If you're worrying marijuana stock prices are too high, but you don't want to miss out on the marijuana opportunity altogether, you might want to consider buying Scotts Miracle-Gro (SMG -0.09%). Why? Because Scotts Miracle-Gro owns Hawthorne, and Hawthorne is one of the marijuana industry's biggest suppliers. Last year, demand for Hawthorne's products slipped, but that drop-off could be over, making Scotts Miracle-Gro a back-door marijuana play worth buying in 2019.
The business
Most of Scott's Miracle-Gro's revenue comes from selling products such as Miracle-Gro and Roundup. But a wave of acquisitions means an increasingly larger share of revenue is coming from its Hawthorne segment.
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In fiscal 2018, Hawthorne only contributed $345 million to Scotts Miracle-Gro's $2.1 billion in revenue, but Hawthorne's revenue was up 20% from the prior year. This year, Hawthorne's sales could be much higher as sluggish demand in mature marijuana markets, including Colorado, ends and demand accelerates in new legal marijuana markets.
Last year, demand for hydroponics, lighting, and other products sold by Hawthorne fell because marijuana wholesale prices tumbled due to oversupply caused by previous hefty investments in marijuana grow capacity. The risk of overcapacity in mature markets remains, but during Scotts Miracle-Gro's recent quarterly earnings conference call, management struck an optimistic tone.
CEO Jim Hagedorn said the company "began to see a return to growth in the U.S. hydroponics business in the second half of the first quarter." He went on to say:
So, we've reported a positive comp in two of the last three months. On a year-to-date basis through January, we're back to flat on an apples-to-apples basis in the U.S. hydroponics business. More importantly, we're getting good feedback that our customers have also begun to see a recovery. If our run rate exiting January holds, we would expect to see positive top line for Q2.
Hawthorne contributed $141 million of Scotts Miracle-Gro's $298 million in companywide sales during the most recent quarter. However, most of Hawthorne's 84% year-over-year revenue increase was because of acquisitions. Excluding deals, Hawthorne's sales fell about 10% year over year in fiscal Q1 2019. That's not good news until you realize the decline is much smaller than in the previous two quarters. In fiscal Q4 2018, Hawthorne's comparable sales fell about 30%, and in fiscal Q3 2018, they fell by nearly 40%.
Check out the latest Scotts Miracle-Gro earnings call transcript.
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What's next
Momentum to legalize marijuana in more states is building. About 66% of Americans favor full legalization, according to Gallup, and an even larger percentage favors legalizing medical marijuana. So far, 33 states have passed pro-pot laws, including 10 states that have OKed recreational use, and more states are likely to follow suit. Industry watchers think recreational marijuana laws could pass in key states, including New York, New Jersey, and Illinois, in the next year or two. If so, it would open legal marijuana up to another 42 million Americans.
A potential spike in demand associated with widespread legalization would be great news, because Scotts Miracle-Gro's other markets are mature and growing slowly. Hawthorne gives the company its best shot at significant sales growth, but the slowdown last year proves this isn't a risk-free business. Investors could see a rebound in demand this year. However, there's no guarantee that will happen, or if it does, that Hawthorne's sales will continue climbing in the future.
Nevertheless, the opportunity is big. Legal marijuana sales in the U.S. were less than $9 billion in 2018, according to GreenWave Advisors, and that's only a small slice of what's estimated to be a $50 billion market. If more states pass pro-pot laws, then Hawthorne should benefit, and that could reward Scotts Miracle-Gro investors. Especially since the company's stock is a bargain, relatively speaking. Unlike other marijuana stocks, its shares are trading at just 17 times next year's earnings estimate, making it one of the cheapest marijuana stocks on the planet.
