Seeking Alpha

This Profitable Cannabis Company Is Uplisting To The Nasdaq

|
About: GrowGeneration Corp. (GRWG)
by: Bay Area Kid
Bay Area Kid
Growth, momentum, long-term horizon
Summary

GrowGeneration reported another quarter of revenue growth and profitability.

Recent positive legislation news has the U.S. cannabis industry approaching an inflection point.

Management's commentary on their conference call outlines further growth for 2020.

Investment Thesis

This article is a follow-up to my August 2019 article titled "GrowGeneration: An Emerging Cannabis Pick and Shovel Play", which detailed a profitable and rapidly growing company serving the legal cannabis market. On November 11th, GrowGeneration (NASDAQ:GRWG) released their Q3 earnings. The company posted attractive revenue growth and margin improvement, while also laying out a number of growth and cost control initiatives designed to take advantage of a growing legal cannabis market.

Company Overview

GrowGeneration is a hydroponic and growing supply retailer serving the legal cannabis market throughout the United States. The company was founded in 2014 with a single store in Pueblo, Colorado. Today, the company is operating 25 stores in 9 different states, with aggressive expansion planned for the foreseeable future. The stores serve amateur home growers, as well as a number of licensed cannabis and hemp producers. The company also operates an online retail platform at heavygardens.com.

On November 25th, it was announced that GrowGeneration would be moving from the OTCX to the Nasdaq. While not necessarily material to the underlying business, uplisting gives access to a wider pool of potential investors, which should make raising capital to fund further expansion easier.

Legislative Advancement

Since my last article on GrowGeneration, the company and industry as a whole have experienced a number of positive developments, none bigger than the U.S. House of Representatives voting to pass the SAFE Banking Act, which would allow cannabis companies to utilize banking services without those banks running afoul of the federal government.

Most recently, the House Judiciary Committee voted to pass the Marijuana Opportunity Reinvestment Engagement Act, or MORE Act. The MORE Act would effectively end the federal prohibition of cannabis by removing it from the list of controlled substances. This would allow the individual states to set their own regulations on cannabis, while also opening up the door for states to import cannabis from other states. The bill needs to be presented before the entire House, and if it passes, it will need to go to the Senate. Provisions in the bill outlining the pardoning of those convicted of marijuana related crimes make it a long-shot to pass anytime soon, but this is the clearest sign yet that federal prohibition is coming to an end.

There are also a number of states that recently legalized cannabis or will have it on the ballot in the upcoming elections. Each state that's added to the list of cannabis-legal states is a new opportunity for GrowGeneration to expand to.

Conference Call Highlights

GrowGeneration held their earnings conference call on November 11th. While the entire transcript is worth the read, I wanted to point out some key statements from management that noted a number of positive developments in the quarter and outlined further growth for 2020:

"In the third quarter, we added four analysts, who all initiated by recommendations from investment banks that include ROTH Capital, Ladenburg Thalmann, Lake Street Capital Markets and Alliance Global Partners."

Institutional investors and analysts are beginning to catch on to the well-run and growing company. With an uplisting to the Nasdaq, expect GrowGeneration to continue attracting attention.

"GrowGeneration Management Corp., our commercial division is now approaching $5 million in sales per quarter and we added over 60 new commercial accounts in the third quarter of 2019... Our e-commerce store HeavyGardens added over $1.4 million, a 40% increase over the second quarter sales. "

Management has made it a point of focus to target large multi-state operators. These large commercial customers will (hopefully) become the long-term customers that build the backbone of GrowGeneration's operations. Previously disclosed multi-state operator clients include iAnthus Capital Holdings (OTCQX:ITHUF), Green Thumb Industries (OTCQX:GTBIF), Acreage Holdings (OTCQX:ACRGF), Cresco Labs (OTCQX:CRLBF) and Curaleaf Holdings (OTCPK:CURLF). Meanwhile, further growth in their online sales shows that smaller amateur growers continue to utilize the company for their growing needs.

"With our success in Oklahoma, which is now at $10 million annual sales and growing. The company assigned two new leases and is opening its 24th location in Oklahoma City on November 15, and 25th location in Tulsa, December of 2019."

Despite a reputation as a fairly socially-conservative state, Oklahoma has been very receptive to cannabis companies. The state's cannabis industry is perhaps the least regulated in the country, allowing for explosive growth. This could lead to Oklahoma being the state bringing in the most revenue for the company.

