Cannabis Investors Should Pay Attention to What’s Happening With These Three Stocks

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One of the big takeaways from recent earnings reports was that American cannabis companies will be investing in capacity expansion in their existing states of operation as well as in several states legalizing for adult-use, especially New Jersey, New York and Virginia, where the large cannabis companies have strong positions in the medical markets already. Several companies that have been riding the buildout of production capacity for the past couple of years should benefit greatly from the continued expansion, but their stock prices certainly don’t reflect these underlying trends. We are talking about Scotts Miracle-Gro (its Hawthorne Gardening division), Hydrofarm and GrowGeneration, which together posted revenue of $682 million in the June quarter.

The New Cannabis Ventures Global Cannabis Stock Index has gained 6.3% so far in 2021, but each of these three stocks has experienced double-digit declines:

Investors should pay attention to this recent breakdown in the stocks, which are either pointing to a flawed core assumption about the growth prospects of the industry or, more likely in our opinion, creating a potentially good entry. Analyst expectations and company guidance reflect the likelihood of continued strong growth, albeit at a slower pace. On its fiscal Q3 call, Scotts Miracle-Gro suggested that its fiscal 2022 growth in its Hawthorne Gardening division, which it expects grew 40-45% for fiscal 2021, should exceed 10-20% (this isn’t formal guidance, which will be provided in November, and was admittedly conservative). Analyst expectations for pure-plays Hydrofarm and GrowGeneration suggest 2022 revenue will grow 28% and 31%, respectively. EPS are projected to increase 54% and 43%, respectively.

While the expectations are for growth to slow, the growth rates remain robust. Additionally, the 2022 revenue estimates are rising for both companies. The 2022 EPS estimates have pulled back slightly for GrowGeneration and have increased for Hydrofarm over the past few months. The sharp decline in the prices and continued growth in the business have left these stocks considerably cheaper than they were at the beginning of the year. Using data from Sentieo, these are the Enterprise Value/Revenue, Enterprise Value/EBITDA and PE ratios from 12/31 and today, looking twelve months ahead (note that Scotts Miracle-Gro is for the entire company and not just Hawthorne):

In all cases, valuations have dropped considerably. For GrowGeneration, the forward EV/Sales ratio has declined 63%, while its EV/EBITDA has dropped 66%. The forward PE, similarly, has fallen 56%. Hydrofarm’s same ratios have dropped 34%, 68% and 73%, respectively. The valuation ratios for Scotts Miracle-Gro have declined 32%, 27% and 33%, respectively.

When assessing the valuations relative to MSO valuations, it’s important to consider that these companies and other ancillary goods and service providers have some big advantages relative to American cannabis operators. For one, they aren’t subject to 280E taxation. Additionally, they can scale their businesses due to the ability to conduct interstate commerce. Finally, their stocks trade on higher exchanges, affording them better liquidity.

While one conclusion might be that investors have lost confidence in the outlook for growth, we think that the weak price action mainly reflects negative near-term technicals. GrowGeneration has broken the $30 price where it raised $172.5 million last December. Hydrofarm continues to trade above its IPO price, but it posted an all-time low in mid-August. Scotts Miracle-Gro took out its 52-week low this past week. The declining prices seem to be feeding on themselves. Additionally, we think these stocks tend to be correlated to the large Canadian LPs, which are in sharp decline, as they trade on higher exchanges as well. The fundamentals, however, are vastly different.

GrowGeneration is by far the leader in the highly fragmented hydroponics store industry and is increasingly leveraged to MSOs. Its growth has been fueled by both organic sales gains as well as new stores and M&A. In 2020, about 40% of its business came from selling equipment, with the balance in consumables. Similarly, Hydrofarm and Scotts Miracle-Gro are market leaders with substantial exposure to capital spending by cannabis operators. These companies should benefit from the growth expansion ahead as American companies continue to add capacity, as they universally discussed just last month. As we highlighted in this newsletter three weeks ago, there is plenty of capital to fuel these expansions.

The weakness in the stock prices has left the valuations on these stocks quite reasonable in our view, and it suggests that perhaps some investors aren’t confident that the buildouts that will benefit these companies will actually occur. We think that the market is still dealing with the parabolic spike from earlier this year and suggest that the price action is more technical in nature. The action in these stocks is either a warning to cannabis investors or an opportunity potentially.

Fire & Flower is a leading, technology-powered cannabis retailer, with more than 90 corporate-owned stores in its network. The company has recently completed two acquisitions that allow it to offer innovative online dispensaries across North America through its Hifyre technology platform. Through the strategic investment of Alimentation Couche-Tard Inc. (owner of Circle K convenience stores), the Company has set its sights on global expansion as new cannabis markets emerge.

Get up to speed by visiting the Fire & Flower Investor Dashboard that we maintain on their behalf as a client of New Cannabis Ventures. Click the blue Follow Company button in order to stay up to date with their progress.

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Alan & Joel

Exclusive article by Alan Brochstein, CFA
Alan Brochstein, CFA
Based in Houston, Alan leverages his experience as founder of online community 420 Investor, the first and still largest due diligence platform focused on the publicly-traded stocks in the cannabis industry. With his extensive network in the cannabis community, Alan continues to find new ways to connect the industry and facilitate its sustainable growth. At New Cannabis Ventures, he is responsible for content development and strategic alliances. Before shifting his focus to the cannabis industry in early 2013, Alan, who began his career on Wall Street in 1986, worked as an independent research analyst following over two decades in research and portfolio management. A prolific writer, with over 650 articles published since 2007 at Seeking Alpha, where he has 70,000 followers, Alan is a frequent speaker at industry conferences and a frequent source to the media, including the NY Times, the Wall Street Journal, Fox Business, and Bloomberg TV. Contact Alan: Twitter | Facebook | LinkedIn | Email

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