Description

Elevator Pitch:

Turning Point Brands (“TPB”) has been written up four times on VIC - the business has had a hectic past with a few strategic pivots and three CEOs over the past few years. TPB is not a well-loved company, and many investors have gotten burned since its 2016 IPO. As a quick anecdote, nearly everyone I’ve spoken to seems to have a negative opinion/story about Turning Point.

However, therein lies the opportunity. After Zig-Zag’s period of over-earning in 2021, subsequent earnings decline in 2022, and stabilization this year, the company is now set up for MSD or higher consolidated top-line growth (excluding its new-gen segment) and even faster bottom-line growth.

TPB trades at just ~7.00x 2024 EBITDA and a high-teens unlevered FCF yield; we believe these low multiples are unjustified because the business has a long runway for growth, lacks capital intensity, has no cigarette exposure, and should be mostly unaffected by economic woes.

Many of TPB’s less attractive peers trade at HSD multiples despite facing more regulatory scrutiny and declining volumes in most of their product lines. One of their better comps, Philip Morris, trades at nearly 13.00x EBITDA today.

Given their growth opportunities and very low cyclicality, a 10.00x EBITDA multiple (HSD FCF yield) seems fair for TPB. Running with this multiple and giving no credit for incremental cash flow or working capital release gets us to ~80% upside from today’s share price and attractive IRRs on what we consider to be reasonable 2025 estimates.

So, What’s Different This Time?

Nothing much; those already familiar with Turning Point and its Stoker’s/Zig-Zag businesses could get up to speed relatively quickly (there haven’t been any major acquisitions or significant transformations in either segment). Instead, this is the first time the company has strongly emphasized organic growth and isn’t talking about acquisitions.

I want to add some color here for those new to the story. Investors who have previously lost money on Turning Point usually overpaid on the back of what they assumed would be rapid growth in one of its segments. In 2018-2019, their New-Gen segment was expected to continue its rapid growth trajectory through acquisitions and organic growth, but the FDA would crack down on Vapes/E-Cigs, leaving this business in limbo to this day. From 2020-2021, Zig-Zag was over-earning, and investors wrongly extrapolated this growth into the future.

On the flip side, those who have had success purchasing TPB in the past did so when the “legacy” businesses were cheap (Zig-Zag / Stroker’s), and that’s the thesis here as well, but I do think the story is the cleanest it’s been since their IPO.

So, Why Now?

Following a hairy past, which included:

• A string of poor acquisitions.
• Regulatory issues that destroyed their new-gen segment.
• A majority shareholder who sold out between 2020-2022.
• Their Zig-Zag business overearning from 2020 to 2021.
• A CEO brought in from a cable company in 2022 to make acquisitions (yes, really).

TPB made a strategy shift to emphasize organic growth and brought in a new CEO, Graham Purdy, in late 2022.

Graham has worked at Turning Point for nearly two decades and played a crucial role in building the Stoker’s MST business and expanding Zig-Zag’s product lines. Before his role as CEO, Graham was COO and Senior Vice-President of Sales. Our conversations with Graham have been positive; it’s apparent he is very passionate about both the Zig-Zag and Stoker’s businesses, he’s not afraid to tell you about the past marketing/product mistakes he’s made, and we believe the role he’s played in growing both Zig-Zag and Stoker’s over the years makes him an excellent fit for the company moving forward.

Some other “Why Now” points:

• Standard General overhang Is gone (old majority shareholder and Hedge Fund who was a consistent seller from 2020-2022).
• Stoker’s growing MST business is now 2/3^rds of segment sales compared to 40% at the end of 2017 (The other 1/3rd is Loose-Leaf, a flat-to-down product line).
• Zig-Zag, after experiencing a decline in sales for the past two years, is set up for MSD+ organic growth moving forward.
• The company is paying off a convertible note due in July 2024; afterward, we expect the company to initiate a buyback and continue debt reduction.
• Consistent top and bottom-line growth starting in 2024 and a clear go-forward strategy should help lead to a potential re-rating for TPB.

Business Descriptions / Growth Opportunities:

Stoker’s (49% of Operating Income):

Stoker’s has two current product offerings (Loose-Leaf Tobacco and Moist Snuff Tobacco) and a third they are working on (FRE Nicotine Pouches).

Loose-Leaf Tobacco (~32% of segment sales):

Stoker’s is the market leader in the Loose-Leaf Chewing Tobacco category; they have a low 30’s market share while also being the #1 discount provider. Loose-Leaf is in secular decline, and category volumes should be expected to continue their downward trend. Stoker’s benefits from having a strong discounted offering and has consistently taken market share in the category as they benefit from continued customer trade down. Yearly price increases and continued market share gains should lead to Loose-Leaf seeing flattish to LSD sales declines moving forward.

