Description

Green Thumb Industries (GTBIF) is a cannabis multi-state operator (MSO), operating in 14 states. GTI grows cannabis in most of its states and operates 67 retail locations in its footprint. With revenue growing from $556m FY20 to approaching $1.2B FY22E, and EBIT increasing from $106m FY20 to >$300m FY22E, GTI is likely worth mid-$30s with significant upside optionality if federal regulations become more sensible.

The $25B legal US cannabis industry is expected to grow ~20% CAGR through 2025 due to state legalization, increasing use among Americans, and gaining share from the $50B+ illicit market. Cannabis is federally illegal, but legal in 37 states either for medical or recreational use. It is illegal to transport cannabis across state lines, so all product is sold in the state it was grown. Each state is its own entity, with unique rules on the number and type of permits granted. As such, choosing the optimal states to invest in is key to a company’s long-term value creation. I believe GTI is among the best MSOs to own long-term because of its capital allocation track record. Founder/CEO Ben Kovler explains the approach to investing capital. 

Q: How did you choose to go to different states? 

A: “I study the numbers a lot, very comfortable with that... Despite 280E [onerous tax structure] the business is generating free cash. And the way we’ve done that, in two words is capital allocation. The longer answer is where you put your chips. We raised the money, those are chips to put in a game, a bet, a business, to allocate into people. Human capital, intellectual capital, actual hard capital goods that we’ve built (facilities) to make something that’s going to yield more than we put in. It’s as simple as you put in $100 how much can you get out? Some people, it appears, go into a business where there’s a negative gross margin and they keep spending into that. That’s the worst thing you can do. We don’t do that, and if we see it we stop spending into it. It’s more fun to go somewhere where you can put $100 and create $500 in revenue and $100 in profit, or whatever the numbers end up being in that analogy. Or, think about the casino. If you’re going in to play poker, why would you go to the game where there’s a lot of other sharks that are likely to take your chips whereas if you could go to a game where you understood all the rules, you knew your cards, you knew what was coming, you knew the other player’s cards and you knew that you had a good hand, it’s a lot easier. Why go play in a knife fight when it’s easier to go sit at the beach? The analogies are all the same and that is our capital allocation strategy. Put money where $1 is going to equal $3, not where $1 is going to equal $0.50. It seems common sense, and the reason we’re able to make those decisions is by studying the data, and that has to do with the simple principles of supply and demand…That’s why early on we were IL, MA, MD, NV as those markets unfolded, it was not CO, OR, WA or CA. And PA, OH became very obvious. NJ, NY, CT, FL, it all just makes tons of sense then all of a sudden we have a portfolio where it’s like oh my gosh this is the portfolio we’d exactly like to have. But that’s because of studying the numbers in advance and kind of seeing the cards that are going to come out. It’s not that fancy. Here are the cards that will come out in 2yrs: New York’s going to be a massive market. It’s not a big mystery. We know that because of how many people live in NY and now it’s legal. It’s the most basic principles. That’s why we acquired a license there in 2018.” – CEO Ben Kovler, Cannabis Investing Podcast, Green Thumb Winning at Capital Markets, 6/7/21 

Kovler is one of the few business leaders that regularly refers to Ben Graham, the Kelly Criterion and Fortune’s Formula, as well as Buffett’s “Wall Street Journal” test for integrity. GTI is also one of the few MSOs that writes an annual letter, which I find better than most in any business. Kovler has clearly read plenty of Bezos, as he refers to “Day 1” for GTI regularly. In addition to these “soft” attributes, GTI is one of the industry’s most consistent operators with top-tier margins, is registered with the SEC (in preparation for eventual major exchange listing) and raises capital at industry low rates without the help (or fees) of bankers. As more investors study the cannabis industry, it would not surprise if GTI traded at a premium based on the quality of Kovler’s communication. There are myriad interviews and podcasts available online, and his message has been consistent for years.

Business model

The business is growing cannabis and selling through GTI-owned and third party dispensaries. GTI targets states that have limited licenses and are likely to flip from medical use to adult recreational. There is operating leverage, as increasing revenue from legalization and fading stigma ramps on fixed capital investments. An example below shows Illinois, which had a Medical marijuana program that GTI participated in since 2015. Beginning in 2020, adult recreational use was legalized–monthly sales in Illinois increased 5x since conversion. 

NY and NJ recreational coming online in the next year should be a similar strong sales tailwind.