"Our private-label program under the [indiscernible] brand will hit our shelves and online in Q4. Our initial private-label lineup includes a one part in micro and macronutrient plus Cal-Mag [ph] powder line for both the Cannabis and Hemp farmers, a [indiscernible] plus micronutrient booster and a root stimulant, all added that can be used with any nutrient regimen. Addition -- additional private label products that will be on our shelves in Q4 include: [indiscernible] for hosting lice, breathable fabric pots and T5 for [indiscernible] for indoor gardening."

The company's decision to drive margin growth by developing private-label products is beginning to bear fruit. Selling their in-house brands should allow them to cut costs and increase gross margins. Should the brands prove particularly successful, management also has the option to distribute through other retailers, both online and in-store.

"We will be expanding into California in 2020, and probably LA area where we don't have locations as of now... Yes. In this store openings we are targeting right now Missouri and Illinois. Still waiting on some of the back east [ph] states right now: New Jersey, New York, need a little more confirmation right now."

Los Angeles is second only to New York City in terms of metro population, not to mention very cannabis friendly, so this seems like an excellent market to get into. Management is also looking to enter new states as they catch up with legalization, but won't enter a market where the regulations are in flux (New York and New Jersey).

Financials

The company reported another strong quarter of earnings, showing impressive revenue growth and cost controls.

Balance Sheet

Income Statement

Source: SEC Filings

Revenue: Revenue grew 159% compared to the previous year period and 11.8% compared to the previous quarter. Revenue growth was driven by new store openings and an increase in same-store sales, which grew 48% compared to last year. With aggressive expansion planned for 2020, the company expects to realize similar revenue growth for the foreseeable future.

Margins: Gross margin came in at 29.9%, which was in line with the previous quarter and up 4.2% from the prior year period. Operating margin improvement was primarily driven by improved purchasing power as a result of their increased scale and the company-wide implementation of their enterprise resource planning (ERP) system, which consolidates accounting, human resources, purchasing and other corporate functions. As more stores and added to their portfolio, and their associated costs are absorbed at a corporate level, operating margin should continue to improve.

Balance Sheet: The company reported a healthy cash balance of $16 million, giving them plenty of dry powder to put to use in expanding in 2020 and beyond. The company's debt continues to shrink during the quarter and now stands at a mere $265,000, giving the company a fantastic debt-to-equity ratio under 0.01.

Valuation: With a market cap of ~$175 million, annualized revenue of $87 million and annualized net income of $4.2 million, the company carries a price-to-sales ratio of 2 and a price-to-earnings ratio of 42, both of which are attractive measures for a company growing as fast as GrowGeneration is.

Risks

While GrowGeneration is not subject to state cannabis laws, its customers are. If cannabis legalization were to be rolled back in these states, or regulations become too oppressive to run a successful business, there would be a reduced need for GrowGeneration's products. This would have a negative impact on the company's revenues and margins.

GrowGeneration only recently turned profitable, so it doesn't have a long history of showing EPS growth. While the company has a number of initiatives that are already proving to drive profitability, there can be no guarantee that the company will show consistent profitability while it is expanding as fast as they plan.

Since the company primarily operates brick and mortar retail outlets, there is always the risk that consumers will increasingly shun going to the store in person and instead buy their hydroponic supplies online. To mitigate this risk, while also driving increased revenue, the company has their online platform at heavygardens.com.

Finally, while there are a number of heavy hitters in the hydroponic and DIY gardening industries, GrowGeneration operates in its own niche. Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) dominate the DIY market, while home-garden leader Scotts Miracle-Gro (NYSE:SMG) has established a hydroponic-focused subsidiary called the Hawthorne Gardening Company. None of these three giants are direct competitors to GrowGeneration, since Home Depot and Lowe's have DIY retail locations, but there is minimal focus on cannabis. Meanwhile, Hawthorne is becoming an industry leader in hydroponic products, but they do not operate their own storefronts and actually supply GrowGeneration with products to sell in their stores. This leaves GrowGeneration as the dominant player in the cannabis growing supply market.

Conclusion

In my opinion, GrowGeneration is one of the better pick and shovel plays in the cannabis industry. Since the company does not touch the plant, it avoids the myriad and ever-changing regulations of the industry, while also allowing the company to operate across state lines. The company is already profitable and is driving further margin improvement via increased scale and the implementation of cost-control measures, including a company-wide ERP system. With more states adopting cannabis legalization and federal legalization a virtual inevitability, the opportunities to enter new markets and drive further growth are substantial.

Disclosure: I am/we are long GRWG, CURLF, ACRGF, GTBIF, ITHUF. 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.