Green Thumb Industries: My Top Pick Among U.S. Based Cannabis Companies

Thesis

I have been studying the cannabis industry since its industry wide rally in early 2021. Since then I have seen a significant number of the players disappear as a result of mergers and bankruptcies. Up in Canada’s more mature market, competition has led to overproduction while prices have fallen and most producers struggle to find consistent profits. In the United States, producers only have to compete with other players within their state. All of the U.S. Multi-State Operators are used to operating in quasi-monopolies where they have significant control over both supply and price, and all of them are currently forced to operate under the oppressive 280e tax obligation.

Of the U.S. MSOs, Green Thumb Industries (OTCQX:GTBIF) was one of the first ones to be able to find profits while operating under 280e. With the federal government currently in the process of rescheduling cannabis to schedule 3, the entire industry is facing a significant catalyst. Their already efficient business model is going to become even more profitable. This is an update to my last article on Green Thumb. After looking over their financials and valuation, I presently rate Green Thumb as a Buy.

Company Background

Green Thumb is a vertically integrated cannabis company. They are currently the second largest cannabis company in the United States by revenue and maintain operations in Illinois, Pennsylvania, Ohio, Massachusetts, Maryland, New Jersey, North Carolina, Florida, Nevada, and California. They currently have 18 production facilities and 86 retail locations across 15 U.S. markets.

Being vertically integrated, they control both their production and distribution in each state they operate in. While this comes with the advantage of knowing they can never be cut off from their supply, it also exposes them to the risk of production. During periods when the price of cannabis is high, they will experience higher margins and returns. They can also expect to have lower margins and returns whenever the price of cannabis is low. With them currently operating in multiple states, and the federal government still restricting transport across state lines, each state currently represents its own unique market.

Long-Term Trends

The U.S. cannabis market is projected to have a CAGR of 14.66% through 2028. Once cannabis is rescheduled, the federal restrictions to moving it across state lines will go away and those states which don’t implement import protections are going to allow their local producers to compete with out of state players. Just like what has already been happening in Canada, I believe that once all the producers in their separate states are finally allowed to compete with each other, a price war will break out in the United States.

Guidance

Their most recent earnings call transcript indicated that they believe the momentum behind an industry-wide sea change has reached the threshold where they believe it is inevitable.

They are ramping up their capabilities in Ohio as a result of the recent passing of recreational use there. They are also preparing for the possibility of recreational use passing in Pennsylvania, Virginia, and Florida.

They recently approved a $50M share buyback and have already used $25M of it.

They intend to continue focusing on customer satisfaction while growing revenue in a responsible manner.

As I have been pointing out to other investors for many years, during hard times people tend to purchase more cheap emotional pick-me-ups, not less. The management at Green Thumb seems to also understand this.

Quarterly Financials

Their quarterly financials are showing fairly steady growth over the last ten quarters. Eight quarters ago Green Thumb had a quarterly revenue of $233.7M. Four quarters ago that had risen to $261.2M. By this most recent quarter that had grown further to $275.4M. This represents a total two-year increase of 17.84% at an average quarterly rate of 2.23%.

Their margins have been slowly compressing at a fairly stable rate. As of the most recent quarter gross margins were 48.58%, EBITDA margins were 27.12%, operating margins were 17.79%, and net margins were at 3.81%.

Their dilution rate has been lower over the last year compared to the previous year. The sum of their last eight quarters of dilution comes to 3.79%; over the last four quarters this has risen/dropped to 0.34%.

Their debt continues to rise, but the rate of their debt increases has been decreasing. The most recent quarter, Green Thumb had -$3.1M in net interest expense, total debt was at $560.4M, and long-term debt was at $297.1M.

Their cash flow varies significantly from quarter to quarter. As of the most recent earnings report, cash and equivalents were $137M, quarterly operating income was $49M, EBITDA was $74.7M, net income was $10.5M, unlevered free cash flow was $4.40M, and levered free cash flow was $3.9M.

Total equity remained fairly stable since Q4 2021.