GTI sells owned and 3rd party brands in its stores, and also sells its brands in 3rd party stores. They describe the model as “Enter, Open, Scale” and have executed in several states.

Product mix and owned brands are as follows. GTI is focused on building high quality cannabis brands, of various formats, at scale. 

Value proposition

GTI’s value is delivering consistent, tested cannabis brands to customers. The value proposition of cannabis is likely underappreciated. Health benefits are numerous as alternatives to opioids, anti-inflammatory, etc. Cannabis is less harmful for recreational users than alcohol. It is also lucrative for states, as cannabis now generates more tax revenue in Illinois than alcohol. As more states legalize and experience these benefits, legalization is very likely to spread.

Peers

GTI is considered one of the “Big 5” MSOs, along with Curaleaf, Cresco, Trulieve and Verano. State footprints and leadership vary among the group, but all will likely have directionally similar outcomes. There are also “Tier 2” MSOs, which generally have smaller footprints and revenue, including Columbia Care, Terrascend, Ascend Wellness, AYR Wellness and others. 

Risks

Regulatory. The key source of mispricing is that many investors are unable to own cannabis businesses due to federal regulation. There is a good chance federal impediments will be removed in the near/intermediate term, but no guarantees. If no law is passed enabling the industry to operate with normal banking (currently almost all cash, which is nonsensical and dangerous for operators), or deduct expenses for standard business purposes, current valuation isn’t as cheap as bulls claim. Using a teens WACC and 60% tax rate makes it hard to generate upside in any DCF. The thesis behind owning GTI is that it is less reliant on the capital markets than peers, so has the capacity to endure regulatory delays more than most. 

As momentum for federal legalization becomes an increasingly bipartisan issue, I doubt the status quo will remain forever, but it could.

Illiquidity. This is probably the main source of mispricing, as GTI trades in Canada and OTC. Inability to trade on major exchanges (and compliance) prevents many institutions from investing in this modestly priced growth industry. As a result, this ~$5B company trades ~$10m daily volume. Shares can trade down meaningfully on no news, but the reverse is also true. For long-term investors, the eventual liquidity unlock is likely a major catalyst.

Execution. This is not a business that any idiot can run. Growing consistent quality cannabis is relatively complex, ~3-5 months indoor and requires precise conditions. Companies must also run professional retail operations to attract and retain customers. Finally, managing relations with local governments and investors requires diplomacy that not all operators have. Mistakes at any step along the way can impair value, but GTI has thus far proven to be an industry leader on all of the above.

Industry growth disappoints. Unlikely due to backlog of states legalizing and consumer attitudes warming towards cannabis. However, if for some reason growth falls short due to persistent illicit market or other impediments, MSO investments will likely struggle.

Valuation

DCF shows conservative implied expectations relative to industry growth. Assuming consensus growth through FY23 ($1.4B rev, $406m EBIT), industry 20% growth through FY26 and flat margins from FY23, GTBIF is worth ~$33/sh @ 9% WACC and 3% LT growth. This assumes cannabis banking reform in the next several years. 

At current price, target growth implies GTI will trade at 12x FY23 EBIT and <10x EBITDA. If they are still growing 20% annual revenue and maintaining margins, current price seems low.

If banking reform never happens, implying double digit WACC and onerous tax rates in perpetuity, downside is real. However, given polling and state legalization trends, that is a risk I am willing to underwrite.

Catalyst

• Legislative progress. Cannabis is a Schedule I drug in the eyes of federal government, subject to the greatest regulation. This makes zero sense, and will almost certainly change eventually. This will open the gates for formal research into the benefits of the plant, and should greatly reduce stigma. It also opens the door to greater capital markets access.

• As New York and New Jersey open for adult use (likely 4Q22 and 2Q22, respectively), it should improve sentiment and dispel many of the myths investors have about cannabis. GTI is licensed in these states, so should drive a material revenue uplift.

Other

• State legalization expands. As states legalize, generating tax revenue and disproving concerns about crime, etc., their neighbors tend to legalize. Momentum continues to favor companies such as GTI.

Source: https://disa.com/map-of-marijuana-legality-by-state

THis compares to a similar map from October 2017

Source: https://www.washingtonexaminer.com/will-2018-be-the-year-marijuana-takes-over

Catalyst

NY and NJ opening for adult use in 2022

Federal banking reform in intermediate term