GTBIF - Green Thumb: As Cannabis Stocks Crash Buy The Strongest In U.S. Cannabis

2023-03-23 07:00:00 ET

Summary

• US cannabis is a great growth story, but the near term has been dominated by price compression.
• Green Thumb maintains one of the best balance sheets in the sector and continues to generate cash flow.
• Green Thumb is one of the few operators which are current on tax payments.
• The stock trades too cheaply in light of the long-term growth opportunity.

As the US cannabis sector undergoes a vicious bear market, industry leader Green Thumb Industries ( GTBIF ) continues to separate itself from the pack. Unlike many peers which aggressively pursued loss-generating growth financed by expensive debt, GTBIF has focused on its profitable core footprint while maintaining a best-in-class balance sheet. While GTBIF is not immune from the price compression impacting the entire sector, the company’s commitment to lean operations and profitability have become even more important differentiators in this tough macro environment. Instead of trying to bottom-pick the tape, it may make sense to stick with the best: GTBIF remains a top pick in US cannabis.

Green Thumb Stock Price

The entire US cannabis sector has struggled to end its decline since the peak in early 2021. GTBIF, in spite of being one of the financially stronger names in the sector, has fallen amidst the crash as its stock was previously bid up to unreasonable valuations at the peak.

I last covered GTBIF in February where I called the stock a buy on account of it being “best of breed” in US cannabis. While there are few catalysts to hope for in the near future, GTBIF stock remains too cheap at current levels.

GTBIF Stock Key Metrics

GTBIF maintains a wide national footprint though its core markets remain in the more profitable limited license states. For just one indication of the company’s strategic positioning, GTBIF owns one of just two licenses in Minnesota, which has yet to come online for adult-use sales.

In its most recent quarter, GTBIF saw revenue grow 6% YOY and decline 1% QoQ to $259 million. That disappointing growth rate was largely driven by price compression, as gross margin declined 500 bps to 47.8%. On the conference call , management noted that unit growth was actually around 28% - overall demand for cannabis products is rising, but has been insufficient to offset price compression. GTBIF is typically one of the only cannabis operators to generate GAAP profits, a challenging feat considering that US cannabis operators are unable to deduct operating expenses from the calculation of taxable income. Thus, it was not so surprising when GTBIF generated a quarter with $51 million in GAAP net losses, but it should be noted that adjusting for non-cash impairment charges (related to their Nevada operations), adjusted net income would have been positive $12 million.

GTBIF ended the quarter with one of the best balance sheets in the sector, with $178 million in cash versus $275.7 million in debt. Many of GTBIF’s peers had taken on large debt loads to finance expensive acquisitions over the past few years, leaving them with significantly more leverage - and risk - in the current environment. I should also note that unlike most multi-state operators (‘MSOs’), GTBIF is also current on its tax obligations. Many MSOs have been deferring taxes as a sort of cheap financing. GTBIF actually saw deferred income taxes decline to $62.6 million versus $81.8 million YOY.

GTBIF is also one of the few MSOs that are still generating solid cash flows - this is in large part due to its conservative balance sheet. I define free cash flow as being adjusted EBITDA minus interest and tax expenses. Under that definition, GTBIF generated $76 million of cash flow in the quarter.

Management noted that the rising interest rate environment has impacted consumers mostly on preference, as consumer demand remains strong but they are purchasing less expensive and lower quality products.

Looking ahead, management has guided for the first quarter to see a mid-single digit sequential decline, mainly due to price compression and seasonality. That kind of outlook may disappoint investors who view cannabis as a high-growth story.

That said, GTBIF still operates in many states that have yet to come online for adult-use sales, including Virginia, Minnesota, and Pennsylvania. I have already mentioned that GTBIF is one of only two medical license holders in Minnesota. That state is expected to legalize the plant soon . Virginia recently experienced a setback when GOP lawmakers killed a bill to bring adult-use sales online by 2024 . Cannabis had previously been legalized for possession in 2021, but GOP lawmakers have since seized control of the House. Pennsylvania neighbors New Jersey and New York, two states which have legalized adult-use sales. While the state senate is still Republican-controlled, new governor Josh Shapiro is confident that they can get bi-partisan support to finally legalize the plant . Without much visibility as to when headwinds from price compression will subside, GTBIF investors can only look forward to upcoming adult-use rollouts to help return the company back to its growth trajectory.

Is GTBIF Stock A Buy, Sell, or Hold?

As CEO Ben Kovler stated on the conference call,

The days of fat margins and easy money and cannabis are waning.

Such headwinds have brought growth rates to a standstill and crushed stock price valuations. But the silver lining is that as weaker operators get flushed out, the stronger operators like GTBIF may emerge with stronger competitive positions. GTBIF has consistently generated among the best adjusted EBITDA margins in the sector.

GTBIF’s strong cash flow generation and balance sheet may enable it to continue playing offense while others are suffering from the rising interest rate environment.

That stronger financial position has led the stock to trade at some premium to the likes of Trulieve ( TCNNF ), but it is curious that GTBIF still trades at a discount to Curaleaf ( CURLF ).

I suspect that the company’s conflict at its board of directors may have contributed to the discount, but on a fundamental basis such a discount looks unwarranted and I expect the stock to regain a material premium on account of the lower risk financial profile. Assuming just 10% revenue growth, 20% long term net margins and a 1.5x price to earnings growth ratio (‘PEG ratio’), I could see GTBIF trading at 3x sales, representing around 65% upside based on consensus estimates. I note that this target can move sharply higher if GTBIF can restore its growth rate.

What are the key risks? Cannabis is a very risky sector in large part due to the fact that cannabis remains illegal on the federal level. Besides limited access to capital, the mere state of illegality may be preventing the average consumer from embracing the plant. I personally find cannabis to be a lifesaving plant, but that realization admittedly took a lot of personal research that I suspect the average consumer would have little patience for. It is very difficult to see an end to the price compression, as legal operators are confined to selling within the small legal market and are competing against lower-cost illicit operators. While valuations are undemanding, high tax rates and cost of capital has constrained free cash flow, and cannabis management teams also do not appear eager to take advantage of low stock prices through share repurchases. Prospective investors need to be prepared to hold such stocks long term without much hope for a quick payoff as catalysts are hard to imagine. After the long period of poor stock price performance, one can argue that these risks have been more than priced in as any sort of optimism may prove to spark a new bull rally in the stock. I continue to view GTBIF as one of the top picks in US cannabis due to the lower-risk financial profile.

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