Why Is GrowGeneration Stock Dropping?

Hydroponics equipment supplier GrowGeneration (NASDAQ:GRWG) is one of several cannabis-related stocks that has taken large losses in recent months.

 

From a 52-week high of $57.10, the stock has declined to trade at just over $9. Here’s are some of the factors driving the precipitous loss of value in GrowGeneration stock and what you need to know about whether the stock could be a buy at its current price.

 

The first and likely most important cause of GrowGeneration’s poor performance over the last year is the company’s anemic growth rate.

 

For 2022, the company projects a maximum revenue of $445 million. Assuming it reaches this target, GrowGeneration would grow by only 5 percent year-over-year, a rate that understandably concerns investors.

 

Married to this slow growth is another problem for the company in the form of low margins. GrowGeneration typically maintains a profit margin under 7 percent, which is extremely lackluster. At this margin rate, significant profitability will be very difficult for GrowGeneration to achieve.

 

Together, these metrics make GrowGeneration a risky proposition. The company not only has limited growth prospects, but it also has difficulty capitalizing on what growth it can achieve. Without substantial increases in one or both of these metrics, it’s difficult to imagine the stock making serious moves back toward the $50 price mark.

One of the most pressing challenges for GrowGeneration at the start of 2022 was a reduction in its full-year guidance for 2021 with respect to same-store sales.

 

The company saw a reduction of these sales by 12.3 percent in Q4. This both showed that the company’s sales were weakening and called into question its ability to accurately predict future sales growth. While this isn’t unheard of in the stock market, such a substantial miss spooked investors, leading to rapid selloffs.

As noted in GrowGeneration’s Q4 earnings call, the company has also struggled to deal with headwinds caused by an oversupply of cannabis in the United States. An extremely productive outdoor growing season in Western states glutted the US market, lowering prices and reducing the demand for indoor growing equipment.

 

This indirectly put pressure on GrowGeneration, which now expects the lower demand for its equipment to carry through at least part of 2022. With lower prices, fewer growing operations will be opening and expanding.

 

This reduces demand for GrowGeneration’s hydroponic equipment and adds further headwinds to its sales growth. Large outdoor crops could also be a problem for the company in the long run, as producers may have less incentive to invest in hydroponic equipment going forward.

 

Another issue addressed in the recent earnings call was the slow progress of cannabis legalization in the United States.

 

While many states have legalized cannabis for either medical or recreational use, the federal government has not made significant moves toward repealing laws against cannabis use at the national level. New states are gradually legalizing, but delays in formalizing rules have left potential producers in these states unable to begin growing cannabis.

 

This state of affairs is a problem not only for GrowGenerations but also for the cannabis industry as a whole. Cannabis stock prices have taken a beating over the last several months as legalization efforts at the federal level failed to materialize. In this sense, GrowGeneration is suffering from broader trends that are also affecting the rest of its industry.

 

Obviously, the outlook for GrowGenerations seems bleak on the surface. The stock has already taken heavy losses, and the prospects for a recovery toward previous highs this year are slim at best. With that said, there are still some arguments in favor of the company at its current pricing.

 

To begin with, let’s examine analyst price targets for GrowGeneration. At present, the median target price is $12, up by more than 30 percent over the current trading price of $9.19.

 

Significantly, the most bearish forecast places the stock at $8 over the next 12 months. This suggests that GrowGeneration may have already lost as much value as it is going to. With up to 30 percent returns to potentially be had, GrowGenerations may be worth a second look.

Another fact that works in the company’s favor is the overall growth rate of the cannabis industry as a whole. By 2028, the North American market for legal cannabis is expected to reach $38.2 billion. This sets the market to grow at a compounded annual rate of 16.6 percent.

 

This rapid growth could bolster GrowGeneration in coming years, even though its current rate of growth is quite slow. By that time, states that have legalized will have solidified their rules on growing and selling, allowing producers to begin investing in growing facilities. Federal legalization may follow, though this remains unclear.

 

The company is also investing in equipment to support vertical farming, potentially the next frontier within the cannabis industry. Vertical farming allows crops to be grown in very limited spaces at high rates of efficiency. A move toward this type of farming will also drive additional demand for hydroponic equipment, adding to the company’s revenues from its core business line.

 

Finally, GrowGeneration’s pricing isn’t out of line at the moment. The company’s price-to-book and price-to-sales ratios are both reasonable for the industry at 1.55 and 1.39, respectively.

 

The price-to-earnings ratio of 268.33 is concerning, but this ratio could rapidly be reduced by future earnings growth if the company begins to find its footing.

 

Although it probably won’t slip into deeply undervalued territory, GrowGeneration is priced more or less fairly at the moment.

Examining these factors together, a slightly different picture emerges. GrowGeneration has lost much of its value for good reasons. Slow growth, low margins and generally unfavorable market conditions have all eaten away at share prices.

 

This may give investors who are willing to hold for the long run a chance to buy at favorable prices. GrowGeneration seems to be fairly valued at the moment, and the projected upside this year offsets some of the risks that come with buying the stock.

 

Overall, GrowGeneration could be a decent buy if you’re bullish on cannabis long-term and willing to be patient. It will likely be a while before the stock begins trending back toward its previous highs.

 

In the long run, though, GrowGeneration could be a success story as revenues from legal cannabis in North America rise.

 

Further legalization and investment in new production should bolster the stock. It should be noted, though, that GrowGeneration is still a relatively high-risk investment and may not be suitable for more conservative investors.

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