Moist Snuff Tobacco (~68% of segment sales):

Stoker’s holds HSD market share in the MST market and operates in the low-cost category. Like Loose-Leaf Tobacco, Moist Snuff Tobacco is also in secular decline. But unlike Loose-Leaf, Stoker’s has and will continue to take enough market share to offset or grow volumes while getting the added benefit of HSD pricing each year.

Stoker’s is the best discount option for MST, and a quick scan of tobacco-related boards/threads/reviews will generally point out that the other discount brands are inferior products to Stoker’s. There is only one discount competitor worth mentioning, Longhorn – which is a deeply discounted and not well-liked MST product priced significantly below Stoker’s in most markets. The better-known and higher-priced brands, such as Copenhagen and Skoal, don’t benefit from diluting their brands and competing for market share with Stoker’s. Instead, they focus on price increases to offset their market share losses and volume declines each year.

There are a few reasons why the large brands won’t start competing with Stoker’s in the discount category anytime soon. Because Stoker’s is a lower-cost product, it also has lower margins, and if the big guys were to start discounting their product, they would have to face lower margins and hope they could take enough market share to offset the decline in profit dollars they’d see. The large tobacco companies aren’t so irrational as to shoot themselves in the foot here. While some, like Altria (“MO”), do have a few discount brands (RedSeal/Husky), they are small, lack consumer loyalty, and are losing share to Stoker’s. I am not a “dipper” myself, but those who have reviewed Stoker’s seemingly always rank it as the best budget dip available – plenty like it more than Skoal, Copenhagen, and Grizz and make the switch once they try it. I do think it’s worth mentioning that there is a surprisingly strong community around both MST and Chewing Tobacco.

Furthermore, Stoker’s is only in ~67% of stores by volume, so the whitespace opportunity here is real. However, they won’t ever be able to get near 100% because they prefer to target high-volume stores, and a lot of lower-volume locations don’t make economic sense. They are in ~79k stores today and are targeting an additional ~30k-50k locations, which should get them near 90%. However, taking advantage of this whitespace opportunity will take time since it’s mostly “trench-warfare” - Stoker’s enters most of these stores individually.

Moreover, Stoker’s runway for price increases is long since the big guys are unlikely to stop taking significant increases anytime soon. Stoker’s is a price follower today, but given the brand loyalty and its continued volume growth, I believe that Stoker’s could continue to take HSD pricing if the big guys were to slow down. Why aren’t they doing it then? Stoker’s benefits from being a price follower right now because it incentivizes more customers to try the product and potentially become long-term users – If they were priced similarly to Skoal/Copenhagen/Grizz, customers would likely stick to those and not try anything new. Finally, as Stoker’s continues to take price each incremental increase will help expand margins. Operating margins are in the low 40% today, while margins for Skoal/Copenhagen are north of 70% – the difference here is mostly pricing.

It seems likely that their yearly price increases, white space opportunities, and continued market share gains should lead to MST seeing HSD+ sales growth.

FRE Nicotine Pouches (De minims % of Sales):

Plenty of investors seem to think it’s too late for Turning Point to enter the Nicotine Pouch market, or I’ve seen others claim this product has just been a total failure since we haven’t seen any growth from it yet. I don’t believe either is true; Turning Point is taking a similar approach to FRE as they did with Stoker’s, targeting high-volume stores and slowly but steadily taking incremental market share over time. FRE isn’t a discounted product like Stoker’s. Still, it does offer an interesting value proposition by having a higher nicotine content per pouch and a large can product that is similar to Stoker’s tub product (basically a massive tub of chewing tobacco). Furthermore, Turning Point is preparing to execute a national rollout in 2024 after testing the product in select markets over the past two years. This roll-out won’t happen all at once and will be similar to the “Trench Warfare” seen at Stoker’s. Turning Point already has relationships with plenty of these stores through Stoker’s. Management seems to think they can get $100M+ worth of the nicotine pouch pie over time – I’m not going to give them any credit for FRE just yet, and while it is a lower-margin product than Stoker’s MST, it’s still an attractive opportunity.

Wait, Aren’t Nicotine Pouches Going to Cannibalize MST?

While pouches have certainly impacted MST, these pouches likely expand the oral category much more than they cannibalize it. Dipping is usually seen as a masculine, tough thing that only men do, and proof of this is that only LSD MST users are female. However, if you look at who is using Nicotine Pouches, ~30% of all users ARE female. It’s anecdotal, but I have plenty of friends who pop these addictive white pouches constantly, and they have never or would never put a dip in. I believe MST and Pouches serve mostly two different customers, and I don’t see the majority of MST users making the switch to Pouches. The ones that are switching appear to be primarily premium dippers (so Grizz, Copenhagen, Skoal) as opposed to Stoker’s customer base, who seem to be the more die-hard type.

Without giving any credit for FRE, I believe consolidated sales growth for the Stoker’s segment will be in the MSD+ range, with operating income growing HSD for many years to come.

