GLASF - Glass House Brands: A Successful Story At An Inflection Point

2023-08-16 06:55:13 ET

Summary

• Glass House Brands is a cannabis producer and distributor in California with a vertically integrated infrastructure that goes from cultivation to sales.
• The company has executed very well on their stated plans, being able to reach their targets ahead of schedule, and is now at an inflection point.
• Glass House has guided very positive numbers for FY 2023 and we believe this is set to continue into 2024, and the stock is undervalued by 25%.

Glass House Brands (GLASF) is a cannabis producer and distributor operating in California. We think that their strategy and proven execution make this player a good pick for acquiring some exposure to this growing and changing trend. Also, the relatively early stage of the company and being close to a turning point makes the current price relatively cheap.

Overview - Vertical integration is the key

Glass House decided some time ago that a big differentiation was needed to compete over more established players: complete control over its product. And this was clearly reachable only by building their own supply chain from production to distribution, to sales. Only by doing this, they could eventually compete with companies like Curaleaf (CURLF), one of the biggest players in that market.

So they decided in 2021 to acquire a 165-acre farm with 6 state-of-the-art greenhouses for the production of Cannabis. This farm started its first production in 2H 2022, as per the schedule announced by the company. The other important part is distribution. After production, Glass House needs to sell its product, and it does so through the "dispensaries".

These dispensaries are also growing fast, and the company increased its footprint by more than tripling this number between 2022 and 2023. Now they have 10 facilities able to distribute, which are also strategically located nearby the cultivation and manufacturing facilities. Most of the additions took place through strategic M&A which, given the conservative valuations of 2022-2023, is also probably a cheaper option than building.

The turning point: Revenue growth and profitability

One of the other positives of Glass House is its economics. Indeed, despite its relatively small scale, they are able to keep production costs very contained. The cost per LB was $127 in 2022 and is guided at $120 for 2023. The average cost in the US is between $150 and $250, so Glass House is very competitive on this side.

The other positive news is also seeing the real execution skills at work: the production costs came down significantly in the last years as a result of scaling.

This proves the ability of management to execute what they commit to and do it within the timeline. And more developments took place in what seems to be an accelerating 2023: (1) the company announced its first FCF-positive quarter ending in March 2023, and (2) an expansion of their production of 250,000 more pounds of high-quality cannabis per year.

Guidance for 2023 now is revenue growth of more than 75% to $160 million. This means that a company growing more than 70% YoY is trading at a P/S multiple of less than 2.

Last but not least, the company recently reported earnings. They were positive, with revenue coming in at $44 million, a $5 million beat. Also, Q3 guidance was raised up to $47 million against the $43 million consensus. Full-year revenue was also guided up to $170 million, versus $160 million before. Again, more proof that management is very good at execution and that the past years' investments in infrastructure are now paying off.

Valuation: Scaling and luckily printing cash

To evaluate the company, we will use a discounted cash flow model, using estimates both guided by the company (for 2023) and also our own assumptions. We make the following assumptions:

• Revenue growth between 5% and 30%, lowering after 2024 throughout 2027 and cooling to 5% after that year.

• Margins are very variable and the company is expected to remain FCF positive after 2023 for every year, with EBITDA margin between 10% (2023) and 18% 2025 onwards.

• Discount rate at 10% to reflect the relatively high cost of capital which comes mostly from equity rather than debt.

We are expecting consistent revenue growth that will later stabilize at 5% after a period of sustained expansion (2023 - 2026). Margins will also follow expansion as economies of scale kick-in and will stabilize at 18% for the long term. This model also forecasts Capex requirements at around 2-3% of revenues, which is in line with what happened in the past. We believe that the company will not stop pursuing strategic M&A to build its infrastructure, and this may be accounted for in Capex.

These are the results of our analysis. Assuming a perpetual growth rate of 1%, the sum of the present and terminal values is around $400 million of total value. After subtracting roughly $60 million of debt we derive an equity value of $344 million, or $4.9 per share. This represents an upside of 25% from the current price.

Conclusion

Glass House is at an exciting inflection point, with production now ramping up and the distribution channel completely expanded and operative. The company has demonstrated a strong ability to execute and deliver, and has strong competitive advantages that can set the company on a prosperous path. The stock seems undervalued with an upside potential of around 25%.

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