GRWG - A Bear Case
Weighing both impending federal policy changes and strong fundamentals, GrowGeneration (GRWG) looks like a promising cannabis stock to buy & hold. With an incoming Biden administration, federal cannabis decriminalization will happen, paving the way to allow banking institutions to service the industry. While GRWG doesn’t operate in the agricultural or distribution segments of the cannabis plant (most impacted from federal banking regulations), it will benefit when legal barriers are removed. As a distributor sales channel of hydroponic equipment and consumable products used to grow cannabis, GRWG stands to benefit from a large shift in federal policy and has already benefited from state policies legalizing both medical and recreational cannabis use.
With everything good happening to the cannabis industry, I lay out a bear case for GRWG and why it should not be bought as an investment.
Executive leadership is the primary reason GRWG is uninvestable. Hindenburg Research, an activist short seller, has published findings detailing the company’s leadership indiscretions going back decades...and it’s ugly. Strong executive leadership teams should display the industry’s best business minds, squeaky clean personal backgrounds, and a track record of wins in previous business dealings. Hindenburg brings to light GRWG’s leadership’s ties to prior penny stock pump & dump schemes, various SEC entanglements, personal relationships with known persons associated with criminal syndicates, various failed business ventures, financial accounting gaps … the list goes on and on and on.
Before moving forward, let’s call a spade a spade: the purpose of Hindenburg’s research is to convince investors to sell GRWG. Hindenburg has a publicly stated short position in GRWG and has an agenda to drive the stock price down. They directly benefit from painting this company or its leadership in a negative light. One should take the research with a grain of salt when weighing its importance in a decision to buy or sell the stock.
While Hindenburg Research’s findings were enough for me to sell my position, I found this wasn’t the only red flag.
Following Bill O’Neil’s CANSLIM methodology when analyzing stocks, one of the metrics is Cash Flow per Share vs EPS. Cash Flow per Share for a great stock should be +20% greater than EPS in the same quarter. Starting with FY2019, they posted four quarters of Cash Flow per share equaling EPS; a 0% increase in Cash Flow per Share vs EPS. FY2020 was shaping up with Q1 & Q3 having both +16.6% Cash Flow per Share increases vs EPS. 2020Q2 posted a -83.3% decrease of Cash Flow per Share vs EPS. I would normally give this one miss a pass due to their strong sales growth over the past 8 quarters, increasing more than 125% (QoQ vs PY Q) and strong EPS growth over the past 6 of 7 quarters (QoQ vs PY Q) because, we’re measuring the total sum and not measuring just one metric. But, I also wanted to deep dive that 1 quarter (1 of 7) where EPS contracted. At first glance, the -700% decrease in EPS vs PY Q occurred in 2020Q1 and my first inclination was, it must have been the impact on their business due to COVID-19. I dug deeper into their 10Q and read:
The net loss for the quarter ended March 31, 2020 was primarily due to the increase in share-based compensation from approximately $80,000 in 2019 to $4.1 million for the quarter ended March 31, 2020.
…
If the new share-based awards effective January 1, 2020 were level vesting over two years and not front loaded vesting then the first quarter of 2020 expense would have been reduced by approximately $2.43 million and the first quarter of 2020 net loss would have been net income of approximately $332,000. Future periods share-based compensation would increase as a result of spreading the $2.35 million over two years, had the awards been level vested.
TRANSLATE: Management decided to bump up compensation all at once vs spreading it out over the next two years and by doing that, hurt earnings for the quarter.
What kind of forward thinking, long-term oriented management team would do that? With everything good happening in this industry, management couldn’t have taken compensation increases over the next two years in order to preserve positive momentum the in their fundamentals? I suppose spreading it out over the future 8 quarters could put stress on future earnings, but then, maybe this isn’t the time to increase compensation if it can’t be successfully managed. I get it, an increase in executive compensation after growing at an insane clip for the past 5 quarters feels earned, but great business leaders are supposed to be the harbingers of good faith with the intention of growing the stock price for all shareholders. There was no better way to increase compensation? In my opinion, this decision represents terrible judgment at worst and poor planning at best. This was red flag strike number 3.
1) Hindenburg Research
2) Cash Flow per Share vs EPS not hitting the mark
3) Management throwing a wrench into earnings, when they had the option to otherwise not, in order to benefit themselves.
For these reasons, GRWG is entirely uninvestable.
In all honesty, if we play devil’s advocate and assume everything in Hindenburg’s Research is true, that is more than enough reason to not own this stock. I encourage everyone to read it in order to familiarize themselves with what a worst case scenario looks like. The overall fundamentals in this stock look pretty damn good and even Hindenburg states, “... bulls would likely argue that the business is positioned well to consolidate its industry niche and grow into its numbers with the backing of strong management.” Unfortunately, that does not seem to be the case.
