As far as cannabis stocks go, GAIA Grow does not exactly fit in my wheelhouse. I am trying to focus entirely on THC-focused cannabis stocks as potential investments. The reason is multi-fold but can be summarized in two: Higher margins and higher demand. GAIA Grow is focused on both industrial hemp and CBD that would be derived from this hemp. Margins may be decent with CBD but, I see CBD being commoditized. Once a product gets commoditized, margins go out the door. Industrial hemp has other interesting aspects about it, but again, margins could be driven down to near zero.
And, then GAIA starts printing some decent numbers and these numbers catch my eye. In fact, in a recent video where I looked at the TOP 10 Most Profitable Cannabis Stocks, GAIA made the list. The list had some 135 other cannabis stocks. This is impressive.
$GAIA stock has mostly been stuck in the middle range, although it did move higher at the beginning of the month of March. The stock has since dropped back downwards.
The Hemp & CBD Markets
The Total Addressable Market for Hemp is thought to be about $15B by 2027. This, up from ~$5B in today’s market. Hemp had largely been illegal across the world up until recently. There really was no infrastructure to speak of prior to the States shifting gears on cannabis in the United States as well as Canada in 2018. Now, with Mexico shifting gears, all of North America will be capable of producing hemp.
Think about that for a moment: This is the beginning of the infrastructure for hemp. Hemp is a highly industrialized product and has many uses.
Here is a bullet list from GAIA’s own website describing the opportunities for the industrial hemp side of things:
- Hempcrete: lasts longer than stone-based concrete, gets stronger as it absorbs atmospheric carbon over time; fire retardant, waterproof, mould and mildew resistant.
- Leftover biomass after extractions can be used to create biofuel as an organic replacement to diesel.
- Grow cycle of 4-5 months: replace lumber and pulp/paper from trees with hemp products from chipboard for construction to toilet paper.
- The rapid-growing crop is an atmospheric carbon sink.
- Fibre can be used for textiles, plastics, insulation.
- Thin-cell organic batteries, conductors (Renewable replacement for graphene).
The trend towards greener lifestyles means that hemp definitely has a future. And, GAIA is one of the companies moving forward with that future.
At the same time, GAIA has recently added three dispensaries to its assets and revenues should start to show up in the earnings numbers. But, the retail stores may take a couple of quarters to get to the point where they are adding to the bottom line on a consistent basis.
I love consistency with numbers. If a company can produce consistent numbers then I can reasonably assume what will happen next based upon past performance. Given that, reasonably, I believe gross revenues will move higher for GAIA:
As you can see, there is a nice progression of increasing revenue. But, it is the lack of infrastructure that is most compelling to me. As the world progresses towards a more green lifestyle hemp will play in nicely with that. GAIA is at the forefront in this movement. As they gain more customers revenues will continue increasing. They will solidify these relationships. While GAIA is not the first to get into the hemp industry, based upon their revenue, they are certainly moving towards a solidified position.
The rate of growth is ~5% QoQ. This growth rate tells the story of how accepted hemp is whether it is the industrial use side or the medicinal side. This puts YoY growth at ~20%. Not many companies are gaining that much traction in their respective industry.
Gross margins are something that I would be concerned with as this kind of product may be prone to becoming commoditized. However, GAIA appears to have that entirely under control:
After having reviewed some 350 cannabis stocks, I can tell you this is some of the best gross margins I have seen. Normally, the best companies are between 60% – 65%. This is easily the very top performer from a gross profit standpoint.
However, margins that high have a tendency to draw in other players. This is a fundamental principle with economics. If a market participant is earning an outsized margin it will draw in other players in order to gain that potential. So, while GAIA is earning an outsized margin level, they also do not live in a bubble, nor are they immune to the laws of economics. My thinking is that eventually, this margin level will normalize. It may take some time before that occurs. But, it will occur. In the meantime, there is no reason to not enjoy the opportunity while it lasts.
One of the strategies that GAIA is utilizing is to do contract farming instead of acquiring farmland. This would normally be a benefit to the company. But, in this case, from a total operating cost standpoint, the costs are too high:
Whereas revenues and gross margins are a direct result of producing and selling products, operating costs are costs associated with running the business. As you work your way down the financial statements, you will find SG&A in the total operating costs. SG&A, of course, stands for Sales, General & Administrative. These are costs such as the rent for a processing facility, the CEO’s salary, and the costs incurred bringing the products to market.
In the case of GAIA, while they are doing incredible with gross margins on producing the products, operating costs associated with running the business are far too high. The chart is pointing downwards. That is not necessarily because they are improving this metric. This boils down to basic mathematics.
Here are the actual Total Operating Costs for GAIA:
As you can see, total operating costs are essentially flatline. But, from the chart above we can see that operating efficiencies are trending lower. Operating Efficiencies deal with total operating costs relative to total revenues. If revenues increase and GAIA maintain the same level then by extension operating efficiencies will improve. It is basic mathematics.
Given enough time and a consistent enough increase in revenues, while holding total operating costs at bay, operating efficiencies will eventually trend downward to very competitive levels.
After operating costs, and before interest, taxation, depreciation, and amortization, you have a profitability level. This level is called EBITDA. This is the metric that put GAIA in the top 10 of all cannabis stocks for this quarter. here is the most current EBITDA chart:
The trend upward is very promising. This shows me that with economies-of-scale, given a consistent rise in revenues, marginal profits will continue to add to the bottom line. This also shows that the business strategy is working. If GAIA were to continue with the strategy and build upon that they will ultimately succeed… all else equal.
But, it all essentially gets to the ultimate bottom line, that being Net Income:
Net income was positive the past two quarters and extension of EBITDA. At this point, a potential investor can see some key information as to what could happen to the stock price. Given earnings per share, via net income, an investor could project into the future what is possible to earn from ownership of this cannabis stock.
Keep in mind, we are looking at continuously increasing revenues to the tune of about 20 YoY. Four quareters from now I could reasonably foresee $22.5M being printed by the company. That is a 20% YoY increase from the latest quarter. Now, we can start to project net income and earnings per share.
Base Case Scenario
What if GAIA started to print $22.5M in just a couple of quarters? And, what if the continued to have their stellar gross margins of +85%? And, what if total operating costs were to remain where they were at approximately $15M? We can build upon this picture and see where things are going and can work down the financial statements. We can build up this model and project into the future.
Here is the base-case scenario for GAIA given its 12 month run rate:
- $100M Total Revenue;
- 85% Gross Margins;
- $60M Total Operating Costs;
- $8M Continuing Costs;
- $17.5M Net Profit;
- 232M shares outstanding; and,
- $.0735 EPS.
Given the current run rate, given the growth rate of the revenue, a future multiple that would be a bit too high would put the stock price at $7.35 at best. But, I’d more than likely only want to pay a lower future earnings multiple. At best, I think GAIA might be a $3.65 stock.
Total operating costs are simply too high to for the current revenue levels. In order to justify the current stock price, revenues would need to increase sizeably. And, total operating costs would need to remain the same. Even with the addition of dispensaries it is not necessarily going to be enough any time soon to get to the revenue levels necessary to justify the stock.
I will keep an eye on this stock. But, my expectation is that investors start to see the reality and sell off their shares. Simply, the stock is too high.
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