Green Thumb Industries Stock: Still At The Top In Cannabis

Introduction

Green Thumb Industries Inc’s (OTCQX:GTBIF) 2nd quarter 2022 results are out, and it’s time to review the company’s status as one of the pre-eminent companies in the fast-growing cannabis industry. This report will be in two parts. First, we will review the financial data for the latest quarter. Second, we will highlight some of the intangibles, things that provide insights into management and company culture, that were discussed in the earnings call. These intangibles are often overlooked but are at least as important as the quarterly numbers that are so closely scrutinized every three months, and perhaps more important to long term success.

The numbers

Revenues were a record $254.3 million, a 4.8% increase sequentially (up 14.6% over Q2 2021), returning to positive growth after a slight decline in the previous quarter. Net income was $24.4 million (.10 per share), up sequentially from $22.1 million. This was the eighth consecutive quarter of positive GAAP earnings, which far surpasses any other MSO.

Green Thumb has essentially two lines of business: retail and consumer packaged goods [CPG]. The 14.6% revenue growth vs. Q2 2021 came entirely from the retail side: the opening of adult-use sales in New Jersey, higher retail sales in the growing Illinois market, the addition of 19 retail stores since Q2 2021, and increased traffic in the 77 stores Green Thumb now operates.

CPG revenue comes from selling packaged product to their own retail outlets and other companies, and flat CPG revenue is consistent with trends throughout the industry. CPG business has been capacity constrained, as companies struggle to supply enough product to meet demand. We saw this most recently in New Jersey, where adult use was delayed until companies could prove they could meet the anticipated demand. In addition, recent inflation and consumer insecurities have started a shift to lower cost value product lines, which mean lower total sales. Interestingly, Founder/CEO Ben Kovler noted in the earnings call that the profit margins from value products were similar to premium lines, which is good news for the bottom line.

Overall, the company reported pricing headwinds in Maryland, Pennsylvania, Massachusetts, and Nevada that counteracted stronger sales in New Jersey and elsewhere. Shareholders should temper expectations for the much hyped New York market, where regulations, delays and taxes are dragging down the future for cannabis. CEO Kovler continues to be enthusiastic about positioning Green Thumb in new and expanding markets. The furious geographic expansion of cannabis in recent years continues unabated. Green Thumb was there when New Jersey initiated adult use earlier this year, and will be in New York, Connecticut, and Rhode Island when they begin later in 2022. A regulatory logjam in Green Thumb’s home market of Illinois has finally been cleared. Virginia is on tap for 2023. Numerous states, including Ohio, Missouri, Arkansas, South Dakota, and Oklahoma, are preparing adult use ballot initiatives for this year that will keep the growth pipeline flowing in 2024 and beyond. Readers should note that cannabis ballot initiatives have had a 100% success rate.

As I wrote in a recent article, cash flow is perhaps the single most important financial metric for any company. For the first time in 10 quarters (also an industry record), Green Thumb had negative cash flow of -$15.4 million. While this surprised shareholders, management stated in the earnings call that it was expected. They gave three reasons. First, there were two large tax payments totaling $65 million vs. none in the first quarter. Second, There were large inventory builds in Maryland and Ohio, and inventory builds often skew quarterly results. Third, 2021 compensation bonuses were scheduled for this quarter. Management is confident Green Thumb will quickly resume its industry leading positive cash flow.

Gross profit margin, which is sales minus the cost of goods sold, [COGS] is an important measure of performance. An increasing gross margin percentage indicates the company is doing a better job in sales and/or becoming more efficient in production. For the latest quarter, Green Thumb gross profit increased by $2.9 million sequentially to $125.8 million, but the gross margin declined from 55.4% a year ago to 49.5%. This reflects the margin compression seen across the industry from increased competition and cost inflation, which overtook increased overall sales. It also included a negative impact of 1.5% from reclassifying certain expenses from SG&A to COGS, which will reduce future taxes on an ongoing basis.

