GrowGeneration Stock Goes Up in Smoke with Cannabis Industry

The green rush is over – or at least on an extended pause – and those who invested in cannabis during those early, heady days probably have The Blues. Once upon a time, Canopy Growth Corporation (CGC) was the biggest marijuana stock of them all. In 2019, it had a market cap north of $17 billion and was backed by billions of dollars from Constellation Brands. Today? The company’s value is bouncing back and forth between about $250 million and $350 million. Last month, it reported a net loss of about $2.5 billion for 2022 and warned investors of its ability to continue as a “going concern.” Just a few days ago, an analyst with investment firm Eight Capital published a report called “Last Puffs of the Roach,” in which he put a $0 price target on CGC shares. “Up in Smoke” might have been a better title.

Headlines out of the cannabis industry are full of such news, from the recent bankruptcy of leading cannabis retailer Fire & Flower to the acquisition of cannabis producer Hexo by Tilray, a cannabis conglomerate that we’ve long avoided. It took us years before we finally took a hit off this dirty bong water of a sector and went long on one of the biggest multi-state operators in the United States. Cannabis remains a highly volatile market in the United States, held together (or not) by a patchwork of state-level regulations. A glut of supply is keeping prices historically low, as we reported earlier this year, and even new markets aren’t ramping up like they did when states like Colorado and Washington first legalized it.

Core Markets for GrowGeneration Not Growing

Don’t just take our word for it. Here’s Darren Lampert, co-founder and CEO of GrowGeneration Corp (GRWG), responding to an analyst’s question during the company’s 2022 earnings report in which revenue dropped by more than 34% compared to the year before:

We are not planning for an imminent turn in the cannabis cycle. … I think the hyper growth, the 20% year-over-year compounded growth that people are expecting through the 20s, I don’t believe that to be true any longer. … [T]he capital has dried up. And with the dry-up of capital, you’re seeing much less building and you’re not seeing the race to the start, which you’ve seen years ago. So, you’re seeing a much more controlled build-out environment. And I do believe that’s what you will see in the future.

Darren Lambert, co-founder and CEO of GrowGeneration

That’s not good news for investors in GrowGeneration, a Denver-based company that supplies the equipment and consumables for growing operations. Last year, we did a deep dive into the company’s growth because a number of our lovely readers told us they believe it was the best pick-and-shovel play for investing in the potential of the cannabis industry. Unlike other growing equipment stocks we’ve analyzed, GrowGeneration specifically serves both the cannabis and indoor vertical farming industries. 

The latter industry is in as bad a shape as the former, with funding to vertical farming companies drying up a few years ago. A couple of these startups opted to jump into the public markets by merging with special purpose acquisition corporations (SPACs) with predictable results. For example, a high-tech greenhouse company called AppHarvest (APPH) reported less than $15 million in 2022 revenues against more than $175 million in losses. After peaking with a market cap of nearly $3 billion in early 2021, AppHarvest is worth about $65 million, with shares trading below 50 cents. Another big name in the industry, AeroFarms, called off its SPAC deal after institutional investors started pulling their money out of the trust. Meanwhile, Agrify (AGFY), which specializes in container farms for weed operations, just completed a 1-for-20 reverse stock split to remain on the Nasdaq with its market cap of $4.5 million.

GrowGeneration Revenues Also Not Growing

Cannabis and indoor farming are the two shaky pillars upon which GrowGeneration has built its business, which it claims is the largest chain of hydroponic garden centers in the United States. The company also operates an e-commerce platform, offers its own line of private label products, and pretty much dabbles in anything to do with growing weed and other high-value plants indoors. Since 2020, GrowGeneration has acquired more than 25 businesses or their assets, cobbling together a growing empire of growing supplies and retail locations. That created the illusion of strong revenue growth over the last few years until the reckoning of 2022:

As we noted in our article last year, same-store sales at 26 locations open for the same period in 2020 and 2021 dropped more than 12% from one year to the next. That was only the beginning. Same-store sales in 2022 were down by more than half compared to 2021, which was “primarily attributable to the downturn in the business cycle for cannabis cultivators, resulting in less supply and equipment purchasing.” The e-commerce segment similarly declined from $36.2 million to $15.1 million year over year. 

The one bright spot was a segment the company calls “Distribution and other,” where GrowGeneration sells products and services to wholesalers, resellers, and retailers. Again, most of this growth was inorganic, mainly thanks to the acquisition of Mobile Media, which develops and manufactures shelving and storage solutions, and Horticultural Rep Group, a specialty marketing and sales organization of horticultural products.

GrowGeneration Stock Not Growing

Not surprisingly, the company’s big plans to open (not acquire) 15 to 20 new stores in 2022 did not go as planned. GrowGeneration acquired or opened only five new locations but also closed eight underperforming retail locations in 2022 and “may consider additional store consolidation in 2023.” It also cut its payroll by about $12 million in the process. Currently, GrowGen has 63 stores across 18 states after adding two stores in Alaska a couple of months ago.

It would take more fertilizer than an MBA can generate to get the growth story going again for GrowGeneration stock. The company is predicting between $250 million and $270 million in revenue for 2023. The high range would basically represent flat growth, which is maybe the best the company can hope for given the current economic climate. Sporting a market cap of just $200 million, GrowGeneration is way too small for our tastes, even while shares are (theoretically) trading at a bargain at a simple valuation ratio of just one. On the plus side, the company has $70 million, no debt, and is at least not currently burning cash.

Our Liking of GrowGeneration Not Grow

GrowGeneration provides the picks and shovels for growing cannabis. So, is there enough cannabis to meet demand right now? (Looks around the office.) Yes, there’s tons of cannabis selection at various price points, some of which are still being grown by black market growers who have been around since cannabis was first discovered by Bob Marley. Legalization at a Federal level might spur more industry growth, but certainly not a return to the demand for growing equipment that accompanied legalization. All those billions of dollars thrown at indoor farming ventures also went directly towards hydroponics equipment. Funding has dried up because you can only sell so many overpriced microgreens. An aptly titled article by Bloomberg a few weeks ago, Funding Is Drying Up for AI-Run Vertical Farms, summarizes the future of indoor farming succinctly (especially the last sentence).

But after firms poured billions of dollars into these startups, pushing valuations into the stratosphere, the industry is now facing a harsh new reality: funding is drying up, profits remain elusive, and creditors are circling. [.] “We really were in a hype cycle,” said Vonnie Estes, vice president of innovation for the International Fresh Produce Association. “There was a lot of money that rushed in without really understanding that this is actually just farming.”

Bloomberg

Let’s forget about the fact that GrowGeneration is well below our market cap limit of $1 billion and just focus on the growing equipment thesis. We don’t believe vertical farming of food products will enjoy any success at scale because it’s not economically viable. We also think that the best way to play cannabis is by investing in multi-state growers like Trulieve (the only cannabis stock we’re holding). If there’s no longer a strong growth thesis for GrowGeneration, it ceases being disruptive, so where’s the appeal? Based on how small this company has become, and how the future growth of hydroponics is questionable, we’re changing this from a “like” to an “avoid” in our catalog. If you want exposure to cannabis, MSOs are probably a better way to play the theme.

Conclusion

Miners extracted an estimated $2 billion during California’s Gold Rush in the mid-1800s but few of them ever got rich. Similarly, very few ganjapreneurs are rolling in the green, and most retail investors have been left with just seeds and stems: Marijuana stocks, as represented by the ETFMG Alternative Harvest ETF (MJ), are down 90% over the last five years versus a 120% return by the Nasdaq. Weed is meant to get you high – not leave you high and dry.