CURLF - Green Thumb Industries: Best Of Breed In U.S. Cannabis

Summary

• Green Thumb Industries Inc. is one of the few profitable companies in U.S. cannabis.
• The company also maintains a more conservative balance sheet than others, and these factors have contributed to a relative premium.
• The U.S. cannabis sector is facing pricing pressures, but the long-term growth story remains intact.
• Green Thumb Industries is a top pick to invest in the long-term cannabis growth story.

Green Thumb Industries Inc. (GTBIF) is often considered the top company in the U.S. cannabis sector, and there's good reason for that. This is a company which has maintained a strong balance sheet and GAAP profitability in spite of the difficult regulatory environment for cannabis operators. Amidst a rising interest rate environment and recession risks, that commitment to risk control is proving valuable.

This is a name which I could have kept in the Cannabis Growth portfolio due to its worthiness as a long-term holding. That said, I have chosen not to mainly because I view multi-state operators ("MSOs") in general to be of higher risk and have thus preferred to invest in names which offer stronger return potential albeit at higher risk. I continue to find GTBIF highly buyable here, as it continues to execute on the long-term cannabis growth opportunity.

GTBIF Stock Price

After bouncing off the lows at the end of the last year, GTBIF has fallen to continue a brutal slide this year.

I last covered GTBIF in October, where I rated it a strong buy after President Biden issued new commentary about his intentions for cannabis reform. The stock has since fallen 40%, as the improving valuation came alongside rising risks.

GTBIF Stock Key Metrics

GTBIF boasts a premier footprint spread across 15 states, with many of these states having yet to legalize adult-use sales.

In the third quarter , GTBIF continued to face pricing pressure macro headwinds as it has throughout the year. Revenue increased 3% sequentially and 12% YOY to $261 million. Adjusted EBITDA grew 7% sequentially to $84 million, representing a 32% margin. This was disappointing because the adjusted EBITDA margin was 35% in the prior year but did reflect continued sequential improvement. GTBIF did, however, generate its 9th consecutive quarter of GAAP profitability with $10 million of GAAP net income. This is a notable achievement because U.S. cannabis operators must pay "280e taxes," in which they are unable to deduct operating expenses from the calculation of taxable income.

GTBIF ended the quarter with $147.3 million of cash versus $255.5 million of debt. During the quarter, GTBIF exercised its right to extend the maturity of its senior debt ($250 million) by 1 year to April 30, 2025 - that debt has a 7% interest rate. Most of GTBIF's peers have greatly increased their leverage profiles after aggressive M&A pipelines in 2020 and 2021, but GTBIF for its part has maintained a more conservative leverage position. It should also be noted that GTBIF is current on paying taxes - many US cannabis operators have deferred large tax balances in an effort to conserve cash. On the conference call, management stated that "worrying about the downside is equally important as planning for the upside, and can actually create more value for stakeholders over time."

GTBIF has historically generated consistently high profit margins, and in the most recent quarter suddenly saw itself come neck-to-neck with Trulieve Cannabis Corp. ( TCNNF ), which has historically been the most profitable operator in the sector.

Management reiterated their long-term guidance for 50% gross margins and 30% EBITDA margins, but investors should likely take that guidance with a grain of salt as this is a sector with rapidly changing regulatory conditions.

GTBIF continued to see strong results out of New Jersey, which came online for adult-use sales this year. Rhode Island came online after the quarter's end on December 1st for adult-use sales and Connecticut is expected to come online for adult-use sales over the next 2 quarters. GTBIF also has both Virginia and New York to look forward to, as these states have legalized adult-use sales but are still in the planning stages of bringing them online.

Management noted that the company outperformed the overall sector. Whereas GTBIF grew 13% YOY and 3% sequentially, the overall sector grew 3% YOY and 2% sequentially.

Unlike many other MSOs, GTBIF is generating robust free cash flow. We already saw that GTBIF is generating positive GAAP net income. Cash flow is even more apparent after adding back equity-based compensation and one-time costs.

I expect most investors may be more focused instead on their announced partnership with Circle K to sell cannabis out of gas stations. GTBIF plans to open 10 RISE Express branded medical dispensaries in Florida, leasing space adjacent to Circle K stores (Circle K operates approximately 600 locations in the state). Despite being long regarded as one of the top overall operators in the country, GTBIF has historically maintained a modest presence in Florida. This announcement has the potential to significantly jump start their growth in the state. Management confirmed that it would be a landlord-tenant relationship and that they are still awaiting regulatory approval.

Is GTBIF Stock A Buy, Sell, or Hold?

As of the latest quarter, GTBIF had 251.6 million fully diluted shares outstanding.

GTBIF maintains a sizable premium to other Tier 1 operators, with only Curaleaf ( CURLF ) trading more expensively.

I'd argue that GTBIF deserves to trade more richly than CURLF due to the stronger margins. That said, does it deserve to trade so much more richly than Verano ( VRNOF ) or Trulieve, two names which generate solid profit margins themselves? GTBIF does have a stronger balance sheet , but there does remain a sizable premium. Looking ahead, investors may do well to maintain a dose of realistic expectations, as it is not entirely clear if SAFE Banking will pass so quickly. Absent the passage of SAFE Banking, there might not be legitimate chances for any sort of legislative reform for many years, especially if President Biden does not win any re-election bid in 2024. That said, GTBIF can still benefit from the same secular trends as it has in the past: ongoing action at the state level.

In addition to the states discussed above, there's yet another state yet to be discussed. In Minnesota, where GTBIF is one of only two licensed medical operators, the midterm elections saw Democrats take control of both the state House and Senate - and the governor is also a Democrat. It appears very likely that Minnesota will legalize adult-use sales over the next year.

What is an appropriate valuation? Assuming a 15% long term growth rate, 20% long term net margins, and 1.5x price to earnings growth ratio ('PEG ratio'), I could see GTBIF trading at 4.5x sales - representing a stock price of $17.65 per share. This is a lower price target that I have given in the past - it reflects lower assumptions regarding long term growth and profitability. That still reflects over 100% potential upside.

What are the key risks? There are many. While GTBIF's margins have remained steady due to its presence in limited license states, that might not prove true indefinitely. Pricing pressures may persist and states might even change their regulatory frameworks.

GTBIF trades over-the-counter ("OTC") and many brokerage firms have already stopped custody-ing cannabis stocks. While this is not necessarily an imminent risk, the risk of improper accounting seems higher in this industry as they are unable to work with bigger accounting firms.

Another risk is that the stock may lose its premium relative to peers. That premium has been narrowing over the past few quarters. One potential reason was the fact that 3 former directors of the board left the company. On the call, management stated:

So what I can say is the Former Directors gave their reasons publicly in the resignation letter and it's tough for me to really expand on that. I think like we have stated, the reasons had nothing to do in support of the emphasized, nothing to do with the company's business performance, our operations, financial performance, nothing about the financial statements or even the financial controls.

It's still not a good look. Yet Green Thumb Industries Inc. remains a high quality name in a sector that should still retain long-term promise. The company's strong balance sheet and positive GAAP margins are a clear positive and should enable the stock to sustain some premium moving forward. The stock has also shown itself to have higher liquidity, making it an appealing option for those looking to invest in short term movements.

I continue to view higher quality MSOs and certain ancillary stocks to be the best way to position long term . Green Thumb Industries Inc. look buyable for those looking for a long-term investment in the U.S. cannabis sector.

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