2023-05-10 11:46:34 ET
Summary
- A favorable legal environment in the cannabis market and CLIPPER distribution agreement should benefit TPB.
- The Vape business is expected to face challenges due to stringent regulations.
- The company is currently trading at a discount to its 5-year average P/E ratio.
Investment Thesis
Turning Point Brands, Inc. (TPB) is poised to capitalize on a favorable legal landscape in the cannabis market, as well as the increasing prospects brought by the CLIPPER distribution agreement. On the contrary, the vape business of the company is expected to face challenges due to stringent regulations. The company is currently trading at a discount compared to its 5-year average P/E ratio. Overall, I am optimistic about the company's long-term growth trajectory, leading me to give a buy rating on the stock.
Business Overview
Turning Point Brands is a manufacturer, marketer, and distributor of adult consumer products. TPB is further divided into three segments; Zig-Zag Products (46% of net sales), Stoker's Products (31% of net sales), and NewGen Products (23% of net sales). Zig-Zag Products segment which contributes 46% of the company's net sales deals in rolling papers and make-your-own ((MYO)) cigar wraps. Zig-Zag is the #1 premium & #1 overall rolling paper in the U.S. with approximately 35% total market share according to Management Science Associates, Inc. (MSAi). Stoker's Products segment, accounting for 31% of the net sales, comprises moist snuff tobacco (MST) and loose-leaf chewing tobacco products. Stoker's chewing tobacco is presently the #1 overall brand in the U.S. with approximately 28% market share. NewGen segment, contributing 23% to the net sales, focuses on the distribution of vape products. This particular segment has been built through strategic acquisitions and new product development.
TPB's segment splits (Investor Presentation)
Last Quarter Earnings
Turning Point Brands reported better-than-expected revenue in the first quarter of FY2023 . Net sales for this quarter stood at $100.96 million (up 0.1% Y/Y) and above the consensus estimate of $97.2 million. Zig-Zag Products' net sales were down 8.3% Y/Y in the quarter due to anticipated inventory reduction by wholesale customers. Stoker's Products' net sales increased 6.2% Y/Y driven by high single-digit growth of MST and low-single-digit growth of loose-leaf chewing tobacco. Furthermore, the adjusted Earnings Per Share ((EPS)) grew to $0.63 whereas the EPS consensus estimate was $0.48.
CLIPPER Distribution Agreement
Turning Point Brands entered into an agreement with Flamagas for exclusive distribution of CLIPPER lighters in the U.S. and Canada which started in the second half of FY2022. CLIPPER is the leading reusable lighter brand in the world and the second-largest overall world lighter brand with a legacy that dates back to 1971. However, it is currently underrepresented in the U.S. and Canada with less than a 3% market share in an approximately $500 million market. By leveraging its well-established distribution infrastructure, TPB aims to amplify the availability of CLIPPER lighters across a broader spectrum of retailers and consumers. As a result, I believe the revenue flow from this distribution agreement should be a growth tailwind for the company.
Industry Tailwinds
Turning Point Brands is well-positioned to benefit from the growing cannabinoid consumption in the U.S. market. The legal cannabis market in the United States is projected to experience substantial growth from $26.1 billion in 2022 to $44.5 billion by 2027, representing an 11.3% compound annual growth rate ((CAGR)). Additionally, it is anticipated that the percentage of the U.S. adult population living in recreational-use states should increase. Currently, approximately 30% of the U.S. adult population resides in states where cannabis is legally allowed for recreational purposes. However, it is expected that this percentage should witness a significant jump, reaching 48% by 2024. These tailwinds should potentially increase the total addressable market and create significant growth opportunities for TPB's Zig-Zag brand.
Legal cannabis market in the U.S. (Investor Presentation)
Growth in Stoker's Products Segment
It is expected that the customers of Turning Point Brands should trade down from premium loose-leave chewing tobacco to discount brands in the coming quarters. This shift can be attributed to the worsening macroeconomic condition and the looming recession. As a result, the company's stoker products segment, which holds the top position as a discount brand with a market share of around 28%, is poised to reap the rewards of this growing prospect in the coming quarters.
Regulatory Environment
TPB is facing challenges in its NewGen Products segment due to the implementation of vaping product bans in the United States. While some cities, such as San Francisco, have completely prohibited the sale of vaping-related items and accessories, most cities and states have imposed restrictions on flavored vape products and online sales. In response, the company underwent an internal reorganization that involved separating the NewGen entities from the rest of the company. As a result of this reorganization, the NewGen business is now operated under a newly-formed wholly owned subsidiary called South Beach Holdings LLC, also known as Creative Distribution Solutions (CDS). Consequently, I believe this reorganization should support TPB navigate the current regulatory environment and pursue value-driven opportunities.
Valuation
Turning Point Brands is currently trading at 8.50x FY2023 consensus EPS estimates of $2.48 and 7.66x FY2024 consensus EPS estimates of $2.76 which is a discount to its 5-year average P/E Non-GAAP ((FWD)) of 14.37x. Moreover, upon comparison with the sector median of 19.36x, the company is at a discount of approximately 55% due to the anticipation that an unfavorable regulatory environment should negatively impact the NewGen Products of the company in the coming years.
Risk
My thesis is predicated on the assumption that regulatory restrictions should primarily impact online sales and potentially result in favouring vape bans. If restrictions are further tightened, such as through a complete ban on vaping products, it could potentially lead to underperformance in TPB's stock.
Conclusion
While it is true that the unfavorable regulatory environment in NewGen Products is concerning, I believe in the ability of the management to capture long-term growth opportunities arising from industry tailwinds and the CLIPPER distribution agreement. Moreover, TPB also offers an annual dividend of 1.23% to its shareholders. Consequently, I am of the opinion that there is good upside potential in the stock and recommend a buy rating on this stock.
For further details see:
Turning Point Brands: Good Upside Potential