CRLBF - Green Thumb Industries: My Strongest Conviction Pick In The Cannabis Industry

Summary

• 2022 was a terrible year for cannabis companies and investors, and 2023 is not looking much better.
• 2023 will be a year for cannabis to be laser-focused on only the strongest and best performing companies.
• Green Thumb Industries Inc. continues to be my strongest conviction pick in the cannabis industry.

The fourth quarter 2022 earnings season for cannabis is picking up speed. Green Thumb Industries Inc. ( GTBIF ) released its Q4 and 2022 full year results on Tuesday, Feb. 28, the first major operator to do so. This report looks at Green Thumb's performance and how well they are positioned to handle the unprecedented challenges the industry faces in 2023 and beyond.

Green Thumb fourth quarter highlights

Here are some Q4 highlights as presented in the Feb. 28 press release:

• Revenue of $259 million increased 6% year-over-year and decreased 1% sequentially.
• Cash flow from operations of $70 million.
• Cash at quarter end totaled $178 million.
• GAAP net loss of ($51 million) or ($0.22) per basic and diluted share.
• Adjusted net income of $12 million or adjusted basic and diluted earnings per share of $0.05, excluding non-cash impairment charges.
• Adjusted Operating EBITDA of $81 million or 31% of revenue.

Green Thumb has been at or near the top of the industry in important metrics, and based on the Q4 report will continue to be so. This is clear in the following charts, which compare Green Thumb to these four high-revenue U.S. operators: Curaleaf Holdings ( CURLF ), Cresco Labs ( CRLBF ), Trulieve Cannabis ( TCNNF ), and Verano Holdings ( VRNOF ).

Green Thumb' GAAP net loss of $-0.22 per share was adversely affected by $88.5 million of non-cash charges against its Nevada operations. Such charges are to be expected in any emerging growth industry. Without the one-time charges, earnings were $0.05 for the quarter and $0.32 for the year, giving Green Thumb a respectable trailing P/E of 25.9. This continues a record of positive EPS far beyond the others.

Cash from operations is extremely important in terms of the ability to make a profit and as a sign of how well a company operates its business. With $70 million in CFO in Q4, Green Thumb continues increasing its level of performance.

Green Thumb has long portrayed superior cash management as a point of pride. At the end of Q4, they increased their cash level by $31 million to a total of $178 million. This is reassuring in a time when new money for the industry is scarce but the demand is high, although it must be noted that they have had little trouble raising money in the past. In July, they were able to extend $250 million of 7% senior notes (an industry-best interest rate) out to April 2025. All this was accomplished while maintaining a low debt-to-equity ratio.

Putting 2022 results in context

Investors are painfully aware of the tough industry conditions that accelerated throughout 2022. A recap of the most impactful trends shows the magnitude of headwinds facing growers and retailers.

• Macroeconomic factors: Cannabis companies experienced the same national economic problems as other industries: labor shortages, supply problems, logistics problems, and inflation,
• Overcapacity: Companies have increased growing capacity to sell in their own and other operations, creating serious oversupply. Furthermore, cannabis is becoming ”overstored” in some parts of the country, meaning that there are more retail stores than an area can support. In Florida, for example, data from the Office of Medical Marijuana Use shows an increase of 16% in cannabis medical card holders in the past 12 months, but an increase of 33% in the number of dispensaries. These two trends mean lower prices along the value chain.
• Regulatory drag: Getting regulations in place and removing unproductive ones was slower than anticipated in a number of important states, including New York, Virginia, Illinois, and New Jersey. As a result, revenue did not start flowing as planned, and investments in those states were left stranded until legislators and regulators get their act together.
• Illegal competition: How do legal companies compete against grey or black market operators who have no costs for testing, safety, labor standards, taxes or fees? The problem is especially acute in states like California, Oregon, and New York where the illegal market is large and well entrenched.

