It's been a dismal year for marijuana stocks tied to large scale cannabis producers, but ancillary businesses that serve the industry are having a banner year. A lack of profits hasn't stopped producers from outfitting their operations with products that ScottsMiracle-Gro (NYSE:SMG) has been eager to provide.
The first year of recreational sales in Canada wasn't nearly as thrilling as investors had hoped, and Organigram (NASDAQ:OGI) looks like the only big producer that avoided a growth-at-any-cost strategy. The cannabis producer's shares have lost 69% of their value since their peak in May, while ScottsMiracle-Gro is up about 65% in 2019.
Which one's set up to climb further in the years ahead? Read on to find out.
The case for ScottsMiracle-Gro
For the past several years, ScottsMiracle-Gro has been plowing lawn and garden revenue into a new line of products for indoor gardeners. Sales from the company's Hawthorne segment, which is geared toward the cannabis industry, have been more than a little disappointing until recently.
During the company's fiscal year that ended on Sept. 30, Hawthorne segment sales jumped 95% higher than in the previous year. In 2018, ScottsMiracle Gro acquired one of the nation's largest distributors of hydroponic products, Sunlight Supply. Adding this huge distribution channel pushed Hawthorne segment sales through the roof, and it could head higher.
It took a while, but Bayer (OTC:BAYRY) and ScottsMiracle-Gro have finally updated the Roundup marketing partnership Bayer inherited along with the rest of Monsanto. The German conglomerate recently agreed to buy four Roundup-brand product lines from Scotts for $112 million, and from now on, Scotts and Bayer will equally share future profits that could reach $15 million in fiscal 2019. In fiscal 2020, Scotts will also receive a larger share of profits derived from the consumer Roundup business, which should drive up its net commission received from Bayer by around $20 million annually.
Companywide, sales during fiscal 2019 increased 18% year over year thanks to contributions from Sunlight Supply, while sales, general, and administrative expenses rose just 11% over the same time frame.
Thanks to a better-than-expected performance, adjusted earnings in fiscal 2019 rose 20% to $4.47 per share. Unlike Organigram, ScottsMiracle-Gro shares profits with shareholders in the form of a dividend that offers a 2.3% yield at recent prices. Over the past year, Scotts used just 68% of free cash flow that operations generated to make dividend payments. That gives the company enough room to raise the payout at the same pace as its bottom line, which is being driven higher by indoor cannabis producers large and small.
The case for Organigram
In Canada, licensed producers and their disappointed shareholders are learning the hard way that raising lots of money is much easier than making any money in this low-margin business. Many of the largest businesses splurged to supply a recreational market that wasn't exactly there yet.
While Canopy Growth, Aurora Cannabis, and their peers have been posting gigantic losses, Organigram looks like a well-managed business positioned to profit. Despite experiencing the same problems as its peers, adjusted earnings before interest, taxes, depreciation, and amortization, (EBITDA) reached 25% of net revenue, which worked out to CA$19.9 million during its fiscal year that ended Aug. 31.
Organigram's still operating out of its first and only facility in Moncton, New Brunswick. There's nothing necessarily wrong with operating multiple facilities, but it's a lot harder to manage expenses from a distance.
Despite just one cultivation facility, Organigram can boast about a 10% share of Canada's adult-use cannabis market. The company expects much higher revenue and lower operating expenses as a percentage of that revenue in 2020.
The better buy
Over the past decade, ScottsMiracle-Gro has provided a total return slightly lower than the S&P 500. Although Scotts will probably outperform the benchmark index in the coming decade, it's already a $5.7 billion company, so huge gains probably aren't possible. We've seen early signs that Scotts has finally figured out how to market products to the cannabis industry. Unfortunately, a chronically underperforming lawn and garden segment could lead to another long stretch of mediocre gains.
Although Organigram might not be the most talked-about marijuana stock in 2020, it could be the best performer in its industry thanks to ultra-low costs of production. That makes it the better buy right now, but tread lightly and watch for signs the company can keep meeting production goals as more retail outlets come online.