In case you haven’t noticed, marijuana stocks are blazing hot, once again. In less than four weeks, the North American Marijuana Index, which is comprised of growers, ancillary pot stocks, and cannabinoid-based drugmakers in North America, has gained close to 50%.
While there’s a lot of buzz surrounding the pot industry, there are two primary catalysts pushing weed stocks higher.
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Here’s why pot stocks are skyrocketing
First, there’s the upcoming recreational marijuana legalization in Canada. Five weeks from this coming Wednesday, adult-use cannabis officially will go on sale in licensed dispensaries in our neighbor to the north. The expected influx of revenue on the heels of strong demand has investors’ imaginations running wild.
The second catalyst, which may even eclipse the fact that legalization is around the corner, has been the amount of deal-making ongoing with the cannabis space. And no, I’m not talking about deal-making within the space, such as when Aurora Cannabis gobbled up Ontario-based MedReleaf for $2.5 billion this summer. Instead, I’m referring to big, brand-name alcohol, tobacco, and pharmaceutical companies angling for partnership opportunities with the fast-growing cannabis industry.
In particular, marijuana stocks have been off to the races since Corona and Modelo beer manufacturer Constellation Brands announced a $3.8 billion equity stake in Canopy Growth Corp. (NYSE: CGC), the largest marijuana stock by market cap, on Aug. 15. The investment priced at a 51% premium to Canopy Growth’s prior-day close, and if the added warrants are exercised, it could eventually push its ownership stake in Canopy Growth to more than 50%. This “Which marijuana stock next?” thesis has been responsible for driving momentum in the industry.
The only marijuana stock that failed to “Gro” in August
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But for as well as marijuana stocks performed last month — a screen of 27 pot stocks with a market cap in excess of $200 million showed that all but three gained at least 11% — one was left out of the party. Finishing the month of August 5.2% lower, Scotts Miracle-Gro (NYSE: SMG) stock offered little for investors to cheer about.
Understandably, Scotts Miracle-Gro isn’t a pure-play marijuana stock like Canopy Growth or Aurora Cannabis. It generated 89% of its sales last year from its traditional lawn and garden segment, which primarily focuses on ways to help with crop yield and aesthetics for commercial and residential customers. The remaining 11% was derived from Hawthorne Gardening, which is the subsidiary responsible for hydroponics, lighting solutions, soil, and nutrients for the medical cannabis industry.
So what the heck went wrong, you ask? It would appear the answer lies with the fifth-largest economy in the world: the state of California.
You see, Scotts Miracle-Gro is primarily counting on the U.S. cannabis industry to drive growth for Hawthorne. California was expected to bring in more revenue with the legalization of recreational weed than all of Canada. However, California has run into a number of issues. Dispensary licenses are being processed at a slow pace, which is creating a production bottleneck for growers, processors, and distributors.
The other issue is that, without an idea of the long-term supply-and-demand outlook, growers have been overproducing. With the California market absolutely glutted with cannabis in the early going, there simply hasn’t been as much need for Hawthorne’s supplies, which focus on improving cannabis crop yields. Excluding its acquisition of Sunlight Supply this year, its Hawthorne segment is likely to deliver an organic double-digit year-on-year sales decline.
Three reasons to be excited about a potential Scotts Miracle-Gro rebound
Then again, weakness in Scotts’ share price in August could actually wind up being an excellent opportunity for investors to get their feet wet in the cannabis space without taking a big risk. There are three reasons, in particular, for investors to be excited about the company’s future.
First, there’s the noted acquisition of Sunlight Supply for $450 million in cash and stock. Since Sunlight Supply and Hawthorne have very similar business models and product lines, their merger should be seamless and lead to an estimated $35 million in annual cost savings. Plus, with an expanded product line, Hawthorne should be able to reach a greater number of corporate clients.
Secondly, Scotts Miracle-Gro surprised Wall Street last month when it announced that it was teaming up with Flowr Corp. in British Columbia to construct a 50,000 square foot research facility. Though the purpose of this venture is to study Hawthorne’s lighting, nutrient, and soil solutions with regard to the genetics and yield of cannabis crops, there’s no telling where such a partnership could end. In theory, this could be a way for Scotts to become a marijuana grower, rather than just an ancillary participant.
Lastly, don’t overlook the company’s traditional lawn and garden business. Though it can ebb and flow with weather patterns, it’s generally predictable in terms of pricing power and profitability over the long run. Sporting a nearly 3% dividend yield and an expected 11% top-line growth rate in 2019 (much of which is from its Sunlight Supply acquisition), Scotts Miracle-Gro is more attractive now than it’s been in a long time.
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Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
