GRWG - Cannabis Investors Should Avoid GrowGeneration For Now

2023-12-04 11:39:02 ET

Summary

• GrowGeneration's stock has risen 60% from its multi-year low in November, but the company has faced challenges in 2023.
• The company reported a decline in revenue and negative adjusted EBITDA for the first three quarters of the year.
• Analysts have revised their estimates for 2024 and 2025, with lower revenue and adjusted EBITDA projections.

I have a lot of exposure in my model portfolio at my investing group to ancillary cannabis stocks, but one I don't own now is GrowGeneration ( GRWG ), which has lifted about 60% off of its multi-year low that was set in November. I owned a large amount when it was down, but I exited it recently. In this piece, I discuss the challenges the company has had in 2023, assess the analyst outlook, look at the chart and review the valuation.

GrowGeneration in 2023

The company reported its Q3 after the market closed on 11/8. Revenue of $55.7 million was down 21% from a year ago. Adjusted EBITDA was -$0.9 million. For the first three quarters of the year, revenue declined 21% to $176.4 million. Adjusted EBITDA has improved, but has been negative at -$1.9 million.

While its cash has declined from year-end, the company has cash and marketable securities of $66.6 million, with no debt. Operating cash flow has been $2.8 million year-to-date through Q3.

One thing that really turned me off with this company earlier this year was their May announcement of a mushroom products supply program with a unit of GrowLife ( PHOT ). The deal was with a horrible penny stock and outside of cannabis. Red flags!

The Outlook

The company has 7 analysts providing estimates for 2024. Before the Q3 report, they were, according to Sentieo, looking for revenue of $231 million and adjusted EBITDA of -$6 million. This was down a lot from right before Q2, when they had expected revenue of $286 million and adjusted EBITDA of $5 million. Now, they expect revenue to fall 1% to $219 million, with adjusted EBITDA of -$2 million.

3 analysts project that 2025 revenue will increase 10% to $248 million, with adjusted EBITDA of $5 million. Ahead of the Q3 report, they were expecting higher revenue ($263 million) and higher adjusted EBITDA ($7 million).

The Chart

The stock is down a lot in 2023, falling 25.8% so far. This is slightly worse than the New Cannabis Ventures Global Cannabis Stock Index, which has dropped 17.5%. Here is the chart for the past year:

What concerns me about this chart is that three gaps were created as the stock rallied off of the lows, and these could get filled. I see support at $2.00-2.50 and resistance at $3.15-$3.50.

Valuation

GrowGeneration did dip below tangible book value after the report, but it now trades at about 1.1X. With no debt and some cash, this is a pretty reasonable level that could provide downside protection. The company is still generating negative adjusted EBITDA, though, and the level is not compelling.

Ahead of the Q3 report, I shared a year-end 2024 target with my subscribers of $2.87. This was based on an enterprise value of 15X projected adjusted EBITDA for 2025. Updating the numbers for the revised projected adjusted EBITDA but raising my target to 20X, which seems high, I get $2.72, which is 6.5% below the recent close. I think that investors can do better with Hydrofarm ( HYFM ), which I think will trade at an enterprise value of 15X projected adjusted EBITDA of 2025 at the end of 2024. This works out to $2.92, more than triple the recent price. Even at 10X, that stock would do better, reaching $1.36, which is up 66%.

Conclusion

If the federal government reschedules cannabis from Schedule 1 to Schedule 3 and wipes out the onerous 280E taxation, cannabis stocks should do better. I think that ancillary companies like GrowGen will ultimately benefit in that scenario, as their customers will become stronger.

GrowGeneration is having a tough year fundamentally and with its stock. It is down a little bit more than cannabis stocks in general, but it has lifted a lot since it made a 52-week low after it reported its Q3. The stock trades at a slight premium to its tangible book value and a very high multiple of its projected adjusted EBITDA for 2025. I do not own it now in my model portfolio, but I would buy some closer to $2.

I think that there are better ancillary stocks to own right now, and I believe that certain Canadian LPs that have a lot of cash and no debt but trade at substantial discounts to their tangible book value look better right now.

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