GrowGeneration (GRWG) is a sequence of hydroponics shops that primarily serve the hashish trade. GRWG reported robust progress in 2019 that has managed to proceed into 2020, which has led shares to ship multi-bagger returns this 12 months alone. Can the outperformance proceed? On this report, I give my verdict on the valuation and my forecast for bettering profitability or lack thereof. I stay skeptical that comparable gross sales progress can proceed past the pandemic, at the very least to the purpose that will justify the present valuation.

The Residence Depot Of Weed

GRWG is the most important chain of hydroponics shops within the USA, with 28 shops unfold over 10 states. Most of its shops are positioned in states which have totally legalized hashish:

(Investor Presentation)

GRWG may be thought-about a “picks and shovels” kind firm for the hashish trade, because it sells provides starting from vitamins & components to lighting:

(Investor Presentation)

GRWG has delivered stellar top-line progress within the triple-digit vary in 2019 in addition to this 12 months. Whereas a lot of the beneficial properties have been pushed via exterior acquisitions of latest hydroponics shops, GRWG has additionally delivered robust same-store gross sales progress:

(Investor Presentation)

This 12 months has seen an unprecedented rally in “software program as a service” expertise shares which have been bid up resulting from recurring revenues. GRWG breaks down what it believes to be recurring revenues as “consumables” which embrace issues like vitamins & components, rising media, and storage containers. GRWG discloses that consumables made up 60% of its revenues in 2020:

(Investor Presentation)

Insider Possession

As of the start of the 12 months, insiders owned a considerable chunk of the corporate, totaling over 13% for officers and administrators:

(2020 Proxy)

Excessive insider possession can recommend that administration is aligned with shareholders resulting from having substantial “pores and skin within the recreation.”

Blistering Valuation

There are 53 million shares excellent for a market cap of $1.2 billion. Annualizing the most recent quarter’s outcomes, GRWG generates $174 million in revenues and $46.four million in gross earnings. Shares commerce at 7 instances revenues, however I choose to make use of gross earnings as a result of gross margins are low at round 25%. GRWG trades at 26 instances gross earnings, which is a lofty a number of. Is that affordable or bubbly? That will depend on your outlook for future profitability, which I focus on under.

Potential Crimson Flags

With firms rising as quick as GRWG and buying and selling with such a excessive valuation, crucial query is: can the expansion proceed? Or extra particularly, will the expansion justify the present valuation? One factor that issues me is that roughly half of the expansion is coming from the acquisition of latest shops:

(Investor Presentation)

Such a method appears inherently unsustainable: for one, if GRWG retains reporting excessive comparable gross sales progress numbers, then wouldn’t new acquisitions come at greater and better costs? If the hydroponics enterprise is such a superb enterprise, then why are shops keen to promote to GRWG in any respect? A discount within the accretiveness of exterior acquisitions would power GRWG to depend on internally generated progress for future progress levers.

On that time, what’s the aggressive benefit or “moat?” There doesn’t appear to be any purpose why Residence Depot (HD) couldn’t promote hydroponics itself (the truth is, it does).

Analysts requested the corporate about potential competitors on the convention name. Analyst Glenn Matson requested:

“Simply curious should you’re seeing any new entrants from under or above on the aggressive panorama?”

GRWG President Michael Salaman responded:

“Hey, Glenn, we have now under no circumstances. There’s – that we’ve seen zero.” (2nd Quarter Earnings Transcript)

Transferring ahead, I’m unsure that’ll be the case.

Second, I think that a lot of the comparable gross sales progress seen in 2020 is as a result of coronavirus and is probably not repeated and even sustained in 2021. Lots of the states that GRWG operates in have already legalized leisure hashish for a while, which means that the one-time “legalization increase” has already occurred.

All these components deliver me to my final level: why isn’t the corporate extra worthwhile than it’s, and might it actually enhance profitability shifting ahead?

Regardless of triple-digit top-line progress, internet revenue has really declined from $1.three million to $480 thousand 12 months to this point. The principle perpetrator seems to be a 10 instances enhance in share-based compensation to $5.three million in 2020, amounting to over 25% of gross earnings.

Now, coming again to my dialogue of the valuation, GRWG trades at 120 instances the final quarter’s earnings annualized. To ensure that earnings to develop sufficient for the P/E a number of to say no to 30, a extra affordable a number of, GRWG would theoretically must see comparable gross sales progress of roughly 68% (assuming no change within the 26% gross margin and that each one gross earnings circulation to the underside line). Whether or not or not that’s attainable will depend on GRWG’s capacity to develop upon this 12 months’s outcomes even after the pandemic. Name me a skeptic.

Lastly, Hindenburg Analysis has launched a very vital report of the corporate. Within the report, Hindenburg Analysis notes the chief administration group’s histories with failed penny shares and pump & dump schemes. The corporate, so far as I can inform, has not refuted these claims.

Conclusion

Earlier than I make a purchase order of the inventory, I’d prefer to see a significant enchancment in working margins. Whereas GRWG has delivered spectacular outcomes, I’m skeptical that comparable gross sales can proceed in 2021 and onwards as soon as we transfer previous the pandemic. As a result of shares have run up to now so quick, GRWG would want to ship roughly 68% comparable gross sales progress as a way to justify the present valuation. Additional, potential buyers ought to hold an in depth eye on share-based compensation as that quantity wants to say no shifting ahead. GRWG seems to be a strong inventory that’s benefitting from the expansion of the hashish trade, however in my eyes nonetheless must show itself to justify my funding.

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Disclosure: I/we have now no positions in any shares talked about, and no plans to provoke any positions inside the subsequent 72 hours. I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (aside from from Searching for Alpha). I’ve no enterprise relationship with any firm whose inventory is talked about on this article.



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