When share prices fall sharply, the initial reaction of many investors is to panic and sell otherwise solid investments. If you own volatile stocks like Canopy Growth and Aurora Cannabis, it can feel like you're holding a grenade. Sometimes, it's better to dump your holdings before the situation gets worse, especially in a bear market. But there are some stocks, let's call them pillars, that should be left untouched when the market tumbles.
I believe one of those pillars is Scotts Miracle-Gro (SMG -1.25%). With a robust business that is growing at an impressive rate and lots of potential remaining, this is one of few cannabis investments that you can buy and simply forget about. The stock is a pick-and-shovel play; Scotts provides licensed producers with the tools and equipment they need rather than growing pot itself, making it a less risky investment overall.
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Why it's a solid long-term investment
Scotts gives investors a way to safely gain exposure to the fast-growing marijuana industry. Its traditional gardening business (which is its U.S. Consumer segment) makes up the bulk of its revenue, but Hawthorne, its subsidiary which sells hydroponics systems, is providing the company with an excellent source of growth. In fiscal year 2020, Hawthorne accounted for 39.5% of total net sales. A hydroponics system uses pipes and pumps to help people grow plants (like cannabis) without soil. It takes up less space and doesn't require the vast resources that would otherwise be needed for conventional farming. And as there are more people and licensed producers growing marijuana, Scotts' top line will only get stronger in the years to come.
The company released its first-quarter earnings on Feb. 3, and its net sales of $748.6 million for the period ending Jan. 2 were more than double last year's tally of $365.8 million. What's impressive is that both of Scotts' segments are growing at strong rates. Its U.S. Consumer business generated revenue growth of 147%, while Hawthorne's sales rose a more modest 71% year over year. With net income of $25.2 million, this was also the first time that the company has posted a profit in the first quarter. Its business is seasonal and usually does better in the warmer months.
Scotts also raised its outlook for fiscal 2021 and now projects that its sales will grow between 1% and 6% for the year, up from an earlier range of 0% and 5%. It expects Hawthorne to lead the way, with its top line rising by as much as 30%. Previously, it was anticipating up to 20% growth. Its U.S. Consumer segment remains unchanged, however, with full-year growth this year likely to come in between 0% and minus 5%.
Over the long term, there are still considerable growth opportunities available for Scotts. After Arizona, Montana, New Jersey, and South Dakota passed measures to legalize recreational marijuana in November 2020, pot is now legal for recreational use in 15 states plus D.C. And there are likely more to come. New York and Virginia are among the states taking a serious look at recreational legalization this year.
It likely won't be until marijuana is legal at the federal level and when all states permit it that Scotts will come close to reaching its revenue peak, and that's why it's a safe bet to continue growing for many years. Without Hawthorne, the business may have been sluggish (although it has gotten a boost amid the pandemic as people get into gardening), but the cannabis industry has given it another gear, which is why this stock is likely to generate great returns for a long time.
The stock is fairly priced and is worth hanging on to in a crash
Over the past 12 months, Scotts' share price has increased by 93%, outperforming the S&P 500, which is up 16% during that period. With a price-to-earnings (P/E) ratio of 27, however, it's still not terribly expensive, and its multiple is in line with the average stock on the SPDR S&P 500 ETF Trust.
Even if its share price were to fall in a market crash, that would simply create an opportunity to buy more shares of the company at a reduced price -- it wouldn't be a reason to sell. During the last market crash, in March 2020, shares of Scotts fell below $80 but would be trading at more than $120 just a month later, back to where they were before the sell-off began.
And with the terrific growth that Scotts is expecting, investors can feel comfortable paying a bit of a premium for the stock. Finding a profitable, cannabis-related business to invest in isn't easy, and Scotts Miracle-Gro is a great option for risk-averse but curious cannabis investors.