Zig-Zag (51% of Operating Income):

The Zig-Zag segment includes rolling papers, wraps, cones, and Clipper lighters. All of which are primarily used in Cannabis consumption. Zig-Zag is a 150-year-old brand, and you might recognize the name from songs like  “Crazy Rap (Colt 45 & 2 Zig Zags!).” It’s worth noting that they don’t actually own the “IP” for the papers portion of Zig-Zag but instead license the brand through what is essentially a perpetual distribution agreement that renews every 20 years (the next renewal is 2032).

Like Stoker’s, Zig-Zag has an attractive white-space opportunity in the alternative channel (Headshops/Dispensaries). Pen is just HSD today, and management believes it’s a ~$100M opportunity over time. They also have room to expand their product offerings at existing stores (For example, less than 50% of stores that carry Zig-Zag papers also carry Zig-Zag cones).

One concern I’ve heard brought up is that as states legalize Cannabis, consumers move their consumption preference towards pre-rolls/edibles/vapes and move away from traditional rolling papers/cones/wraps. While Zig-Zag’s overall market share does decline once a state legalizes, the Cannabis pie gets a lot larger, offsetting Zig-Zag’s share losses. An interesting opportunity that Zig-Zag is working on with some MSOs is for an MSO's pre-rolls to be Zig-Zag branded. Previously, during the “Cannabis Boom” of 2020-2021, dispensaries wanted everything under their own brand/banner, but some are slowly moving away from that.

This segment was over-earning during the COVID era since everyone stayed indoors, worked from home, and thus had more time to consume Cannabis. This also led to elevated distributor inventory to meet the increased demand and avoid supply chain issues. However, the papers and wraps business has now stabilized and should be growing sequentially moving forward.

Zig-Zag has historically had an older audience, but that is changing as the company works to target a younger demographic through social media. They are also working on turning Zig-Zag into more of a lifestyle brand, recently partnering with the clothing store Zumiez, and are actively looking for other similar partnerships. These partnerships essentially function as profitable marketing for Zig-Zag.

Clipper is a Cannabis centric lighter where customers frequently use its flint system to pack Marijuana. Clipper Lighters was a brand Turning Point picked up through a distribution agreement they signed in 2022. Clipper is the #1 reusable lighter and #2 overall lighter in the world but has very little presence in North America today, controlling just a 3% share of a ~$500M market.

If you would like additional details on Zig-Zag, I recommend reading the other write-ups, as there is some helpful info there. Anyway, there are a few main growth drivers here, so you have Clipper, E-commerce, the alternative channel, more states legalizing Cannabis, and new product introductions. I think a reasonable assumption is that these add up to Zig-Zag growing MSD starting in 2024.

New-Gen (De minims % of Operating Income):

Vape distribution business that should be viewed as nothing more than a call option at this point. It’s EBITDA positive, not growing, and is likely to be divested in the coming months/years. This segment used to represent a material portion of Turning Point’s business, but post-FDA regulatory scrutiny, I am assigning zero value to the business.

Putting it all together:

As stated, I believe Turning Point can grow the top-line at MSD+ for the foreseeable future, with the bottom line growing in-line or faster on a consolidated basis. They have clear white-space opportunities and are bringing several new products to market. Additionally, they will see a $2M-$3M cost savings benefit from a manufacturing automation project they expect to have completed by year-end. The CEO and Chairman purchased shares in the open market earlier this year, and I would not be surprised to see TPB throwing up HSD top-line growth in 2024/2025.

The company will generate a lot of cash over the next two years and is working to address its convertible notes due July 2024 (They have ~$120M left). After that is knocked out, the company will either pursue buybacks or pay down its $250M senior notes due in February 2026. Whichever takes priority (buybacks/debt pay down) will depend on the rate environment at that time, but I believe we’ll likely get a combination of both starting in Mid-2024.

In conclusion, I see them doing $105M+ of ADJ-EBITDA in 2025 (2023 EBITDA guide of $92M-$95M) on what I consider to be reasonable assumptions. The company is already run-rating near $100M in EBITDA today before any cost savings. Zig-Zag appears to have stabilized as of the most recent quarter and should return to solid growth in 2024. Moreover, the continued margin expansion in the Stoker’s business will help accelerate the bottom line faster than the top line, and the company has two call options with FRE and New-Gen, which we aren’t assigning any value to.

Modeling Assumptions:

• Zig-Zag: MSD top-line and bottom-line growth leading to ~$71M in EBIT for 2025.
• Stoker’s: MSD top-line and HSD bottom-line growth leading to ~$67M in EBIT for 2025.
• New-Gen: No contribution to EBIT (assumes B/E for 2025).
• Normalized Corporate Expense at ~$48M for 2025.

Catalyst

- Turning Point demonstrates consistent top/bottom-line growth.
- FRE is a success leading to accelerated Stoker's growth.
- Resolution for the New-Gen Segment.
- Sell-Side beats.