• Brett Schafer

Grow Generation: Not So Deep Dive

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Show Notes

(Ryan) What they do: GrowGeneration is the largest hydroponics supplier in the US. Verticalroots.com defines hydroponics as “a way to skip the soil, sub in a different material to support the roots of the plant, and grow crops directly in nutrient-rich water.” So this includes selling items like organic nutrients or soils, but also items like lighting and equipment. And those two items get grouped into either consumables or non-consumables for grow generation (60/40 split).

They have a bunch of different store types and sizes too, it’s not just one uniform layout like you might get with a mcdonalds or something like that. Some of their garden centers also act as warehouses or distribution or fulfillment centers. Majority of their sales come from customers that are individual cultivators or indoor gardeners, that kind of thing, but they also have commercial customers. So once a commercial customer gets a cultivation license they usually have to outfit their areas with lighting, equipment, all that stuff. That accounted for about 25% of overall revenue in 2020.

But it’s not all just physical retail. They have 2 websites which customers can order from which are growgeneration.com and agron.io. Agron.io is more of a way for commercial customers to manage their purchases and logistics. It’s an e-comm site too, but sounds like it’s a little more holistic.

(Ryan) History: Looks like it was incorporated in Colorado in 2014. Both Darren Lampert and Michael Salaman the CEO and COO have been there since the start. Lampert was a securities attorney and Salaman was the CEO at Skinny Nutritional Corp for 14 years prior to moving to GrowGeneration. That was a company that sold fruit-flavored zero calorie water, but that company eventually declared bankruptcy amidst a whole bunch of director resignations following some undisclosed lawsuits. Not really a great background there.

But now GrowGen is doing fine. They’ve slowly scaled up their store count to what is now 60 stores. They came public two years after founding the company and COVID helped spur growth for the company.

(Brett) Industry/Landscape/Competition:

  1. 1,800 hydroponics-focused stores in the United States

  2. Market size is apparently close to $10 billion now, supposed to double over this next decade

  3. Competitors: small chains (very fragmented market), Home Depot, and a little bit from Amazon and eBay. Very simple competitor base to understand

(Brad) Management and Ownership:

CEO Darren Lampert:

  1. Founding member of Lampert and Lampert — an institutional fund

  2. Former portfolio manager

  3. CEO of growgeneration

President Micahel Salaman — former chairman of skinny nutritional corp

CFO Jeff Lasher

  1. Former CFO of Crocs

  2. Most recently the CFO of Coravin a a CPG company

COO also a former SVP at Crocs and most recently a self-employed consultant and the COO of a company called popsockets

Salaman and Lampert both own roughly 2.5% with insiders owning 8% total of the company Blackrock nd Gothem own 10% together. 52% total held by institutions

(Brett) Valuation:

  1. Market cap of $1.9 billion, ticker GRWG

  2. P/S of 5.7

  3. P/GP of 20.8

  4. Expect share count to steadily rise, rev or GP per share a great metric for this company

(Ryan) Earnings:

  1. H1 2021 revenue was $216M, up 182% YoY

  2. Gross margin was 28.3% during the period. Up slightly from the year before.

  3. Net income was $12.9M

  4. OI was $17M

  5. And $25.5M in Adj. EBITDA

  6. But doing roughly 1% OCF margins due to them increasing their inventory.

  7. Q2 rev growth on a per share basis was still about 131% YoY

  8. 60% comp store sales growth in H1

  9. Guiding for $455 to $475M in FY revenue

(Brad) Balance sheet and liquidity:

  1. $67 million in cash and equivalents

  2. Also $57 million in marketable securities that it doesn’t include in cash and equivalents

  3. It has another $120 million in inventory and prepaid costs

  4. $108 million in goodwill vs. $62 million year over year. This is a rollup so that can sort of be expected

  5. ($32 million) in net accounts receivable

  6. $27 million in what it calls an operating lease liability but very little long-term debt on the balance sheet coming with an 8.125% interest rate

  7. $3 million in stock based compensation so far this year vs. $5.3 million year over year

  8. It has another 425,000 shares in warrants which is roughly 1% dilution

  9. Net income positive

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Anecdotal Evidence:

  1. (Ryan)

  2. (Brett)

  3. (Brad)

Future growth opportunities:

  1. (Ryan) Would it be better to buy storefronts in the states that haven’t legalized yet? Lower cost, can adapt the stores to include cannabis oriented products as the stores get legalized. Other than that, I’d like to see the growth of their private label products. Went from less than 1% of sales in H1 2020 to 7% in H1 2021.

  2. (Brett) Vertical farming. This equipment is important for the industry. We did the show on App Harvest, and while that looked like a very hard business to make money in, if people are going to spend money building those things, that is potential business for Grow Generation’s products.

  3. (Brad) Continued legalization across the United States. Gallup has public approval at nearly 70% vs. under 30% when we were born. Deep red states like Mississippi and S Dakota are easily passing reform

Highlights and lowlights:

  1. (Ryan) Highlights: Comp store revenue growth of 60% is awesome to see. It can obviously be profitable. Love the commercial relationships. That simply feels more sustainable than selling to the home. Lowlights: Is this a secular trend or did covid create a boost in farming? A little difficult for me to tell. And then the management woes from the hindenburg report.

  2. (Brett) Highlights: growing industry, niche enough to build a customer base outside of the Home Depot/Lowe’s crowd, management seem very competent. Lowlights: Market opportunity seems uncertain. I would like to see them have the ability to acquire these businesses through cash from operations.

  3. (Brad) Highlights: Really impressive blend of growth (albeit some inorganic with 60% SSS growth) for how early this company seems to be on the growth curve. Lowlight: Very little barrier to entry with no regulatory hurdles to climb here unlike when touching the actual plant

Bull Case:

  1. (Ryan) If this is the beginning of a secular trend and comp store sales can remain high, possibly even double digits, then this could make for a great investment. Especially if they can continue to grow that store count organically or even inorganically at the right price.

  2. (Brett) Something around 150 stores, sustained high single digit comps, 10% OCF margins, and share count not ballooning. That probably adds up acceptable stock performance if you assume an average market multiple

  3. (Brad) This becomes the go-to ancillary crop supporter for all of the major MSOs. I do not think supplying home grows is a scalable business, but that absolutely could be and it’s already finding success there.

Bear Case:

  1. (Ryan) Low cost of equity subsides and the roll-up strategy becomes less lucrative. That might be overly pessimistic given the current comp store growth, but Aterian is a great case study here. Roll-up strategies don’t sound so great when you start looking at an 8% cost of capital.

  2. (Brett) Financing growth proves harder than we might think. Does a retail roll-up deserve such a premium valuation?

  3. (Brad) Home Depot, Lowes, Menards, oh my!

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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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