Cannabis companies are just starting to roll out the earnings season and with some big names on deck this week, Stifel analysts Andrew Carter and Christopher Growe published an earnings preview report. Once darlings of the cannabis industry, hydroponics are fading fast as the market for Scotts Miracle-Gro (NYSE: SMG) and GrowGeneration (NASDAQ: GRWG) have slowed to a crawl. He wrote, “The 2021/2022 hydroponics recession has been deeper and longer than we originally anticipated with a significantly greater impact to our covered companies than we originally anticipated. But, we contend the hydroponics category will at minimum regress to underlying demand for cannabis (HSD) with an improvement in durables demand eventually taking hold.” The coverage for Canopy Growth (NASDAQ: CGC) basically said that the company’s cash burn is destroying the company’s value.
Scotts Miracle Grow
The analyst is being super cautious on his numbers and estimates that the third fiscal quarter earnings will be $1.55 for Scotts. This is a 60% drop from last year and according to Carter, well below consensus ($1.74). “We believe consensus estimates do not fully appreciate the magnitude of the challenges impacting F3Q22 outlined with the June update: adverse April weather impacting U.S. Consumer purchases of higher margin lawn care products, retailer inventory reductions, Hawthorne underlying revenue decline accelerating, fixed cost deleverage, and inflation not fully offset by pricing.,” he wrote. “We estimate total revenue will decline 26% with the gross margin down 830 bps. We estimate U.S. Consumer F3Q22 revenue will decline 15% with volume down 25%. We estimate Hawthorne revenue will decline 59% with the underlying revenue decline accelerating to -63% (-48% F2Q22).” He said he is keeping his full-year estimate of $4.76, which is roughly in between the company’s guidance range of $4.50 – $5.00.
Carter went on to point out that investors will have a hard time finding anything to motivate them to buy shares for a while. The company could finish the year at 6X debt/EBITDA, not too appealing for investors. He suggested spinning out the Hawthorn division, but then also said the chance to do so has probably passed.
“We have written positively about a potential separation of the two segments (core Consumer, Hawthorne), potentially as a source of unlocking value, but also necessary with capital allocation increasingly inefficient,” said the report. “But we believe this is no longer a viable option with the current structure’s inefficiencies for capital allocation and investor interest an ongoing headwind. We view the RIV Capital investment as a poor use of capital with the strategy articulated by the company undifferentiated and misguided (in our view) with the pursuit highlighting the corporate ownership structure’s risks.” He is maintaining a share target price of $93 and the stock was lately selling at approximately $86 a share.
Carter’s estimate for GrowGen’s second-quarter revenue is $85 million, which is a drop of -32% over last year and just above consensus. “Our outlook includes a 41% decline in organic revenue growth: 50% same-store sales decline, a 20% decline for the combined e-commerce platform, +20% underlying growth from distributed products, incremental contributions from new stores and expanded locations,” the report said. Having said that, the analyst was more favorable to GrowGen than to Scotts. He thinks that the company’s cost savings plan will help it in the back half of 2022. He also noted that his estimates didn’t include benefits from reduced inventory levels, and he thinks rightsizing the inventory will be a tailwind for cash flow aiding the company’s efforts to achieve break-even cash flow while investing behind the organization.
Carter even went on to write that he thinks his 2023 outlook will prove to be conservative, however, he walked that back a little saying, “but proof points for a recovery have yet to take hold even as we start to anniversary softer category trends from one year ago.” He is maintaining his Hold rating and believes it will take time for enthusiasm to return to the sector of hydroponics. He did point out that GrowGen has $60 million in cash and is making the right investments, it’s just that investors won’t see that return for some time. His target price is $5.50 and the stock was lately trading at $4.74.
The rare Wall Street sell rating is given to Canopy Growth by Carter, who has also lowered his price target to C$2.90. The stock recently closed at C$3.29. The report said, “We approach our estimate for a C$80 million adjusted EBITDA loss cautiously; our estimates suggest modest underlying improvement y/y driven by cost savings/synergy realization against sales declines include higher margin C3 sales against the C$64 million 1Q22 loss (included C$20 million COVID subsidies). We estimate a total cash burn of C$130 million.” He believes revenue will fall 4.5% in the fiscal year 2023 and was very focused on the company’s cash burn. He estimated the company will burn through $630 million by the fiscal year 2024.
He went on to write, “We believe the magnitude of the ongoing losses and risks associated with liabilities remain underappreciated with all non-Constellation shareholders bearing outsized risk. The recent early conversion of C$263 million of convertible debt provided additional flexibility reducing liabilities, but at a significant cost to equity holders with the shares down 35% following the announcement (S&P 500 +1%) through final pricing.” He thinks the company may retire even more convertible debt that could further dilute shares by as much as 21%. He finished with a quick analysis of the parts writing, which suggested no value for the global cannabis businesses given the significant losses; C$17 million for the Canadian retail network; C$450 million of value to Canopy for Biosteel, Storz and Bickel, and This Works; and C$982 million for investments in U.S. with the options valued at 50% of capitalized value not including Jetty.” However, he did note that there could be a quicker improvement in the company’s fundamental performance, platform innovation could quickly gain traction and maybe there could be creative actions by Constellation Brands that could drive value.