2023-06-06 07:05:19 ET
Summary
- Green Thumb Industries has long been considered the highest quality operator in US cannabis.
- But the rising interest rate environment coupled with persistent pricing pressures has only highlighted the gap even further.
- Much of that gap can be credited to management's refusal to conduct reckless M&A and take on the associated expensive debt.
- The stock is still too cheap here and is a top pick in the US cannabis sector.
After this long, painful period for the cannabis sector, I am finally of the view that Green Thumb Industries ( GTBIF ) may be the only investible multi-state operator. GTBIF is now the only large MSO which is still generating positive GAAP profits. That is not to say that making such a determination would have been easy, as the struggles faced by peers appear to be self-inflicted. Besides strong execution, it is clear that a more conservative M&A strategy has been the primary differentiator with peers, as GTBIF entered this rising interest rate environment with far less leverage on its balance sheet. Whereas I am expecting substantially all other MSOs to dilute shareholders with expensive equity offerings at some point in the next 12-18 months, GTBIF does not have that same risk. I reiterate my strong buy rating for the stock.
GTBIF Stock Price
The entire cannabis sector has been suffering from a vicious bear market for over 2 years at this point.
I last covered GTBIF in March where I rated it a buy and called it the strongest operator in US cannabis. That thesis remains in play though one mustn’t ignore the possibility that GTBIF is the best operator in a bad sector.
GTBIF Stock Key Metrics
GTBIF is now just one of a large handful of MSOs which have wide-reaching footprints.
The latest quarter saw continued headwinds from price compression and a weak economy. Revenue grew just 2.4% YOY to $248.5 million as strong 9.4% growth in retail revenue was offset by weakness in the wholesale business. Gross margins stood at 50.2% and adjusted EBITDA increased 210 basis points to 30.7%. The strong margins are quite impressive considering that most peers are showing margin contraction across the board.
GTBIF was able to generate $9.1 million in GAAP net income, which I must add, looks like a “legit” number as there aren’t any non-cash line items boosting that number on the income statement. GTBIF is now the only large MSO generating GAAP net income. Lean operations may explain the discrepancy with Curaleaf ( CURLF ) and Cresco Labs ( CRLBF ), but what about traditionally lean operators in Verano ( VRNOF ) and Trulieve ( TCNNF )? The answer is debt. GTBIF ended the quarter with $185.4 million of cash versus $277.8 million of debt, representing a substantially lower leverage position than peers even before accounting for the lower amount of deferred taxes. That in turn leads to lower interest expenses and 280e taxes. GTBIF generated $44.2 million of operating income and paid $3.8 million in interest expense and $33.6 million in income taxes in the most recent quarter. In contrast, VRNOF generated $33.8 million of operating income and paid $15.9 million of interest expense and $28.3 million of income taxes. TCNNF generated $17.9 million of operating income (after adding back impairments) and paid $22.7 million in interest expenses and $35 million in income taxes. Notice a trend? Because US cannabis operators are unable to deduct operating expenses from the calculation of taxable income, the real cost of debt is considerably higher. With cost of capital rising rapidly, this ability to generate real cash flow is a valuable differentiator. Moreover, I expect MSO peers to need to issue dilutive equity in order to reduce leverage on their balance sheets, something that appears far less likely at GTBIF. On a side note, I would not mind a dilutive equity offering at GTBIF to pay down debt as the associated multiple expansion from a decreased risk profile should help offset any dilution to shareholders (though I reiterate that such an event does not appear imminent here).
On the conference call , management gave greater insight in their investment strategy, emphasizing their preference for internal growth versus M&A. Management discussed having a greater understanding of the ROI of building a new facility in Minnesota or New Jersey versus acquiring outward with operators of unknown baggage.
The company has the upcoming adult-use rollout of Maryland to look forward to later this year, but I must also highlight recent developments in New York. As Green Market Report highlights , New York regulators have issued updated guidelines which pave the way for existing MSOs to begin adult-use sales as early as the end of this year, a significant improvement over the prior path of 3 years. GTBIF has a substantial presence in New York and given their strong financial position, I expect the company to be able to invest more aggressively than peers in this state.
An analyst asked management regarding their view of share repurchases to which they replied that “everything’s on the table.” In my view, while the company has less leverage than peers, it still has more leverage than I would like, and the net margins are not high enough for comfort. I am of the view that any excess cash after reinvestment in the business should go toward paying down debt which, while potentially being less accretive to shareholders, would help improve the financial stability of the company and should also lead to multiple expansion.
Is GTBIF Stock A Buy, Sell, or Hold?
GTBIF has traditionally traded at a rich premium to peers, but the stock is now trading at a discount to CURLF (though still trades at a premium to other Tier 1 operators).
There was once a time in which I viewed the relative discounts at TCNNF and VRNOF as being enough to exclude GTBIF from my portfolio. This higher interest rate environment, however, has helped to highlight the stronger management execution and foresight at this GTBIF team. I still view US cannabis to be a wonderful long term growth opportunity, but the ride is likely to be highly tumultuous between now and eventual federal decriminalization. Investors should be focused on names that can survive for the long term - a basket approach is not suitable considering the existential risk faced by many highly leveraged peers.
What are the key risks? While GTBIF is GAAP profitable today, it is possible that continued pricing pressures eventually eat away at their margins, similar to what has occurred at peers. With new states like Maryland and New York coming online in the near future, I expect the company to be able to sustain resilient margins in spite of any pricing pressures. I view the lower leverage position as being the primary reason behind the company’s outperformance relative to peers. Thus, the biggest risk may be if management shifts gears and engages in aggressive debt-fueled M&A or aggressively invests in low-margin states. Just as the woes of peers appear self-inflicted, GTBIF can easily suffer the same fate due to their own sword. Regulatory risk remains present, including the risk that regulatory reforms do not happen for many years. US cannabis operators have limited access to the capital markets and pay egregiously high corporate tax rates, holding back cash flows until politicians finally decriminalize the plant. Additional risks include any developments which negatively influence public perception of the plant, though I find such a risk to be unlikely given the plant’s long existential history. I rate GTBIF a strong buy and this is arguably a top pick among MSOs in the US cannabis sector.
For further details see:
Green Thumb Industries May Be The Only Buy In U.S. Cannabis