Backdoor Marijuana Investment Play

Scotts Miracle-Gro (SMG), a company that is best known for Scotts branded products like fertilizers and grass seeds, is also a backdoor marijuana investment play.

Most marijuana investors know this, but they may not fully understand how Scotts is involved in the marijuana industry and why that could make Scotts slightly more of a risky investment than some people believe it to be.

Scotts Miracle-Gro is a very well-known business and it has a good reputation. However, its core business is not one that is typically booming.

Over the past ten years, prior to 2020, Scotts average sales grew just 2%. This shouldn’t bee much of a surprise considering the business the company is in. Furthermore, the average 2% sales growth could in many years be contributed to nothing more than price increases.

Then came 2020, when people where stuck at home, looking at their poorly maintained lawns and starting gardens. Due to increased demand, likely because of pandemic-related changes to people’s lives, Scotts' annual sales increased by 24%.

Company management and analysts all believe that most of the people who took up gardening or did decide to improve their yard, will continue to stick with Scotts and their new hobby.

With that said, analysts are only expecting Scotts' sales growth to be in the 2-4% annual growth range during the coming years. Not the kind of growth you may expect from a high-flying marijuana stock.

Scotts has exposure to the marijuana industry through its fertilizers and the basic equipment needed to set up a marijuana farm.

Back in 2014, Scotts formed the Hawthorne Gardening Company, which sells products used by cannabis growers. Then in 2015, Hawthorne bought General Hydroponics, a 35-year-old liquid nutrient producer, of which its products are considered the gold standard by many marijuana farmers.

While the Hawthorne Gardening Company does sell fertilizer, due to its acquisition of General Hydroponics, the growth in the division comes from new marijuana growing facilities being opened.

So as the pace of legalization of marijuana in US States and major countries around the world slowly diminished, the need for new hydroponic growing equipment that Hawthorne sells also began to drop.

More recently the marijuana industry has been in an ‘oversupply’ situation. This not only nearly stopped all sales from Hawthorne, but it also hurt Scotts' sales figures. With annual sales growth dropping from 24% to a more expected 2-4%, Scotts' stock price has taken a massive hit, falling from a 52-week high of $193.50 down to currently trading in the low $80 range.

Some investors argue that now is the time to buy SMG because of the low valuation, decent dividend and potential for the marijuana industry to make another move forward.

For that to happen, we will need to see one of two things to occur:
1. A massive increase in marijuana usage in the states that it is legal, or
2. New states in the US or countries around the world open their doors to the marijuana industry.

Either of these situations would increase demand for marijuana, thus new grow houses would need to be built and supplied so they can begin growing marijuana. Without either happening, Scotts' Hawthorne business will continue to produce just mediocre numbers.

Some investors believe that SMG is undervalued, and that very well may be true. If the marijuana industry continues to grow in the future and we see more and more US States and countries around the world legalize the substance, then Scotts' Hawthorne division will perform better, helping push the SMG stock price higher again.

But there are two problems investors face while they wait for legalization to occur.

First is that SMG's management has reportedly been considering spinning off the Hawthorne business, and thus their whole marijuana industry connection. This would be force SMG investors to consider whether or not they owned SMG for the marijuana play. Analysts believe that the growth will largely come from the Hawthorne side of the business, and thus spinning it off would allow investors to reap the greatest benefits since it will no longer be ‘held back’ by the Scotts side of the business.

The second issue investors will be facing is simply time. The amount of time that they will have to wait for the new laws to be passed. Investors need to consider the opportunity cost of waiting a long time. In the past, in the US, the legalization cycle has taken a few years. We have a few new states all at once and then nothing for a few years. So, it may be a few more years before we see another big demand surge for Hawthorne’s products.

Some analysts will agree that SMG is a good buy with or without Hawthorne and that it is even worth holding, as long as Hawthorne is still a subsidiary, while you wait for new states to legalize marijuana. But that is a decision each investors needs to consider individually especially since SMG has shown us a very good example of a boom-and-bust business just over the past few years. This has been evident in the SMG stock price peaking at $244 per share back in March of 2021 and the stock now trading at just over $80.

Matt Thalman
INO.com Contributor
Follow me on Twitter @mthalman5513

Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.