Consumers and investors alike are excited about the emergence of the cannabis industry in the U.S. Legalization is gaining momentum state by state and social acceptance at the federal level. Specialty retailer GrowGeneration (GRWG +3.65%) is a potential stock for investors looking for broad exposure to U.S. cannabis. Here are three reasons why GrowGeneration is positioned to thrive in the coming years.
1. Cannabis laws are rapidly changing
In 2012, Colorado and Washington became the first states to legalize recreational cannabis. Since then, the momentum has picked up across the United States. Recreational cannabis is now legal in 19 states, and 36 have legalized it for medicinal use.
Cannabis technology company Flowhub estimates that the U.S. cannabis industry is currently worth $61 billion, and given that most users are in young, emerging demographics, that number could certainly grow. Approximately 65% of recreational users and 59% of medicinal users are millennials or gen Z.
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Rising demand could lead more users to grow their own cannabis, which is allowed under many states' legalization laws. As of now, it's legal to grow cannabis in 18 states, so both private and commercial growing could be on the rise.
2. GrowGeneration is expanding in multiple ways
GrowGeneration is a specialty retailer, best thought of as a Home Depot for cannabis. The company operates a network of 53 stores (with more on the way) across 12 states. It sells all of the equipment and supplies for growing, including climate controls, lighting, soils, fertilizer, and additives.
The company is seeing strong same-store sales growth, up 51% in the first quarter of 2021 over Q1 2020. Same-store sales measure how much more revenue is being generated by the company's existing footprint, and when they increase, it's a good indicator that consumers are buying more frequently.
However, GrowGeneration is also aggressively expanding its store count, both organically and through acquisitions. In July, the company announced a deal to acquire HGS Hydro, a hydroponics retailer in Michigan (terms were undisclosed). The deal will add $50 million to GrowGeneration's annual revenue and increase the company's total store count to 65 upon closing.
The company is targeting 100 stores companywide by 2023, which could significantly increase revenue, especially considering GrowGeneration's strong same-store sales growth. Management is forecasting full-year 2021 revenue of $460 million, an increase of 138% year over year.
3. Strong financials will get stronger
Rapidly growing companies often lose money because they invest so heavily to fuel that growth, but GrowGeneration is already profitable. The company posted positive earnings before interest, taxation, depreciation, and amortization (EBITDA) of $19.2 million in 2020, and management expects that number to grow by 202% in 2021 to $58 million, so profit growth is accelerating.
This is especially important because GrowGeneration uses acquisitions to help expand its store footprint -- being profitable allows management to fund these moves directly instead of offering shares to raise money, thereby diluting investors. In Q1 2021, the business spent $39 million on acquisitions, with a total of $92 million in cash and equivalents left on its balance sheet. Investors will want to keep an eye on how much cash the business goes through to see if a share offering does become necessary.
Here's the bottom line
GrowGeneration isn't alone in the cannabis supplies space. It faces competition from many little "mom and pop" type stores, and big-box competitors such as Home Depot and Lowe's also offer hydroponic gardening supplies. However, GrowGeneration's focus as a specialty retailer could help it maintain its growth, and its product selection and expertise should be advantageous.
The stock currently has a market cap of just $2.5 billion and trades at a price-to-sales ratio of 5.8 using management's 2021 guidance. Larger (and slower-growing) competitor Home Depot trades at a similar P/S of 2.4, so GrowGeneration appears favorably valued given its stronger growth and smaller size.
Investors will need to keep an eye on the company's expansion plans and how it executes them. A meaningful drop in growth could signal that competitors are eating into GrowGeneration's business, but that doesn't appear to be the case yet. If same-store sales and store count continue to expand over the coming few years, investors could see the stock's price grow along with it.
