Olga Tsareva
Investment thesis
GrowGeneration (NASDAQ:GRWG) is a company dedicated to selling hydroponics equipment. GrowGeneration currently has more than 60 stores spread across America. It also operates an online superstore for growers with more than 10,000 products available for shipping nationwide. Products sold by GrowGeneration include organic nutrients and potting soils, advanced lighting, and state-of-the-art hydroponic equipment for indoor and outdoor use. Hydroponics is a technology used for various crops, including Cannabis, the company’s primary market. The Cannabis industry has seen a slowdown in America due to delays in establishing new markets in New Jersey and New York and because of falling prices in some young markets, such as Arizona, Illinois, Massachusetts and Michigan. Given the legislative uncertainty surrounding the legalization of cannabis and deteriorating corporate results, the action at the moment is a hold.
The hydroponics industry
Hydroponics is a system that allows growing without having to use soil but by planting plants directly in an aqueous solution. Hydroponics is used for indoor growing and allows growers to control plants much more carefully. Pests or excessive light can damage crops: through hydroponics, all these factors can be managed. This makes it possible to produce crops faster and increase crop yields, unlike traditional methods. Hydroponics has widely used in emerging industries, including cannabis and hemp cultivation. Vertical farms producing organic fruits and vegetables also use hydroponics because it allows them to grow in confined spaces.
GrowGeneration‘s target customers include “commercial growers in the plant-based medicine market, artisan growers, and vertical farms growing organic herbs and green leafy vegetables.” To these must be added all Cannabis producers, whose numbers are growing significantly in America. Retail stores present in America often do not belong to chains and are therefore an opportunity for company acquisitions.
Total sales in the hydroponic equipment industry are expected to exceed $16 billion by 2025. In addition, there are currently over 15,000 active cannabis cultivation licenses in North America, which is growing. The average cultivation facility is about 36,000 square feet, and it is expected that over 34,000,000 pounds of Cannabis will be produced by 2025.
Competitors
Major competitors include local and national sellers of gardening supplies, local retailers of hydroponic products (over 1,000 retailers) throughout the United States and other specialty growing equipment, and online retailers and significant online marketplaces such as Amazon (AMZN) and eBay (EBAY), which are often able to offer products at lower prices. In addition to having the largest chain of stores in America, the company competes by offering the widest selection of hydroponics products, end-to-end solutions for all types of growing environments, in-store sales and product support direct-to-producer pricing, and top-notch customer service.
Latest earnings results
Last quarter’s results were very negative, continuing the trend of recent months for this company. The problems are still the same and mainly relate to the company’s inability to cope with inflation, the seasonality of the products that GrowGeneration sell, and the general contraction of the cannabis market due to oversupply driving prices down. These have been the most important results:
- Revenues declined by 43.5%, mainly due to a decline in store sales. However, be considered that five new stores were opened.
- Revenues from e-commerce decreased to a quarter of Q2 revenues in 2021. The decrease depends on the closure of the Agron.io trading company’s trading platform.
- Store and other operating expenses increased by $1.2 million from the previous year. The increase is mainly due to the opening of 5 additional locations.
- Cash and short-term marketable securities totalled $65.6 million. Inventory is $99.1 million. We know from the last quarterly report that the company had entered the year with an excessive amount of accumulated inventory.
Guidance update
In the previous quarterly report, management reported that inflation, declining demand for hydroponics equipment, and an oversupply of cannabis in the marketplace had hit GrowGeneration’s business hard. The company now expects 2022 revenues to be between $250-275 million, a -35% decline from 2021 revenues. The company also expects negative EBITDA, between $12-15 million, a significant reduction from the initial 2022 guidance.
Risks and opportunities
Among the advantages the company has, is the leader in the sale of hydroponics products in the Cannabis industry. These products range from growing structures to lighting to soils, so a consumer can find within a GrowGeneration store virtually anything to start or continue their business. Moreover, with more than 60 stores, some territorial coverage is guaranteed, from coast to coast. Agriculture is a sector that does not adapt very quickly to new technologies, so it may still be many years before we see a massive use of hydroponics: in this discussion, however, some emerging sectors should not be considered, among which the most important is Cannabis, which is grown in greenhouses adapts very well to this type of technology.
The Cannabis sector is still immature and will always remain subject to strong political pressure from conservatives who will push to limit its use. So even if legalization in the various states were to continue at the same rate as in recent years, the risks in this sector would remain high, and the share price could continue to encompass these uncertainties. The company is inevitably seasonal: this is not a problem. However, the company is still too dependent on the cannabis industry, and the contraction of the industry combined with rising inflation has hit its business hard. In addition, GrowGeneration has not yet managed to achieve positive free cash flow. Although the company is not on the verge of bankruptcy and can continue operations for several more years, we still do not know when it can be positive for free cash flow.
Conclusions
GrowGeneration is still a very young company taking its first steps in an industry that is also reasonably new: it is normal for there to be missteps in management and for results to deviate from initial forecasts. Despite this, the stock was the subject of a speculative frenzy in 2021, which had the only merit of allowing the company to raise capital. Now that the frenzy has disappeared and pessimism has taken place, the company appears correctly valued. However, the economic situation and business still appear very unstable, so significant declines between now and the year-end cannot be ruled out.
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