'Pick and Shovel' Companies May Not Be Safer Than MSOs

• Before 2022, it was commonly believed that "Pick and Shovel" companies that are suppliers to the MSOs were safer places to invest in the cannabis universe.

2022 proved that wisdom is incorrect. An equal-weighted basket of the agriculture technology stocks in the graph declined by 80% in 2022, compared to a 73% decline in the MSOS ETF. 

Two companies, Agrify AGFY and Hydrofarm HYFM, experienced sharper declines of 99.6% and 94.5%, respectively. Even the group's best performer, Scotts Miracle Grow SMG, was down 69.8%, barely beating the MSOS ETF.

The color-coded segments of the bars in the graph add up to the total projected funding requirements (negative net cash flow) as a percentage of the market cap. Every company, except Scotts Miracle Grow, is expected to have negative EBITDA (green). Interest expense (blue), CAPEX (yellow), taxes (purple), and debt maturities (black) all increase projected negative net cash flow. The companies on the graph have funding requirements that range from 338% of the market cap for Agrify to 5% for UrbanGro (UGRO: Nasdaq). Note: cash taxes are negligible for the group, given their negative EBITDA and lack of 280e exposure.

The red line on the graph shows total liabilities to market cap. We have found that ratios over 3x generally indicate financial stress/distress. Leverage is a critical consideration for companies in this industry because equity issuance is highly dilutive at current prices and may not be possible for companies with negative 2023 consensus EBITDA estimates. Surprisingly, however, Agrify completed an $8.7M equity raise in December, pushing its stock lower by over 40%.

Companies like Agrify and Hydrofarm, which have significant negative cash flows and total liabilities / Market cap over 3x, are in danger. GrowGeneration GRWG, Scott Miracle-Gro, and Urban Gro UGRO have small negative net cash flows and easily manageable leverage and should be able to finance themselves readily.

There is no inherent safety in investing in "pick and shovel" companies. Investors need to be focused on cash flow analysis to spot potential portfolio problems early.

The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.

The Viridian Cannabis Deal Tracker provides the market intelligence that cannabis companies, investors, and acquirers utilize to make informed decisions regarding capital allocation and M&A strategy. The Deal Tracker is a proprietary information service that monitors capital raise and M&A activity in the legal cannabis, CBD, and psychedelics industries. Each week the Tracker aggregates and analyzes all closed deals and segments each according to key metrics:

• Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors - from Cultivation to Brands to Software)

• Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A) Status of the company announcing the transaction (Public vs. Private)

• Principals to the Transaction (Issuer/Investor/Lender/Acquirer) Key deal terms (Pricing and Valuation)

• Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)

• Deals by Location of Issuer/Buyer/Seller (To Track the Flow of Capital and M&A Deals by State and Country)

• Credit Ratings (Leverage and Liquidity Ratios)

Since its inception in 2015, the Viridian Cannabis Deal Tracker has tracked and analyzed more than 2,500 capital raises and 1,000 M&A transactions totaling over $50 billion in aggregate value.