Blue Jeans to Miners in the 21st Century

This week we will be looking at the US cannabis industry and talking about a stock in the ‘picks and shovels’ side of the industry, a real blue jeans to miners story. US cannabis stocks have been in a relentless bear market, hovering near all-time lows despite the industry showing huge growth. 

Before we continue, this is not an industry that TAMIM currently invests in and it may never be. That being said, we do acknowledge the potential in the industry and, given its current changes in legalisation, it currently presents as a perfect example of the benefits of identifying 'picks and shovels' or 'blue jeans to miners' companies.

Cannabis operators face enormous constraints as a result of cannabis not yet being legal at a federal level. These constraints include higher taxes, no access to capital and an inability to list on the primary exchanges. The ancillary companies that provide services to the industry get the benefits of the industry growth without suffering the constraints.

Ancillary Companies

An alternative way to gain exposure to the growth in cannabis is to invest in ancillary companies; the companies that provide goods and services to the cultivators. They are the ecosystem that facilitates the growth of the cultivators. As the cannabis industry grows, it’s not only the operators that grow and sell cannabis that will benefit. The companies providing finance, equipment, and other goods and services will also be winners. Farming businesses have never been overly attractive; they tend to be cyclical, reliant on external factors like weather and so much can go wrong. On top of this, the risk of crop contamination is always present. As many of these cannabis companies are essentially just farmers, investors may prefer to allocate to the companies that provide equipment or even software to optimise crop growth. These companies typically come with less risk and, since they don’t grow or sell cannabis, they usually can trade on the primary exchanges.

Scotts Miracle-Gro (SMG.NYSE)

​SMG manufactures and sells products to the consumer lawn and garden market, the company was founded in 1951 by Horace Hagedorn and is now run by his son Jim Hagedorn. SMG is a family-run business with the Hagedorn’s owning around 27.1% of the business still. While SMG has been a steady business that benefited from Covid, what we are interested in is their ancillary cannabis segment, Hawthorne. Hawthorne has built a portfolio of leading hydroponics companies (i.e. the systems used to cultivate cannabis in a greenhouse). Hawthorne supplies the nutrients, lighting equipment, and other essentials to cultivate the crop. As the industry grows, so does Hawthorne. With the rapidly expanding footprint of cannabis legalisation across the east coast, where cannabis needs to be cultivated indoors, Hawthorne will further benefit from increased demand for their products

Source: SMG company filings

​SMG is a safer way to gain exposure to the cannabis sector and it’s listed on the primary exchanges. It has an Apple-like presence in the lawn and garden industry. SMG also has first-mover advantage when it come to the picks and shovels in the cannabis space, their Hawthorne segment has quickly grown to a billion-dollar business.

Source: SMG company filings

​SMG’s business will also benefit from changing demographics; millennials have been proven to spend more on their home as opposed to boomers. Pandemic-related stay-at-home orders resulted in a lot of consumers developing new hobbies, igniting the huge shift towards DIY driven by millennials. These trends will support SMG as well as boost their ecommerce activity. Scotts Miracle-Gro’s recent Super Bowl ad was leaning into this growing demographic: the millennial gardener.

Source: SMG company filings (ORC Engine, January 2022)

​SMG saw its share price come down from US $250 on 1 April 2021 to around US $117 today. Their core business was a huge beneficiary from Covid with the shift to DIY but their Hawthorne segment has struggled with the oversupply of cannabis and fractured supply chains, leading to a 38% decline in sales for the first quarter. SMG provided a $150m convertible loan to Canadian cannabis investment company RIV Capital (RIV.CNSX) who have taken stakes in a portfolio of different Cannabis-related companies. This convertible note gives SMG shareholders further exposure to the broader cannabis theme.

SMG is currently trading at about 12x NTM EBITDA. When you compare this to other hydroponics companies like Hydrofarm (HYFM.NASDAQ), who are trading at 17.2x EV/EBITDA, you can see that there is some value here with the Hawthorne business. At current prices, the market isn’t ascribing any value to the Hawthorne business; investors are essentially paying for a steady gardening business with the potential upside of cannabis exposure.

Potential Catalysts:

• Further/ongoing legalisation throughout the US
• Uplisting of cannabis stocks from OTC markets to the bigger exchanges - i.e. the value of their investments through RIV Capital will go up
• Spinning off of Hawthorne; this would come with a few dis-synergies but, if done at the right time, it could create serious value for shareholders