What the numbers mean for investors

Taken as a whole, the Q2 2022 results reflect a steady hand in the C-suite and a robust company strategy. Sales and profits continue to go up. The number of stores increases to position the company where growth will be strong. There were few surprises, which shows the company’s skill in managing investor expectations and delivering on promises. The biggest surprise, negative cash flow, was fully discussed in the earnings call (as reported above) and does not appear to be cause for concern. Management also acknowledged that the stickier issues of cost inflation, consumer sentiment, and margin compression are affecting business performance. The first two will change sooner or later. The third is a normal part of any developing industry, not a sign of impending doom that some commenters suggest. Overall, the Q2 results show a company still on track to be one of the dominant players in cannabis.

The message for investors from the latest quarter is to stay the course. The forward P/E estimate for 2023 is 31, which is respectable for an emerging growth company. The 2024 P/E estimate is 21, which matches the current S&P500 P/E and significantly below the norm for a company like Green Thumb. Since 2017 revenues have jumped from $40 million to $893 million and the company has become consistently profitable, but as the chart below shows the share price is the same as five years ago. It’s only a matter of time before the stock catches up to financial performance, and now is a very good time to add to your Green Thumb investment or start a position.

As with any emerging growth company, there are risks. Margin compression is here to stay. The stock price is somewhat tied to the economy and investor sentiment, both of which could remain as headwinds for some time. Inflation could continue to hurt sales and profit margins. The big catalyst, federal cannabis reform legislation, could mean stock gains of 100%, 200% or more, but its progress in the short term is uncertain.

More important than the numbers

The most important factor in business success is the quality of management. Superior management takes advantage of good business conditions and surmount bad business conditions. At a higher level, it establishes principles and values that define the company’s “personality” and overarching approach to business, and promotes business success. It establishes the way the company does business and informs short- and long-term decision making. Assessing management quality can be difficult, but one way is to study a company’s principles and how committed they are to following them.

Green Thumb has stated their principles explicitly, and the earnings call included evidence that they are following through. CFO Anthony Georgiadis underscored their importance by making them the last item investors heard in his earnings report. They are:

1. Tune out the noise: Green Thumb doesn’t make decisions based on stock price action or investor sentiment. They are willing to take actions like the reclassification of SG&A expenses reported above that might hurt a quarterly report if it benefits the long term business. In a different vein, they put investors on notice in the earnings call that they are ignoring the noise about federal legislation, or as CEO Kovler put it, “Despite the noise [about legislation] we are doing what we do best, keeping our heads down on execution and our eyes on the prize.”

2. Be the consumer: Everything the company does is based on the consumer. In any industry, having customers that feel satisfied, respected, and understood is a key to success. One small example: retail staff at Green Thumb are not “budtenders,” they are “People Care Specialists.” The recent push into value products is another example.

3. Watch the cash: No one watches cash better than Green Thumb. As reported above and in my recent article titled Green Thumb: Undisputed Cash Flow Champion In Cannabis, the company is the industry leader in cash flow and GAAP income. Their cash stewardship has been rewarded by allowing them to borrow money at an industry best 7%.

4. Be opportunistic when others are fearful: Over the past year, as stock prices plummeted, consumers lost confidence, and inflation hit hard, Green Thumb continued its full bore expansion, opening 19 stores, expanding cultivation, and developing new product lines. They invested $69 in capital expenditures in the latest quarter.

Finally, CEO Kovler ended the earnings presentation with what he called “one of the most important aspects of our culture” – giving back to the community. Green Thumb is on track to donate over $1 million in support of communities damaged by the war on drugs by the end of the year. Although many investors may view such initiatives as a distraction or an afterthought, businesses don’t operate in a hermetic customer-company dyad. They operate in communities, and a healthy community fosters a healthy company. It is a big advantage that Green Thumb sees beyond quarterly profit and loss and understands the bigger picture.

Summing up

Green Thumb is one of the pre-eminent companies in the fast-growing cannabis industry, and the current quarterly report is evidence that they are continuing on that path. They lead the industry in numerous ways, including cash flow, net income, and financing. Their status is evidence that they have the most important factor in business success: superior management. Investor sentiment is overriding sound and promising fundamentals, which provides the opportunity to start or add to a Green Thumb investment at unreasonably low share prices.