Why this Pick-and-Shovel cannabis stock says its stocks are too cheap
During the call for third quarter results to Scotts Miracle Gro (NYSE: SMG)CEO Jim Hagedorn has not so subtly given his opinion on the share price, saying, “I am a huge fan of buying our shares at these prices.” While it’s not uncommon to hear CEOs say this about their companies, Hagedorn may not be just talking about his company’s actions in this case.
With the bulk of a $ 750 million share repurchase authorization available, the company is considering its shares at a discounted price. But should investors also consider buying?
Scotts Miracle-Gro and its redemption thesis
Operating in the lawn and garden and hydroponic gardening markets, Scotts is a very seasonal business, receiving 75% of its sales in the second and third quarters. Aided by the pandemic and increasing home spending, the company posted monstrous results for these quarters in 2020, leaving comparables very difficult to achieve this year. As the company surpassed those comparables in 2021, the market was unimpressed, causing stocks to fall more than 40% from their 52-week high.
However, despite the market reaction, Scotts was able to increase its revenue by 8% year-on-year for the third quarter and even increase its earnings per share by 12% in the same period. Through this apparent discrepancy between the growth of the company and the performance of its shares, Hagedorn developed his opinion on the company’s share price by saying: wait until we do. ”
At its current price, $ 250 million in repurchases equates to 3% of the company’s outstanding shares and offers intriguing potential for investors, as Scotts has seen its P / E ratio drop to 15, from the S&P 500Average P / E of 31. Instead of paying a special dividend, share buybacks can reduce a company’s total number of shares if done correctly and can be a great way to give money back. to shareholders, especially if its share price begins to recover over time.
Hawthorne’s explosive and hidden growth
Functioning as a pick and shovel game for the marijuana industry, Hawthorne, Scotts’ indoor gardening and hydroponics segment, might be the most compelling case for an investment in the business. After growing 48% year-over-year sales in the third quarter, despite difficult comparisons, Hawthorne now accounts for 26% of the company’s overall sales.
Scotts’ rapidly growing segment has positioned itself beautifully to continue to benefit from the ongoing legalization of marijuana; it provides the lighting, nutrients and growing media needed to produce it efficiently. As the company continues to make new targeted acquisitions, it aims to improve overall segment profitability through its Project Catalyst initiative, a “company-wide restructuring effort to reduce operating costs.” . In addition, this initiative is expected to create “acquisition synergies within the Hawthorne segment”.
With Hawthorne generating a profit margin of just 12% over the US consumer segment (outdoor and lawn) margin of 26%, this move could boost profitability in the indoor gardening and hydroponics segment. Ultimately, management expects Hawthorne to end the year with growth of over 40%, on top of its 60% growth rate from a year ago.
Scotts Miracle-Gro is the best of both worlds
Thanks to low growth and high margins in Scotts’ consumer staples segment in the United States, as well as high growth and low margins in its Hawthorne segment, the overall valuation of the company looks quite muddled. But the two distinct lines of business fit together well, as its core segment’s cash generation helps fuel Hawthorne’s growth. In a way, it reminds of constant growth eBay (NASDAQ: EBAY) before the spin-off of its strong growth Pay Pal (NASDAQ: PYPL) unity and perhaps foreshadows the potential success of an investment in Scotts Miracle-Gro at today’s discounted price.
While a spinoff of the Hawthorne segment from Scotts is unlikely to be imminent, the company’s current P / E of 14, coupled with the potential of the nascent segment, puts me in line with CEO Hagedorn and his bullish view of the ‘action.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.