Introduction
One of the first articles I wrote was about the budding cannabis market in the United States. The thesis of the original article was that Turning Point Brands (TPB) would see growth within the Zig-Zag brand, which I consider to be a marijuana adjacent product. The article explored the growth trajectory of the cannabis market as well as the financials of the company. In this article, I am following up to see how Turning Point Brands has performed. Turning Point Brands operates in three segments, Smoking, Smokeless, and NewGen. The Smoking segment hasn’t seen volumes increase as I expected and the Smokeless & NewGen segments have large headwinds to overcome. Therefore, I am not interested in this company at all, especially at 5.16x book value.
Cannabis Market Growth
Source: DISA
When I wrote the first article back in 2018, a total of 29 states had some sort of marijuana legalization or decriminalization with 8 states legalizing the substance. Now in 2020, only 8 states have laws that deem marijuana as fully illegal while 11 states have legalized it. On top of this, 2020 will see 11 more states allowing a vote to legalize cannabis. The long-term trend is very clear – marijuana is slowly becoming legalized in different forms across the country. Also to note is that a few months after writing my initial article in 2018, the entire country of Canada legalized cannabis.
Source: Marijuana Business Daily
With more states every year leaning more toward legalization of marijuana, the market growth for the products has been projected to be great. According to the above graph, the current market for retail cannabis is around $19 billion and will grow by over $10 billion in 4 years. No wonder why pot stocks have been hot for the past few years!
Cannabis Adjacent Brands
Source: CSP Management Handbook 2020
So, how does Turning Point Brands factor into this cannabis craze? Well, Turning Point Brands is really a tobacco products company. The company sells products such as chewing tobacco and tobacco alternatives such as vape products. But Turning Point Brands has a very popular tobacco brand that is a marijuana adjacent product in Zig-Zag. As can be seen, Zig-Zag is one of the most popular cigarette rolling papers and also has a 75% share of the cigar wrap market. The Zig-Zag brand is also synonymous with marijuana “joints” while cigar wraps are traditionally used for marijuana “blunts.” In my original article, my thoughts were that the Smoking segment at Turning Point Brands would see growth in sales powered by the Zig-Zag brand due to the expanding marijuana market.
Financials Since I Last Looked
Income Statements
Since I last looked at the company’s financial statements, overall revenue has seen good growth. In 2017, Turning Point Brands posted revenues of $285.78 million and in 2019, posted $361.99 million, a GAGR of 8.2%. But what was the major source for this growth? Well, it was not the Smoking segment; in fact, Smokeless and NewGen segments powered this growth in sales. Smokeless saw revenue grow from $84.56 million to $99.89 million (a clip of 5.71% per year) and Newton saw revenue grow from $91.26 million to $153.36 million (a clip of 18.89% per year). This is compared to Smoking, which went from $109.96 million in 2017 to $11.51 million in 2018 then to $108.73 million in 2019. For the Smoking segment, volume in 2019 was down 4.9%, volume in 2018 was down 0.7%, and declined 3.7% in 2017. As can be seen, the cannabis industry has not had a large impact on the sales of cigarette rolling papers.
On top of the lack of any uptrend in volume sales of Smoking products, the company hasn’t even been seeing bottom line growth from the other segments. In 2017, operating profit and net income were $49.68 million and $19.65 million. In 2018, these numbers did grow to $48.48 million and $25.29 billion but have dropped to just $26.86 million and $13.77 million in 2019. This is due to the fact that the Smokeless segment (~52%) and NewGen segment (~16%) have lower gross margins than the Smoking segment (~55%).
The NewGen segment had a decrease in gross margin from ~30% due to restructuring charges to reduce staff by 10% and “right-size” infrastructure. To add to all these negatives SG&A cost as a percent of revenue have increased four percentage points since 2017. Overall, the trend of cannabis legalization has not added anything to the Smoking segment as can be seen by decreasing volumes. Although Smokeless and NewGen saw good volume growth, the overall trends in this industry have been downward.
Balance Sheet
As of the most recent quarter, the current ratio and quick ratio for Turning Point Brands was 3.11x and 1.66x. This is rather high liquidity and there is no doubt the company can meet any short-term obligations. The debt to equity is at 3.18x. Turning Point Brands is also not very highly leveraged. Overall, the balance sheet is in very good shape.
Risks
Source: American Lung Association
While the legalization and growth of the marijuana market really haven’t done anything for Turning Point Brands, there are other risks to this company. The first is the obvious factor that tobacco sales have decreased over the long term for years. The graphic above shows just how the trend affects Turning Point Brands as all age groups saw declines from 2002 to 2018.
Source: American Lung Association
While the past years have been great for vaping sales and have boosted the NewGen segment revenues for Turning Point Brands, this trend may have slowed down drastically. As can be seen above, the majority of growth in this space is from younger demographics. What can also be seen is that the trend for adults has been moving downward. Due to high rates of underage usage of e-cigarettes and vaping mechanism, more scrutiny has been placed on regulation for these devices. This has and will surely cause a much lower growth rate within the NewGen segment in the future.
Valuation
As of writing, the current stock price of Turning Point Brands is around $29. This means it is trading at a P/E of 13.24x using the TTM EPS of $2.19. The company is also trading at a P/BV of 5.16x, as book value per share is $5.62.
Conclusion
In my article from 2018, I thought that Turning Point Brands had a good catalyst for sales growth within the Zig-Zag brand from the expanding cannabis market. Well, I was very wrong. More states in the U.S. have allowed marijuana either recreationally or medically and all of Canada has legalized the plant. As the market has expanded further, volumes within the Smoking segment have only decreased. Turning Point Brands has therefore seen a decline in margins as the other segments power growth. The company does have a great balance sheet but overall, there lacks a real investment catalyst to get behind. Tobacco use and e-cig/vaping are seeing strong headwinds and I am not interested in the company at 5.16x book value.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