And here comes 2023

Looking forward into 2023, what does the landscape look like for Green Thumb and the industry as a whole? Some of the headwinds from 2022 will eventually abate, particularly nationwide economic issues like inflation, labor shortages and supply chain problems. Other issues, like price compression from oversupply and overstoring, are naturally self-correcting as weaker operators are forced to leave the business. Although regulatory progress continues to move forward, drag from regulatory delays will continue. Just this week, the newly Republican House in Virginia refused to draft cannabis regulations required by the 2021 state law, thereby postponing Virginia sales indefinitely. The drag is especially noticeable in states with a strong social equity component, which adds another layer of rules to be negotiated, implemented and followed. New York, for example, barely met its own deadline for starting rec sales in 2023 by opening a single store in December 30 . At this store, owned by a non-profit organization that fights homelessness and AIDS, lines were around the block on opening day.

The illegal market will continue to be a major headwind for the indefinite future. Authorities in states with the biggest illegal markets, such as New York, California, and Michigan, are unwilling to commit the resources to attack the problem. This is nothing less than a failure of our representatives to do their job. It will be very difficult for legal companies in states such as those to survive and thrive. That being said, legal cannabis is still big business there. Although the legal market share in California is only around 40%, that amounted to $5.3 billion in 2022, showing that legal cannabis has a value proposition that users respond to.

The consequences of the difficult conditions that arose in 2022 and are continuing in 2023 are already being seen. Companies are reducing exposure and taking losses in areas where they failed to gain traction. Thus we have the recent $88.5 million charge Green Thumb is taking against its Nevada operations. Earlier this year, Curaleaf announced it is exiting California, Colorado and Washington. There will be many more such announcements throughout 2023.

We will also be seeing more companies that are unable to pay their bills. The most notable example to date comes from Innovative Industrial Properties, Inc. ( IIPR ). Several tenants have been unable to pay the lease costs on their IIPR-owned facilities. Dane Bowler wrote a very thorough report on the situation: Innovative Industrial's Loan Style Leases Are Struggling The point is not that IIPR is struggling, but that an increasing number of cannabis companies are showing signs of failure. As CEO Kovler said in the earnings call ,

The pricing pressure has squeezed margins to a spot that given 20E [ph], there is not the cash flow for the marginal player

Another sign of tough times to come are more layoffs, such as this MJBizDaily report of recent reductions at nine different cannabis companies.

What next?

2022 was a tough year for cannabis, and as of this moment 2023 doesn't look much better. We will see more companies unable to service debt or leases and more retrenchment. The eventual alleviation of price pressures and other headwinds will take time to work out. It's not the time to make risky bets on companies that are struggling now and will only see more pressure over the next couple of years.

As we navigate what CEO Ben Kovler calls “the middle innings of the industry,” investors will want to own the companies best equipped to make it to the late innings in a position of strength to exploit the new opportunities that will inevitably present themselves. The historical record shows Green Thumb is clearly one of those companies. The latest quarter had a weaker performance than usual, not unexpected given the adverse conditions. Even so, Green Thumb Industries Inc. enters 2023 with lower debt levels than peers, a high cash level, positive cash flow and even positive earnings ex-one time charges.

There are risks, of course. The turnaround time for the industry is uncertain. Although Americans support cannabis availability by a large margin, there is still a power base that opposes it. This faction has been effective at the federal level and in some states. In addition, as use increases, so will the reports of harm caused by cannabis, thereby retarding its acceptance. Also, the problems of regulatory drag and the illegal market are not going away. There's little doubt that the cannabis industry will continue to be challenged.

The investment case for Green Thumb doesn't depend on Chuck and Mitch and Joe. It doesn't depend on whether public servants find the fortitude to correct the mess they have created in California and elsewhere. The investment case starts with the still growing popularity of legal cannabis and an industry that is still expected to grow by double digits for most of the decade. Green Thumb has proven that it has what it takes to be successful under very adverse conditions while other companies struggle. Ironically, bad news from other companies is good news for Green Thumb. Bad news underlines Green Thumb's excellence, and signals a future business landscape with less competition. As CEO Kovler said in the earnings call ,

We are in the midst of a washout that will leave the industry with fewer operators, not more.

It has been said that the only constant is change. It would be a mistake to act as if the present industry tribulations will go on forever. No one knows when or how change will happen, but we can be confident that when it does, Green Thumb Industries Inc. and its investors will be there to reap the benefits.

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