Mindset Goes Rogue

Despite the Most Competitive Markets, Grown Rogue is Thriving

Warning: The following column is about a microcap company. Microcaps by definition can be illiquid and experience wild gyrations. It is important to do your own due diligence, rely on your own research and understand that microcaps can be very volatile. Please proceed reading using your highest levels of caution. That being said…

Oregon is one of the toughest cannabis markets. How do you deal with seemingly unlimited competition, plunging flower prices, an entrenched legacy market and a sophisticated, discerning consumer? In Oregon, if flower isn’t great quality, priced at a low price, it doesn’t sell.

Yet amidst these tough conditions, one company is thriving while also generating the most elusive thing in cannabis: Free Cash Flow. Let me reiterate that a cannabis operator in Oregon is generating free cash flow in a state where the average selling prices have been $700-$800 a pound for indoor flower and $250-$300 a pound for outdoor flower.

The company is Grown Rogue (Canada: GRIN, OTC: GRUSF), one of Oregon’s leading brands and the latest addition to the Mindset portfolio. And one may be tempted to ask: is Oregon a fluke? Surely Grown Rogue couldn’t duplicate that in another competitive state, right?

And yet the company has done just that in Michigan after entering two years ago. Remember, Michigan has seen cannabis prices plunge from $3500 to $1500-$1000 a pound, and a larger multi-state operator recently took a $300+ million write-down due to conditions in the state. In the meantime, Grown Rogue has risen to a top 5 flower market share position (according to Leaflink) and has reported positive free cash flow from its operations in the state.

I think that something special is going on. Grown Rogue’s focused strategy on craft cultivation and a relentless attention to costs and efficiency are separating the company from everyone else.

Grown Rogue is completely focused on producing high-quality cannabis. Lots of companies say this, but Grown Rogue is approaching this from a craft perspective. This means starting small and ensuring the best practices are used, the yields are right, and the best, trendiest genetics are grown and most importantly staying close to what customers want. It is only then that Grown Rogue expands.

But equally important to producing a great product is the cost to produce that quality of product. And here is where I believe the magic happens. They can produce high quality indoor cannabis for an all-in cost of below $560 a pound (opex +COGS). That means selling $700 a pound flower in Oregon is profitable and generates free cash flow. And Michigan pricing that is crashing towards $1000 a pound and hurting so many other cannabis companies is even more profitable for Grown Rogue. (Note Grown Rogue also grows outdoor cannabis as well, but its their capabilities in indoor that are the most eye-catching.)

Grown Rogue stands out for their relentless focus on cost and efficiency. The company has a low employee count per grow facility and a very lean management structure with a no-frills approach. CEO Obie Strickler sets an example by having in my opinion the worst CEO office I’ve ever seen. It is even generous to call it an office as it is a room off their main grow facility in Oregon and it has no doors.  Obie likes to joke that the success is from his “open door” policy!

Keeping costs low certainly doesn’t come at the expense of employee satisfaction. While visiting Grown Rogue in Oregon, I was struck by the smiles, passion, and general good feeling from every person I met and that includes everyone from trimmers, to grow technicians, their head of sales and cultivation director. This might well be their secret ingredient: motivated and passionate employees. This is a credit to Obie and the Grown Rogue management who consistently spoke about the importance of culture.

This frugality extends to capital expenditures as well. Grown Rogue has spent just $3.5 million of CapEx to build a top 5 flower producer in Michigan that generates free cash flow and should earn over $8 million in annual revenue in 2022 and nearly $12 million in revenue in 2023. They have also eschewed fancy conferences and outside investor relations firms to keep G&A expenses low as well.

This focus on costs, capital, and culture might have something to do with the high insider ownership. Obie Strickler owns 20% of the company and insiders in total own over 40%.

2023 Projections

I expect Grown Rogue to earn more than $7 million in EBITDA in 2023 on $22 million in sales, with conservative metrics assuming no price rebound and continued pricing weakness in Oregon and Michigan. I’m estimating a 32% EBITDA margin. An amazing stat if you consider this is what big multi-state operators report in limited license states where cannabis pricing is significantly higher and competition much lower.

