UGRO - Bengal Capital - urban-gro: Pricing Power And Compounding Knowhow In Cannabis Growing/Care

2023-03-05 03:00:00 ET

Summary

• urban-gro is a company focused on designing, specifying, architecting, equipping, and commissioning cannabis facilities.
• We believe that UGRO can build significant value from their current depressed price level.
• In 2023, we will be looking at UGRO to continue to grow its pipeline of cannabis work while managing its expenses conservatively.

The following segment was excerpted from this fund letter .

urban-gro, Inc. ( UGRO )

urban-gro is a company focused on designing, specifying, architecting, equipping, and commissioning cannabis facilities - facilities that are, in the broader sense, on the frontline of indoor agriculture. UGRO also has a decent amount of non-cannabis business, which we discuss below as well. The company, after completing a few acquisitions last year, has 160 employees - the majority of whom are architects, engineers, construction managers, and horticulturalists.

Just as Grown Rogue's ( GRUSF ) core competency of growing good quality cannabis at reasonable costs is undervalued, so is the core competency of building a cannabis facility that can create quality cannabis at reasonable costs while also being capital efficient. We believe that UGRO has one of the deepest competencies in the latter we have found in the industry, and we believe that they can build significant value from their current depressed price level (market cap of ~US$43mm and an enterprise value of ~US$28mm because they are net cash) for a few reasons:

• Building Cannabis Infrastructure, Like Growing, Is An Underappreciated Competency: Many industry watchers would be surprised to know that the industry suffers from something which we term the "golden toilet" syndrome. The syndrome is that buyers can spend an absurd amount of money for something which functions just as well as a similar object that is orders of magnitude cheaper. We have seen repeatedly that many large MSOs have significantly overspent on facilities that are not meaningfully more productive than Grown Rogue's facilities, or even significantly less productive. UGRO prevents golden toilets from being built.
• The Market Has Punished UGRO Unreasonably For Cyclicality: As a construction-linked company, UGRO depends on the industry to invest in capex. As the industry has pulled back on capex, so have UGRO's revenues (not to mention its stock price). However, much of this capex is still necessary (especially with markets coming online and the absence of any sightline on interstate shipment), so we view much of it as delayed versus canceled (e.g., after New Jersey recently switched to adult use, UGRO started to sign design-build contracts for facilities in the state). Here also UGRO's non-cannabis business becomes more important, as it evens out the volatility of cannabis by providing more stable revenue streams. Construction is a cyclical industry, and UGRO is no different. We expect that its pipeline will continue to improve, and revenues will begin to inflect at some point in 2023. UGRO's basic business model is also fairly straightforward, so we feel the downside case is fairly protected - especially when considering that UGRO carries no debt and has significant (est. >$15mm) net cash on its balance sheet.
• UGRO Has A "Virtuous Cycle": As we discussed above, the building of cannabis infrastructure itself is a place where companies can stumble before they even begin to operate the facility. Because of UGRO's focus on infrastructure building and diverse client set, UGRO works on more facilities than any individual cannabis company - even the largest ones. Thus, UGRO's learning compounds at a much faster rate than any individual cannabis company, and so its core competency advantage deepens. Over time, we believe that larger MSOs will realize that they must engage UGRO or a company like it just to stay competitive because, simply put, UGRO will be designing better facilities and it will make more sense for companies to hire UGRO vs. trying to build the same capabilities in house. Beyond large MSOs, and dovetailing with our commentary on SLB financing above, we believe that REITs will be forced to repossess some facilities in the coming years where incremental capital and know-how is required to make the facility reach minimum necessary efficiency. We believe UGRO is well positioned to see a significant amount of this kind of business - the "remediation" of the capex mistakes of large MSOs.
• An UGRO Subscription Service Offering Has Significant Optionality: Beyond the initial end-to-end designing, architecting, construction management, etc., UGRO has the opportunity to create a subscription service offering in the future involving monitoring, consulting, and assistance in running a facility. Like in building infrastructure, we believe that UGRO's compounding know how in cannabis growing/care will provide significant value to operators, which may in turn create a "sticky" service offering with significant pricing power on UGRO's part.

In 2023, we will be looking at UGRO to continue to grow its pipeline of cannabis work while managing its expenses conservatively.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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