- GRWG reported strong quarterly results with 190% top-line growth.
- Comparable sales were 60%, with the remainder of growth driven by external acquisitions.
- The stock fell 40% since reporting earnings - I explain what's causing the stock price weakness.
- I take a serious look at the bull case and explain the upside ahead.
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I have previously been a vocal critic of GrowGeneration (NASDAQ:GRWG). My main issues largely focused on some hairy connections regarding the management team as well as my confusion on why hydroponics stores are willing to be acquired at such low multiples. GRWG fell around 40% after reporting its latest earnings - and I am now slightly changing my stance. The stock appears to offer a better risk-reward and I model the potential return that investors can expect from current levels. I remain wary of the potential management risk, but acknowledge that GRWG may prove to be a valuable addition as part of a diversified cannabis portfolio.
GRWG Stock Price
GRWG reported earnings on August 12th before the bell. In spite of what appeared to be typically strong results, the stock crashed.
There were brief moments of some recovery, but GRWG has since continued to fall and now trades around $25 per share. What was so wrong about the earnings report?
Why Did GrowGeneration Fall After Earnings?
The latest earnings, on the surface, appear strong. Revenues grew 190% to $125.9 million. I note that Q2 2020 should not be considered an easy comparable because, in that quarter, GRWG grew revenues by 123%. While GRWG has historically achieved accelerated growth through external acquisitions, the company posted 60% comparable sales growth in the quarter. The company posted some operating leverage as adjusted EBITDA grew faster at 229% to $14.5 million. Net income grew 161% to $6.7 million.
The company has been taking steps towards achieving further margin expansion. Private-label and proprietary product sales now total 7% of overall sales.
The problem appears to have come from guidance. GRWG raised full year revenue guidance to between $455 million and $475 million. That is higher than initial guidance of $415 million to $430 million provided at the beginning of the year and represents 136% at the low end. However, consider that GRWG has generated $215.9 million of revenues year to date, and just generated $125.9 million of revenues in the latest quarter. GRWG's guidance seems to imply that the third and fourth quarters will show stagnant growth from this past quarter's levels - if GRWG maintains the current quarterly run-rate, then it should end the year with around $467 million in revenues. GRWG maintained adjusted EBITDA guidance at $56 million at the midpoint, suggesting some deceleration in margin expansion.
Wall Street appears to be concerned that GRWG's rapid growth is about to moderate significantly.
Is GRWG Stock A Buy, Sell, or Hold?
We can see consensus estimates below:
Wall Street expects growth to slow to 31% next year, then decelerate even further to low double-digit levels. I view these estimates to be potentially conservative, especially if GRWG is able to keep acquiring assets at low valuations as it has done historically.
Nonetheless, is the stock a buy based on consensus estimates? First, we must project long-term net margins. I use Home Depot (HD) as a comparison to determine the ceiling of what to expect. In its latest quarter, HD earned 11.7% net margins and 33.3% gross margins. In comparison, GRWG earned 5.3% net margins and 28.4% gross margins. Clearly, investors must count on operating leverage for net margins to expand.
Let's start with the conservative case. I assume that GRWG can achieve 8% net margins - this will be driven through gross margin expansion (increased private-label sales) and operating leverage. I assume that GRWG can grow its top-line by at least 10% annually for the next decade, as I view cannabis to be a long-term secular growth opportunity. Using 2023 estimates of $686 million, GRWG is trading at 2.2x sales and 27.5x "adjusted earnings." I would expect GRWG to trade at a price to earnings growth ratio ('PEG') of 2x, meaning that shares should trade at 20x adjusted earnings. This calculation suggests that GRWG is moderately overvalued.
But GRWG bulls will argue (and likely rightfully so) that these estimates are too conservative. In particular, why should overall long-term growth be 10%? I could see the argument that same-store sales growth may be 10% by itself. Let's instead assume that GRWG can sustain 15% long-term growth. In this case, GRWG should earn at least $711 million in 2023e revenues, and I would expect the stock to trade at 30x adjusted earnings - equal to 2.4x sales. GRWG is trading at 2.2x 2023e sales, suggesting modest upside.
But perhaps this is still too conservative? If GRWG can continue acquiring assets on the cheap, then perhaps it could achieve 20% long-term top-line growth. Perhaps it can also achieve 9% long term net margins. In this case, GRWG would be trading at 2.1x 2023e sales, and I'd expect the stock to trade at 3.6x 2023e sales - suggesting 70% upside over the next 2 years. What's more, GRWG would potentially be able to deliver 20% annual returns at that price, giving investors exposure to the long-term growth of the cannabis industry.
I remain wary of the management risks highlighted by the Hindenburg report. It is also possible that GRWG is unable to keep acquiring assets at these low valuations - such an outcome should be expected at some point. But for investors willing to tolerate a little bit of hair on the investment thesis, GRWG is finally priced at a valuation that may be able to deliver solid returns over the long term, especially if it could deliver on taking market share and achieving margin expansion. Because there aren't any regulatory barriers to entry in the hydroponics space, I am doubtful that GRWG will offer the same upside as investing directly in the stocks of multi-state operators ('MSOs'), but I expect the stock to offer solid returns nonetheless. Due to where MSOs are currently trading, I would need GRWG to fall some more to become more attractive - the stock is still trading at a "Nasdaq-premium" since MSOs are not trading on major exchanges. I rate shares a hold, though I wouldn't fault anyone for jumping in light of the recent poor tape action.
This article was written by
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