Their returns have been declining. As of the most recent earnings report ROIC was 0.46%, ROCE was 2.19%, and ROE was 0.62%.

After Rescheduling

In a post-rescheduling environment, the cannabis industry will no longer be burdened by the 280e tax obligation. The chart below shows their net margins both if they didn’t have to pay taxes at all, and also if they only had to pay 21% of their pre-tax net income. When rescheduling arrives, Green Thumb will experience an immediate improvement to their profitability metrics. While this most recent quarter had a net margin of 3.81%, without any taxes that would have been 16.34%, and without 280e that would have been 12.91%.

Valuation

As of November 24th, 2023, Green Thumb had a market capitalization of $2.41B and had a market price of $10.21 per share. They do not pay a dividend, so using their forward P/E of 57.47x, their EPS Long-Term CAGR of 20.0%, I calculated a PEGY of 2.874x and an Inverted PEGY of 0.3801x. This implies an intrinsic value estimate of around $3.88 per share.

If I instead apply an estimate for their post-rescheduling forward P/E, I get a significantly different result. Using my estimates for their post-rescheduling margins, the forward P/E of 57.47x becomes a 16.96x. This produces an PEGY estimate of 0.848x, and an inverted PEGY of 1.179x. This implies that their post-rescheduling intrinsic value is around $12.04 per share.

Risks

Green Thumb has positioned itself into the states with a higher average price of cannabis. By focusing on states with higher prices, they have been able to maintain better margins than most of their competition. The primary risk with this strategy becomes a reality when cannabis is finally allowed to be shipped across state lines. I expect that as soon as they are allowed, producers in states where the price is low will begin shipping it to places where the price is high. I expect for this to cause revenue increases for producers already operating in the cheaper states, and margin contractions for operators in the states where it is currently more expensive.

This may sound like heresy to some of you, but with their two largest U.S. competitors, Trulieve (OTCQX:TCNNF) and Curaleaf (OTCPK:CURLF), both experiencing negative net income and shrinking revenue, I actually believe Green Thumbs primary long-term competitive threats are in Canada’s more mature ecosystem. If the federal government allows importation from Canada, their producers are likely to flood U.S. markets with their ultra-cheap flower and concentrate. However, I believe an additional threat comes from Canadian retailers. Specifically, I consider High Tide (HITI) to be the single most competitive cannabis company in Canada, and they have already declared that as soon as the laws change, they intend to use M&A activity to execute a rapid expansion of their bankruptcy–inducing business model south into the United States. It’s reasonable to assume that some of the other Canadian players will join them.

Catalysts

As I have already mentioned several times, rescheduling will remove the 280e tax obligation from the U.S. sector. When this happens, I expect that the entire industry will experience a significant rally.

The passing of a version of the Safe Banking Act will finally allow institutional investment into the industry. As any experienced investor will tell you, retail doesn’t typically have the ability to move markets, institutions do. Once they are finally allowed to, I expect that institutional investment money will flow into the sector. I expect that these inflows will drive industry valuations higher.

Because it contains a mix of urban and rural which reflects the nation as a whole, Ohio has a very long history of being a bellwether indicator for the nation. If it wasn’t heavily gerrymandered to favor Republicans, it would still be considered a purple state. Earlier this month, Ohio voters approved recreational cannabis, becoming the 24th state to do so. With almost half of the states currently allowing it, I view this as a strong indicator that even if the current push to reschedule fails, another drive to change the Federal laws will be taken up.

Conclusions

Green Thumb is my top pick among the United States cannabis companies. Their higher margins have allowed them to find profits through 280e, and are an indicator that when the laws change and the tax burden is reduced, they are likely to be more profitable than most of their competition. Their margins also better prepare them for the outbreak of the potential price war. Although I do not currently own any GTBIF, I plan on building myself a small position over the coming months. If the states prevent interstate commerce, then I may hold this position for many years, but if an interstate price war breaks out, I will likely sell as I see it begin to negatively affect industry-wide margins.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.