Legal marijuana is expected to be a huge growth business, with some projecting a market opportunity of up to $ 166 billion. This is many years away, as the industry is still largely in its infancy. The projection, however, shows how excited Wall Street is about legal weeds.
The problem is that investors in the early days have a bad habit of getting too excited and driving story stocks to unrealistic heights. The recent declines in marijuana producers suggest that this has happened again. Here's why Scotts Miracle-Gro (NYSE: SMG) was not hit and why it might be a better option for long-term investors who are interested in the space.
The Picks and Shovels
If you buy a marijuana breeder like Canopy Growth you're banking on the future of the legal pot. It is a notable actor in space, but its future will not be nearly as rosy as hoped that legalization does not continue to spread in the United States. Its entire future largely depends on more people taking the legal opportunity to consume marijuana. This is not bad or different from the other pot stocks; It is a problem everyone faces when competing for market share.
This last point is important: There are many companies looking for a piece of marijuana market. Sure, Canopy is a big player, but not the only one. This is where Scott's Miracle-Gro comes into play. This company has been in the market for slow and steady lawn care for a long time, helping people to develop and keep themselves pretty in courtyards and flowers. A few years ago, management decided it wanted a piece of marijuana market as well.
Instead of breeding the plant, she stayed in knitting and bought her way into the hydroponic supply room. The facilities where marijuana is grown usually use hydroponic systems. At the time, Scotts is one of the largest suppliers in the hydroponic industry, with $ 176 million in revenue in the hydropower-focused Hawthorne division last quarter. This corresponds to an annual execution rate of around 700 million US dollars. This is big business – and it is growing. Management estimates that organic sales increased nearly 20% year-on-year in the first nine months of fiscal year 2019 (recent acquisitions have further increased Hawthorne's total sales).
Either way, a winner
What's exciting is that it does not matter who wins the marijuana market share war. Scotts can provide you with all the tools and resources you need. Pot companies will still benefit from the increasing demand in the end market, resulting in interesting statistics.
It seems that legal marijuana has not changed as much as many had expected. According to industry analyst BDS Analytics, by 2018 90% of marijuana sales in Massachusetts were illegal. In California, the figure was almost 80%. In Oregon and Washington, pot sales are estimated to account for around 50% of total sales. Although many thought legal marijuana would displace illegal marijuana from the market, this does not seem to happen – at least not fast.
The big problem is most likely the cost. Without having to deal with taxes and regulations, illegal marijuana is cheaper. It is similar to the idea of buying cigarettes from regions with lower taxes in order to sell them in regions with higher taxes. It is not legal, but tax evasion results in lower selling prices and / or higher profits for the cigarette seller. Since illegal marijuana producers already violated the law before the pot was legal, the fact that they continue to satisfy the demand for low-cost weeds should come as no surprise. But it could be a thorn in the side of companies hoping for huge growth in the legal marijuana market.
Scott's Miracle-Gro, on the other hand, benefits in every way. Sure, it would rather sell to people who are on the rise. But anyone can buy hydroponics consumables from the company, meaning that Scott not only wins when legitimate marijuana production grows (no matter which companies are the major players), but also benefits from illegal marijuana producers struggling to gain to stay.
Worth a Second Look
Scott's Miracle-Gro does not offer the yield growth potential of a pure pot paper, as slow and even lawn care still accounts for approximately 75% of the upper limit. But if the marijuana market continues to grow, as Wall Street expects, Scotts will be able to use the site without having to own a grower. After all, the breeder you select can become a winner in a highly competitive market, where some growers still play outside the legal limits. In addition, Scotts has begun to reduce the leverage needed to build its hydroponic business, and the company is likely to make a deep leap if you're interested in the marijuana space. By contrast, income investors are likely to appreciate the company's return of 2.1%.