Cannabis investments have proven to be very risky over the past year. With Aurora Cannabis (ACB -2.40%) and Scotts Miracle-Gro (SMG -3.10%), investors have two very different ways they can gain exposure to the industry. Are you better off investing in a cannabis producer with global reach, or a hydroponics company that has more of an indirect interest in the industry? Let's find out.
Do Aurora's rewards outweigh its risks?
Aurora has a presence in more than two dozen countries across the world, and it's an appealing long-term investment if you expect cannabis legalization to continue its progress around the globe. The potential is significant: By 2025, Grand View Research projects that the legal marijuana market will grow to $66.3 billion, growing at a compounded annual growth rate of 23.9%. It's one of the reasons Aurora appeals to investors, because the company has ambitions that go beyond North America.
The problem is that in the near future, there are many headwinds that could impact its growth and overall profitability. From vaping concerns weighing on the cannabis 2.0 market to a relatively low number of retailers open in Canada some 15 months after the country legalized recreational marijuana, there are many challenges still ahead for the industry.
With Aurora already falling out of favor with many investors for a lack of profitability and disappointing sales numbers, there's little reason for much bullishness in the short term. If Aurora can weather the storm, it could have significant growth opportunities ahead. However, that could still be many years away, and the industry will likely look much different than it does today, leaving many questions about what Aurora's growth prospects may look like.
Is there enough growth with Scotts?
Scotts is definitely the safer cannabis play given that the company isn't a producer of marijuana and it doesn't have to worry about quality or which direction pot prices are going. Instead, the plant-growth specialist is effectively a supplier for the industry, and as long as more people are growing marijuana, there will be demand for its products.
The company's growth has been strong thus far, with sales in fiscal 2019 rising 18.5% from the prior year -- much of that coming from the Hawthorne growing company, which provides supplies for hydroponic gardening (growing plants without soil). Revenue for the Hawthorne segment actually rose 94% and the overall growth was weighed down by the company's U.S. consumer segment, which focuses on the lawn and garden business. That segment of the business grew at a much more modest rate of 8% from the prior year.
With such a strong performance in 2019 from Hawthorne, Scotts is expecting 2020's sales for that segment to be between just 12% and 15%. It's a modest expectation and one that could highlight the limited growth that Scotts may achieve in light of it not selling cannabis or being directly involved in the industry.
The company is already off to a strong start, as it recently reported first-quarter results that beat expectations. Sales were up 23% and Hawthorne's top line increased 41% year over year. Scotts' quarterly loss was also better than what analysts were expecting.
Which stock is the better buy?
Both stocks have a lot of potential to benefit from the cannabis industry's growth over the years. However, the advantage goes to Scotts. The company is profitable, it can benefit from the growth of the U.S. cannabis market (whereas Aurora can only sell hemp-derived cannabidiol products since pot remains illegal at the federal level in the U.S.), and it also trades at a more reasonable multiple. Selling at around 15 times earnings and just 2 times its sales, Scotts has a cheaper valuation than Aurora, which investors value at 10 times its top line, and which has no profit to even generate a price-to-earnings multiple.
And given how volatile the industry has been of late, with the Horizons Marijuana Life Sciences ETF losing more than 40% of its value in six months, now is a time that investors should be looking for safer investment options. While both stocks have great growth potential, Scotts is a more balanced and value-oriented investment, making it the better overall buy today.