Cannabis investors should pay attention to what is going on with these three stocks – New Cannabis Ventures
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One of the main lessons to be learned from recent earnings reports is that U.S. cannabis companies will invest in expanding their capabilities in their existing operating states as well as in several states legalizing adult use, in particular. New Jersey, New York and Virginia, where the big Cannabis companies already have strong positions in the medical markets. Several companies that have increased their production capacity over the past two years stand to benefit greatly from the continued expansion, but their stock prices certainly do not reflect these underlying trends. These are Scotts Miracle-Gro (its Hawthorne Gardening division), Hydrofarm and GrowGeneration, which together reported sales 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 seen double-digit declines:
Investors should pay attention to this recent stock split, which indicates either a flawed basic assumption about the industry’s growth prospects, or, more likely in our view, creating a potentially good entry. Analysts’ expectations and company forecasts reflect the likelihood of continued strong growth, albeit at a slower pace. In its call in the third quarter of the fiscal year, Scotts Miracle-Gro suggested that the growth of its Hawthorne Gardening division for fiscal 2022, which is expected to increase by 40 to 45% for fiscal 2021, should exceed 10 to 20% (this is not a formal guidance, which to be provided in November, and was admittedly conservative). Analysts’ expectations for the Hydrofarm and GrowGeneration pure-plays suggest 2022 revenue will increase by 28% and 31% respectively. EPS is expected to increase by 54% and 43%, respectively.
While growth is expected to slow, growth rates remain robust. Additionally, revenue estimates for 2022 are up for both companies. BPA 2022 estimates fell slightly for GrowGeneration and increased for Hydrofarm in recent months. The sharp drop in prices and continued growth in business have made these stocks considerably cheaper than they were at the start of the year. Using data from Sentieo, these are the Enterprise Value / Revenue, Enterprise Value / EBITDA and PE ratios of 12/31 and today, for the next twelve months (note that Scotts Miracle-Gro is for the whole company, not just Hawthorne):
Either way, valuations have fallen considerably. For GrowGeneration, its EV / forward sales ratio fell 63%, while its EV / EBITDA fell 66%. The futures PE, likewise, fell 56%. The same Hydrofarm ratios fell by 34%, 68% and 73% respectively. Scotts Miracle-Gro valuation ratios fell 32%, 27% and 33%, respectively.
When weighing valuations against MSO valuations, it is important to consider that these companies and other providers of ancillary goods and services have big advantages over US cannabis operators. On the one hand, they are not subject to the 280E tax. In addition, they can scale their business due to their ability to conduct interstate commerce. Finally, their shares trade on higher stock exchanges, which gives them better liquidity.
While one conclusion could be that investors have lost confidence in the growth outlook, we believe the weakness in prices primarily reflects negative short-term technical data. GrowGeneration broke the price of $ 30 where it raised $ 172.5 million last December. Hydrofarm continues to trade above its IPO price, but hit an all-time low in mid-August. Scotts Miracle-Gro hit a 52-week low last week. The fall in prices seems to be feeding on itself. Additionally, we believe these stocks tend to correlate with large Canadian LPs, which are down sharply as they also trade on higher exchanges. The fundamentals, however, are very different.
GrowGeneration is by far the leader in the highly fragmented hydroponics store industry and is increasingly used by MSOs. Its growth has been fueled by both organic sales gains as well as new stores and mergers and acquisitions. In 2020, around 40% of its activity came from the sale of equipment, the balance in consumables. Likewise, Hydrofarm and Scotts Miracle-Gro are market leaders with substantial exposure to the capital expenditures of cannabis operators. These companies are expected to benefit from the expansion of growth to come as US companies continue to expand capacity, as they universally discussed last month. As we pointed out in this newsletter three weeks ago, there is a lot of capital to fuel these expansions.
The weakness in stock prices has left the valuations of these stocks quite reasonable in our opinion, and this suggests that some investors may not be convinced that the developments that will benefit these companies will actually occur. We believe the market is still grappling with the parabolic peak at the start of the year and suggest the price action is more technical in nature. The action of these stocks is either a warning to cannabis investors or a potential opportunity.
Fire & Flower is a leading technology-based cannabis retailer, with over 90 company-owned stores in its network. The company recently made two acquisitions that allow it to offer innovative online dispensaries across North America through its Hifyre technology platform. Thanks to the strategic investment of Alimentation Couche-Tard Inc. (owner of Circle K convenience stores), the Company aims for 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 to stay updated on their progress.
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Alain and Joël