When heeding activist research, be skeptical when talking heads make claims like the those laid out in Hindenburg’s piece. They have a short position; they want the stock to go down. Gauge your own risk profile and trading style. Do your own homework.
Happy Stock Picking!
With everything good happening to the cannabis industry, I lay out a bear case for GRWG and why it should not be bought as an investment.
Executive leadership is the primary reason GRWG is uninvestable. Hindenburg Research, an activist short seller, has published findings detailing the company’s leadership indiscretions going back decades...and it’s ugly. Strong executive leadership teams should display the industry’s best business minds, squeaky clean personal backgrounds, and a track record of wins in previous business dealings. Hindenburg brings to light GRWG’s leadership’s ties to prior penny stock pump & dump schemes, various SEC entanglements, personal relationships with known persons associated with criminal syndicates, various failed business ventures, financial accounting gaps … the list goes on and on and on.
Before moving forward, let’s call a spade a spade: the purpose of Hindenburg’s research is to convince investors to sell GRWG. Hindenburg has a publicly stated short position in GRWG and has an agenda to drive the stock price down. They directly benefit from painting this company or its leadership in a negative light. One should take the research with a grain of salt when weighing its importance in a decision to buy or sell the stock.
While Hindenburg Research’s findings were enough for me to sell my position, I found this wasn’t the only red flag.
Following Bill O’Neil’s CANSLIM methodology when analyzing stocks, one of the metrics is Cash Flow per Share vs EPS. Cash Flow per Share for a great stock should be +20% greater than EPS in the same quarter. Starting with FY2019, they posted four quarters of Cash Flow per share equaling EPS; a 0% increase in Cash Flow per Share vs EPS. FY2020 was shaping up with Q1 & Q3 having both +16.6% Cash Flow per Share increases vs EPS. 2020Q2 posted a -83.3% decrease of Cash Flow per Share vs EPS. I would normally give this one miss a pass due to their strong sales growth over the past 8 quarters, increasing more than 125% (QoQ vs PY Q) and strong EPS growth over the past 6 of 7 quarters (QoQ vs PY Q) because, we’re measuring the total sum and not measuring just one metric. But, I also wanted to deep dive that 1 quarter (1 of 7) where EPS contracted. At first glance, the -700% decrease in EPS vs PY Q occurred in 2020Q1 and my first inclination was, it must have been the impact on their business due to COVID-19. I dug deeper into their 10Q and read:
The net loss for the quarter ended March 31, 2020 was primarily due to the increase in share-based compensation from approximately $80,000 in 2019 to $4.1 million for the quarter ended March 31, 2020.
…
If the new share-based awards effective January 1, 2020 were level vesting over two years and not front loaded vesting then the first quarter of 2020 expense would have been reduced by approximately $2.43 million and the first quarter of 2020 net loss would have been net income of approximately $332,000. Future periods share-based compensation would increase as a result of spreading the $2.35 million over two years, had the awards been level vested.
TRANSLATE: Management decided to bump up compensation all at once vs spreading it out over the next two years and by doing that, hurt earnings for the quarter.
What kind of forward thinking, long-term oriented management team would do that? With everything good happening in this industry, management couldn’t have taken compensation increases over the next two years in order to preserve positive momentum the in their fundamentals? I suppose spreading it out over the future 8 quarters could put stress on future earnings, but then, maybe this isn’t the time to increase compensation if it can’t be successfully managed. I get it, an increase in executive compensation after growing at an insane clip for the past 5 quarters feels earned, but great business leaders are supposed to be the harbingers of good faith with the intention of growing the stock price for all shareholders. There was no better way to increase compensation? In my opinion, this decision represents terrible judgment at worst and poor planning at best. This was red flag strike number 3.
1) Hindenburg Research
2) Cash Flow per Share vs EPS not hitting the mark
3) Management throwing a wrench into earnings, when they had the option to otherwise not, in order to benefit themselves.
For these reasons, GRWG is entirely uninvestable.
In all honesty, if we play devil’s advocate and assume everything in Hindenburg’s Research is true, that is more than enough reason to not own this stock. I encourage everyone to read it in order to familiarize themselves with what a worst case scenario looks like. The overall fundamentals in this stock look pretty damn good and even Hindenburg states, “... bulls would likely argue that the business is positioned well to consolidate its industry niche and grow into its numbers with the backing of strong management.” Unfortunately, that does not seem to be the case.
When heeding activist research, be skeptical when talking heads make claims like the those laid out in Hindenburg’s piece. They have a short position; they want the stock to go down. Gauge your own risk profile and trading style. Do your own homework.
Happy Stock Picking!
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