Hydrofarm Stock: Why I Still Think It Could More Than Double (NASDAQ:HYFM)

Almost 5 months ago, I shared a positive perspective on Hydrofarm (NASDAQ:HYFM) here, discussing how the cheap stock could increase significantly. It is down since then. As I disclosed in that article, the stock was 9.3% of my Beat the Global Cannabis Stock Index model portfolio at the time, and now, despite a substantial reduction I made on Friday, it is 16.4%. In this follow up, I look at the chart, discuss the Q3 and the updated outlook and update my target, which is much higher than the current price.

The Chart

While the stock is up a lot from the all-time low set near the end of Q2, it is down substantially from where it was a year ago:

Since my piece in early September, the stock has dropped 14.8%. The New Cannabis Ventures Global Cannabis Stock Index has declined just 4.1%, and the Ancillary Cannabis Index has fallen 8.6%, so Hydrofarm is lagging other cannabis stocks.

I liked the late-June action, as it looked like a high-volume sell-off that could prove to be the very low. I see support above that level at $0.85 and $0.75. The resistance that I see is at $1.25.

I think that a big challenge for the company and others is the potential delisting by the NASDAQ. I don’t fully understand why investors fear reverse-splits, but this would allow the company to get back above the $1 minimum. The company has not yet disclosed receipt of a notice from NASDAQ. When the company is cited, it will have at least six months to get the price above $1 for 10 straight days to avoid delisting.

I wrote about another ancillary company, GrowGeneration (GRWG), in early December. GrowGeneration is a customer of Hydrofarm. That stock has dropped 16% since then, while HYFM has rallied 22%. Since the HYFM article in September, GRWG has dropped 24% compared to the 11% decline in HYFM. I have my eyes on GRWG for the reasons I mentioned in that article about why I was avoiding GrowGeneration.

Taking a longer look, the stock is down about 98% since the first trade in late 2020:

2023 and the Outlook

In November, the company reported its Q3, and analysts were projecting revenue of $56 million with adjusted EBITDA of $1 million, according to Sentieo. Revenue was slightly worse than expected at $54.2 million, down 27% from a year earlier. Analysts currently project it will be $51 million in Q4, which would be 16% lower than a year earlier. While revenue was weak and a bit less than expected, the company reported adjusted EBITDA of $0.5 million compared to -$9.0 million a year earlier.

The company guided for full year net sales to be $230-240 million with adjusted EBITDA being “modestly positive.” The three analysts expect that revenue will decline 33% in 2023 to $231 million with adjusted EBITDA of $1 million. This improvement from 2022 is magnificent, as the company has a lot of debt still. The good news on the debt, which is mainly due in 2028, is that the cash balance has increased in 2023 as the company has reduced inventory. The company reported current assets of 3.8X current liabilities, with net debt of $90 million.

The outlooks for 2024 and 2025 changed after the Q3 report. Ahead of the report, analysts were projecting revenue of $239 million in 2024 and $257 million in 2025. Now, they expect lower revenue, with 2024 declining 3% to $224 million and 2025 rising 6% to $238 million, slightly below the prior forecast.

Adjusted EBITDA projections have decreased too. Analysts were expecting 2024 adjusted EBITDA of $12 million, and now they expect it to be $10 million. For 2025, the outlook is for it to increase to $15 million down from their $16 million forecast ahead of the Q3 report.

The fundamentals have been quite challenging, but the company has done a good job, in my view, of reducing expenses despite the sharply lower revenue. The operating loss in the first three quarters of 2023 was $38.3 million. The operating loss in 2022’s first three quarters, excluding an impairment charge, was $62.6 million. In Q3, the improvement continued as the company’s operating loss dropped 20% despite a 27% decline in revenue. Why? Operating expenses fell 25%.

Companies with high debt, like Hydrofarm, need cash flow from operations to help them either pay down the debt or to be in a position to refinance it. Again, this debt is mainly due in 2028, so it’s not a near-term issue. Through Q3, Hydrofarm generated $8.6 million from its operations, with $7.7 million in Q3. Capital expenditures have been $4.1 million year-to-date.

Big Upside Ahead Potentially

In the piece in September, I shared a one-year target of $3.59 based on hitting an enterprise value of 18X projected adjusted EBITDA for 2025. In a piece that I shared with subscribers to my investor service just a week ago, I refined that target to just 12X, but this is $2.66 at year-end, which would represent a rally of 165%. I think 12X is kind of low.

Ahead of the Q3 report in November, I had shared a target of $2.32 for year-end 2024 based on an enterprise value of 15X projected adjusted EBITDA for 2025. So, why is my target higher now despite my lower multiple? A slightly lower adjusted EBITDA but less net debt.

My target works out to 5.8X tangible book value reported in Q3, so things will have to be getting better enough so that investors are willing to focus on the earnings power. The stock currently trades at 2X, which is better than almost every MSO. Many of the MSOs have negative tangible book value.

Hydrofarm has just three analysts and seems very out of favor with investors. I like that the current estimates aren’t forecasting a lot of growth, as if 280E goes away they will likely rise a lot. The projected adjusted EBITDA margin for 2025 is 6.4%, which is well below the peak of 9.8% set in 2021 and about the same as in 2020.

Conclusion

I continue to be positive on Hydrofarm, but I was positive at a higher price previously! I own a very large position in my model portfolio, and I have also shared this as one of my three Top Picks (along with another ancillary and an LP). As much as I like it, it’s not my largest position in my model portfolio as of 1/26, as it is the third-largest.

I have explained that I see it as very cheap with a nice chart. Investors are quite excited about 280E potentially going away, as some of the MSOs have taken out their peaks from early September. My view is that if 280E goes away from cannabis being rescheduled by the DEA (from Schedule 1 to Schedule 3), it will help the ancillaries that serve cannabis producers, which will have better cash flow after the elimination of that taxation.

As I said above, it faces potential delisting and could need to reverse-split to keep its NASDAQ listing. This could turn off investors and yield a better entry in the future. The debt remains quite large, and this could lead to problems ahead with the stock if the cannabis sector doesn’t start improving.

So, I see Hydrofarm as offering a potential to more than double in price in 2024, but it could go down. I see the stock as having better prospects than the MSOs, especially if 280E remains in place. As a reminder, HYFM is not subject to that tax and is listed, unlike the MSOs, on the NASDAQ. Cheap and out of favor!

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.