of 5%, and EBITDA to remain relatively flat. This sharp decline from current growth led to a drop in market sentiment and a sell-off, causing the stock price to fall. The weak forecast is due to lower than expected CapEx trade sales to customers due to headwinds in the cannabis market.

Despite the company’s unimpressive short-term estimates due to the cannabis industry, the long-term outlook looks solid. BDSA, a leading market researcher for the cannabinoid industry, forecasts that global cannabis sales will grow with a CAGR of 16% to $61 billion by 2026, and in the direct interest of the hydroponics industry and, in turn, of GrowGeneration.

To grow its footprint in the industry, the company acquired 23 new locations for approximately $81 million, entering various markets and achieving robust market growth in 2021, both organic and inorganic. Additionally, its website attracts over 160,000 visitors per month, helping to cross the $36 million mark for online sales. This strategy of market penetration and growth is working well for the company as it scales up operations across the country to inflate revenue, reduce cost of sales, improve profitability and secure a long-term position.

The company plans to invest approximately $20 million in 2022 to open 15 to 20 new stores and an additional $10 million for acquisitions and technology spending. These can easily be covered by the company’s available cash of $81 million, but are expected to be covered by cash generated from current year operations, which will keep the company’s liquidity position strong and intact. The company is essentially debt-free with strong liquidity, strengthening its fundamentals and fostering growth prospects through lucrative acquisitions.

GrowGeneration is stepping up its initiatives in 2022 to overcome headwinds related to the cannabis industry, including through market growth achieved through capital investments. By 2023, the company expects accretive earnings from its 2022 investments to trigger and inflate revenue growth, including reaching a 20% share of its private label revenue, up from 8% currently. Based on the current state of the business and industry growth, it is likely that the company will achieve these goals by the next fiscal year.

Evaluation

A simple look at the company’s relative valuation metrics shows a direct decline from its valuations a year ago. The PE multiple dropped from over 150 to around 35, PS from around 6 times sales to 1.2, and PB dropped from a multiple of 9 to around 1.

Even though these values ​​have seen a sharp decline, the PE is still nearly 1.7 times the industry median of 13.56, and the PS is a bit above the industry median of 1, 02. PB is the only metric where the company does better than its counterpart at about half the industry average.

The clubbed shared price pushed valuation metrics up a ridiculously high multiple earlier this year, and those metrics will most likely persist through the year and even start to gain momentum once the outlook market positives will kick in and the stock price will begin to rise relative to earnings. , which shouldn’t be impressive for 2022.

Risk-averse investors will find these valuations attractive enough to seize the opportunity and gain a foothold in the hydroponics industry. On the other hand, risk-averse investors might still want to wait until at least the second-quarter earnings report.

Conclusion

Despite the headwinds, the long-term outlook for the cannabis industry is strong, and with the MORE Act underway, GrowGeneration stands to benefit greatly from the strong market demand that is expected to be created for CapEx sales to the industry in because of its strong position. in the hydroponics industry.

GRWG’s footprint in a large number of states, which continues to grow rapidly, will allow the company to firmly establish itself in mature and emerging cannabis markets when the industry is strengthened by the federal government, initiating a strong market demand for cannabis grow facilities.

The decline in the share price has helped dampen previously lofty valuation metrics and bring them back to acceptable levels. If the company starts delivering in line with its forecast in upcoming quarterly reports, the stock could start to see a climb in the heavily guided 2023 expectation by the third or fourth quarter of 2022.

Overall, the company operates as an integral function of a growing industry, has strong fundamentals, and is well positioned to capitalize on the upcoming boom in the cannabis industry.