I realize that $7 million may not sound like a lot. But what is more important is that Grown Rogue has figured out a formula that can be replicated and that formula can generate a lot more than $7 million.

What Happens When Grown Rogue Enters a Limited License Market?

After succeeding in the hyper-competitive markets of Oregon and Michigan, Grown Rogue is now looking east. So, what happens when a company with the ability to grow Cannabis at an all-in price of $560 enters a market with average selling prices ranging from $2000 to $4000? The Michigan experience tells us that the company will take market share, generate cash, and grow profitably at much better margins due to higher prices. It means that markets like Massachusetts, now described as unattractive by MSOs as they lose market share and margins, are a potential gold mine for Grown Rogue.

The financial opportunity could not be greater. I estimate Grown Rogue could earn at least $4 million in EBITDA from entering a new limited license state on limited capex like it did in Michigan. If Grown Rogue can enter just one additional state next year, then the company could be earning at least $11 million, meaning the stock trades at just two times. Compare $7 million to $11 million of EBITDA today to Grown Rogue’s market cap of only slightly more than $20 million.

But one additional market is not the company’s end objective. According to the CEO, the company’s goal is to enter at least ten states in the next five years. That’s $40 million of additional potential cash flow. Do the math and you start to see the enormous upside that can occur to this small company as it enters limited license markets with its unbeatable cost structure, winning quality and great prices. Grown Rogue doesn’t have to be the biggest company to provide truly outsized returns to investors.

Interstate Commerce Opportunity

Grown Rogue also operates a large outdoor farm in the Rogue Valley of Oregon, one of the country’s largest cannabis producing regions with near-perfect growing conditions. This means Grown Rogue is an interstate commerce play as well. If need be, the company has plenty of potential to rapidly expand its outdoor grow and produce up to 80,000 pounds annually and to sell its indoor flower at much higher prices elsewhere. Consider that in New Jersey, flower is retailing for upwards of $8000 a pound, more than ten times the current price Grown Rogue is seeing for its product that is simply much, much better in quality.

Operational Excellence is in Short Supply in Cannabis, Licenses Are Not

Grown Rogue is interesting not only because of its potential to enter limited licenses states, but as an operational partner or even an acquisition target. I can think of several larger companies that have great licenses but struggle operationally. There are some interesting pairings, where 1+1 could equal much more than 3.

Mindset Leads Convertible Debt Deal

Grown Rogue joins my stable of smaller, more agile cannabis companies showing success in their various strategies, but with focus on quality and cost that competitors struggle to compete with.

And this is why I’m investing in Grown Rogue. My firm’s investment comes in the form of a convertible debt deal. The investment pays a 9% yield, and I can convert my debt into equity at C$0.20 per share, a premium of over 40% to where the stock currently trades. The debt also comes with warrants that convert at C$0.25 per share as well. If I convert my debt and the warrants that come with my financing, my two investment funds will own over 5% of the company.

As a big investor and believer in Glass House (OTC: GLASF), I see this new investment as a wonderful pairing. Glass House is pursuing a different, bigger strategy, looking for size and scale from their state-of-the-art greenhouse with a cost structure that most can’t compete with, depending on near perfect weather and a state-of-the-art facility to grow the best sun grown cannabis possible.

Grown Rogue is my craft indoor producer that also has outdoor capabilities as well. It’s a hybrid play. Grown Rogue isn’t trying to be Budweiser, but your local craft brand that everyone loves. There is room for both strategies to work and win.

Grown Rogue may look small and insignificant, but my research tells me that what they are doing is special and can and should lead to outsized returns for investors. Investors who have been focused on limited licenses are missing out on the fact that operational excellence is what is in short supply in cannabis. The cannabis supply chain continues to be quite immature. There is a lack of consistent, high-quality cannabis grown at a great price for consumers. Grown Rogue has figured out the magic formula and now they are coming for those limited license states. And investors and competitors should pay attention.

Below is a great in-depth interview with the CEO: