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Better Know a Marijuana Stock: Scotts Miracle-Gro

Few industries pack the long-term growth potential that comes along with legal pot, which is a very big reason why marijuana stock investors have been flocking to the "green rush." We certainly don't have to look for too long to find robust growth estimates for legal pot.

Cannabis research firm ArcView is forecasting that North American legal sales will more than triple from $6.9 billion in 2016 to nearly $22 billion by 2021. Investment firm Cowen & Co. has taken things a bit further. It's calling for $50 billion in legal cannabis sales in the U.S. by 2026. This would essentially assume a national legalization of the drug, given that an estimated $46.4 billion in North American sales last year were conducted on the black market, per ArcView. The ability to steadily transition consumers from the black market to legal channels is what provides the marijuana industry and pot stocks with such a robust long-term growth opportunity.

Image source: Getty Images.

However, there are dozens of marijuana stocks to choose from, and emotions surrounding the industry run high. In other words, investors might be buying into marijuana stocks without fully understanding the risks involved.

With this in mind, we're taking the time to analyze one marijuana stock each week until we've covered all of the major players with a market cap of at least $200 million. Here are the marijuana stocks we've discussed so far:

Today, we're going to take a closer look at Scotts Miracle-Gro (NYSE: SMG).

What Scotts Miracle-Gro does

For many consumers, Scotts Miracle-Gro is a familiar name, as it's one of the largest lawn and garden care companies on the planet. Its primary goal for well over a century has been to help consumers fertilize their lawns and improve their gardens and landscaping. You'll often find its products under the Scotts, Turf Builder, Ortho, Roundup, or Miracle-Gro brand names; the company has well over three dozen brand-name products in its portfolio.

Where the company gets its marijuana stock association is through a subsidiary, Hawthorne Gardening. This subsidiary provides products geared at Scotts' burgeoning hydroponics business (i.e., growing plants without soil). Cannabis, specifically medical cannabis, can be grown via hydroponics.

Image source: Getty Images.

Promise and opportunities

As you can already guess where this is going, the most intriguing growth opportunity at the moment for Scotts Miracle-Gro is the hydroponics side of its business. Scotts has long been focused on improving plant growth for consumers and businesses, and the expansion of medical and even recreational cannabis is opening the door for its subsidiary Hawthorne Gardening to provide soil, nutrient, lighting, and hydroponic solutions to aid in the growth and yield of medical marijuana crops. Though the legal pot industry may be more or less nascent, Scotts has plenty of expertise in improving yield, which makes it a potential leader in soil, nutrients, and lighting needs.

It's important to note that Hawthorne is mostly growing inorganically at present. It gobbled up General Hydroponics in 2015, and bought a majority interest in Gavita the following year. Scotts' CEO Jim Hagedorn suggested recently that much smaller mom-and-pop-type acquisitions are also in the works, but that they usually take longer to finalize since family-owned companies can be a bit of logistical challenge to incorporate into Scotts' larger business. The addition of these family-owned enterprises should further kick Hawthorne's sales growth into high gear. Entering June 2017, year-to-date sales for Hawthorne were up a blistering 17%, compared to estimated sales growth for the entire company of just 3% to 4% this year. 

Yet Scotts' core business of lawn and gardening care is also what makes this marijuana stock so appealing. The company is only generating around 10% of its total sales from its fast-growing hydroponics business. The remainder of its sales come from its traditional lawn and garden business. Though this business is susceptible to economic fluctuations and weather patterns, it also provides a legitimate fallback for investors should the federal government tighten marijuana regulations. In other words, this ship isn't sinkable if the marijuana industry encounters problems, which isn't the case for most pot stocks.

Image source: Getty Images.

Risks and concerns

Unlike most marijuana stocks, Scotts Miracle-Gro is consistently profitable, so that's one thing that its investors don't have to worry about. Nonetheless, there are risks and concerns to be wary of.

To begin with, the federal government could indeed put the kibosh on the legal U.S. pot industry at any time if it wanted to, which would crush Scotts' fastest-growing segment. We have to remember that marijuana is still a Schedule I drug at the federal level. This means that pot, like LSD and heroin, has no recognized medical benefits and is entirely illegal. The federal government has, thus far, been willing to keep a hands-off approach to legal marijuana, delegating the responsibility of overseeing and regulating legal cannabis to the individual states that approve it. However, White House press secretary Sean Spicer commented in February that this administration likely wouldn't be so lax on marijuana, which means a tightening in regulations could be forthcoming. That would be bad news for Scotts Miracle-Gro.

Valuation is another concern that should be monitored. Scotts isn't exactly trading in nosebleed territory at roughly 21 times its estimated full-year EPS in 2017, but it recently saw its stock explode higher despite issuing a profit warning. The entire reason its share price jumped was based on growth from its Hawthorne Gardening subsidiary, while investors ignored weakness in its core lawn and garden business. Still, we need to remember that 90% of Scotts' revenue is derived from its traditional businesses. If investors place too much emphasis on its smaller, faster-growing hydroponics business, we could see Scotts' valuation rise to an unsustainable level, leading to an increase in the stock's volatility.

It's also likely that Scotts won't remain the only large player in hydroponics if more states begin legalizing recreational marijuana. Hawthorne's sales growth rate is probably going to slow from its year-to-date 17% in the years to come.

Image source: Getty Images.

Should you buy Scotts Miracle-Gro?

Now for the all-important question: Should you buy Scotts Miracle-Gro?

On one hand, there's something extremely comforting about having a legitimate lawn and garden business to cushion it if its marijuana-based efforts don't work out. Hagedorn seems to believe that cannabis can be a growth driver for Scotts for years to come, but investors in Scotts should be well protected from downside by the company's core lawn and garden operations.

On the other hand, Scotts has already seen a healthy appreciation in its share price on account of growth in its hydroponics division. The only other state to have made an effort since the November elections to legalize medical or recreational marijuana was Vermont, but its governor vetoed the recreational cannabis bill that made its way to his desk. In short, expansion isn't a guarantee, but it's very much needed to keep up Hawthorne's torrid organic growth rate.

My personal opinion is if you do you want to dip your toe into the water with marijuana stocks, a company like Scotts Miracle-Gro is the way to do it. The company is profitable and it provides a fallback just in case the legal marijuana experiment hits a snag. This doesn't mean Scotts is going to be right for every investor, but it's certainly worth a closer look for those who want to take advantage of growth in the legal pot industry.

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Sean Williams has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.