Is Scotts Miracle-Gro (SMG 1.02%) a lost cause?
You might be tempted to think so, looking at its dismal stock performance so far this year. And a recent CNBC report about Scotts Miracle-Gro CEO Jim Hagedorn probably didn't give investors the warm fuzzies about where things are headed, as he let loose with a profanity-laden rant directed at the management team of Hawthorne Gardening, the company's cannabis-focused subsidiary.
But don't let all of this cloud your perspective about Scotts Miracle-Gro. Right now is a great time to buy this top marijuana stock. Here are four reasons I think that's the case after listening to the company's fiscal 2018 Q3 earnings conference call.
Image source: Getty Images.
1. Setting itself apart as a marijuana market leader
Let's first address Hagedorn's rant in Scotts Miracle-Gro's Q3 conference call. Yes, he did use quite a bit of profanity in responding to a question about why the company was backing away from the goal of $120 million in operating profit by 2020, a goal that Hawthorne announced in April with the acquisition of Sunlight Supply. And yes, Hagedorn did accuse Hawthorne's management team of being "gun-shy" in providing financial estimates.
However, I think it's important to look at Hagedorn's statements in context. He doesn't want to overcommit to results that can't be achieved. The initial $120 million was given based on market assumptions that proved to be inaccurate in recent months. Hagedorn started off the call by saying that he's "never been more proud" of his team than now, as the team has "maintained a focused and determined approach to their work despite all the noise around them."
Perhaps most importantly, Hagedorn said that Scotts is "distancing ourselves from our competitors and clearly establishing Hawthorne as the market leader" in the cannabis industry. I think he's right. With the acquisition of Sunlight, Hawthorne is the No. 1 supplier for marijuana growers. As the industry takes off, so will Scotts Miracle-Gro.
2. Sunnier days ahead for the California market
The main reason for Hawthorne's recent struggles -- and the walking back of that $120 million profit goal by 2020 -- is the weaker-than-expected California marijuana market. Hagedorn said bluntly that "if you ever want to see how politicians can screw something up," look at California.
But there's good news. Scotts Miracle-Gro is seeing things get better in California. Product shortages have spurred more growing, which means more sales for Hawthorne. The regulatory environment should also improve, with California starting to issue permanent cultivation licenses and counties getting their acts together. Hagedorn said there's "some light at the end of the tunnel" in California, which generated around half of Hawthorne's total revenue.
3. More states headed toward marijuana legalization
Hagedorn predicts that Connecticut, New Jersey, and New York will legalize recreational marijuana. He supported New Jersey Gov. Phil Murphy's 2017 campaign. Murphy wants to legalize recreational marijuana in the state, but legislative efforts to do so this year withered on the vine. I suspect, though, that Hagedorn's optimism that New Jersey will allow legal use of recreational marijuana in the not-too-distant future is warranted.
If New Jersey legalizes recreational pot, Hagedorn thinks that both Connecticut and New York will follow. Again, I think he's probably right. My view is that as states see their neighbors' tax revenues increase from legalizing recreational marijuana, they'll fall like dominoes with their own legalization efforts -- just like what happened with state lotteries.
Here's the kicker for Scotts Miracle-Gro: The marijuana markets in Connecticut, New Jersey, and New York would together be bigger than California's market. And these states would be more likely to have more indoor growing facilities, which would translate to higher lighting system sales for Hawthorne. With more states legalizing medical marijuana, Scotts' prospects are even greater.
4. Solid prospects for the other 92% of the business, too
Although Scotts Miracle-Gro is a top marijuana stock thanks to its Hawthorne subsidiary, we do need to remember that 92% of the company's revenue stems from its consumer lawn and garden products. Scotts' biggest business got off to a slow start in 2018 because of an unusually long winter, but sales have kicked into high gear this summer.
There are several reasons to be bullish about the prospects for Scotts' lawn and garden business. The company continues to invest heavily in research and development. This effort pays off with new products that drive revenue growth, like Miracle-Gro Performance Organics fertilizer that will launch in 2019. Scotts also intends to raise prices in 2019, which will boost revenue.
In addition, if scientists' projections of generally warmer weather in the coming years prove to be correct, Scotts Miracle-Gro could have more longer summers than longer winters down the road. That would probably translate to higher sales for its lawn and garden products over the long run.
Trends on its side
Hagedorn stated in Scotts' conference call that "societal and legislature trends are on our side" for its Hawthorne business. He added that while there will probably be continued volatility, "the long-term opportunities in this space remain significant for those willing and capable of taking a long-term approach." That perspective seems on target to me.
Scotts Miracle-Gro has endured a challenging year in 2018. But the future opportunities for the company in supplying the cannabis industry and in marketing consumer lawn and garden products appear to be very good. With Scotts' share price close to its two-year low and the prospects of better days ahead, I think there's no time like the present to buy this stock.
