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Oversold is an understatement
Three stocks have been punished and are looking awfully cheap right now
Stock market rollercoaster
In case you weren’t paying attention last week, the stock market went on a rollercoaster ride starting Monday morning because of a Chinese company called Evergrande. The company, which is one of the biggest real estate developers in China, notified investors that they would most likely default on an upcoming payment on its roughly $300bn in debt owed.
I’m not going to dive into the details of it but that rattled markets last Monday with the S&P down 73 points or -1.7%.
That’s a big deal considering the market hasn’t had a pullback of over 5% in 232 days.
Though the good news is that by week’s end, the stock market has rebounded to more than where it closed on September 17th, closing up .5% from the prior week.
This was caused by Evergrande announcing that they were able to make the interest payment on Thursday and the markets cheered.
But this is not why I’m writing this article, this is just the precursor to what I’m trying to highlight. Cannabis-related stocks continue to get oversold because of macro conditions, such as Evergrande, that quite literally have nothing to do with the direct industry that they are in. #frustrating.
Picks and shovels
I’ve written an article in the past about a picks and shovels play in the cannabis market via a stock called Hydrofarm HYFM 0.00%↑. You can read the article via the link Vertical Farming: Picks and Shovels.
Anyways, the reason I highlight picks and shovels is that it grants people exposure to a market without actually being directly in that market.
The easiest example is why own a gold mine and all the issues that come with it when you can just own the part of the business that sells picks and shovels for all the miners mining gold?
These types of companies are supposed to be less volatile than the main market you’re pegging to and thus, allowing you to benefit from the growth in that market without having to deal with anxiety attacks every week.
The three stocks that I’m talking about are:
All of these companies sell hydroponic equipment which happens to mostly be for the cannabis industry. Even with the cannabis industry still growing at its own pace and with homeownership skyrocketing since COVID began, all three companies saw their stock prices go up in 2020 but have been struggling recently.
Investors have worried about lower consumer demand in 2022 and narrower profit margins thus resulting in their respective stock prices tumbling since the start of the year. However, I believe that this skepticism is overblown.
While the expectations are for growth to slow, the growth rates remain robust. You have each company GRWG, HYFM, and SMG growing YoY at +143.8%, +49.7%, and +18.1% respectively.
Scotts Miracle-Gro even gets a 1.8% dividend yield.
Additionally, the 2022 revenue estimates are rising for both companies. The 2022 EPS estimates have pulled back slightly for GrowGeneration and have increased for Hydrofarm over the past few months. The sharp decline in the prices and continued growth in the business has left these stocks considerably cheaper than they were at the beginning of the year.
So with these companies growing rapidly, and Hydrofarm and GrowGeneration acquiring assets to grow their portfolio and footprint, having these companies trading at this steep of a discount are insane.
But, with the pullback that each stock has had over the last few months, this could be an incredible buying opportunity to get these companies on the cheap while we know for certain that the overall industry is growing.
A little about each.
GrowGeneration was an investor favorite going into this year. Even Jim Cramer was praising it for the longest time (FYI, I actually can’t stand that guy) though the most recent earnings release sent the stock tanking from $43 to $35 in a day. Investors were worried about the rest of the year’s growth after the company raised its 2021 revenue guidance to $455M – $475M.
Meanwhile, net income more than doubled to reach ~$6.7M and cash and short-term securities approached $124.5M from $177.9M at the end of the previous year.
Though all of this was not enough for investors to continue buying in at the multiple and decided to jump ship.
With the company losing 40% of its value since that release, an overreaction is an understatement. Makes little sense to me that having a company growing that fast, while raising full-year sales guidance and completing 12 acquisitions adding 20 hydroponic retail locations taking its total store count to 58 would trade so low.
As I mentioned in my article that I wrote earlier in the year, Hydrofarm has many catalysts, one being the same one that Scotts is experiencing itself with the cannabis industry, though my point was about rolling up assets via M&A.
So far this year, the company has made four acquisitions totaling over $440M in transaction value and adding $164M in incremental sales. Half of these acquisitions are expected to be accretive within its fiscal year.
The company is executing well on strategy and has beaten earnings estimates every single time (past three quarters) yet the stock has seen so much volatility which leaves many, including myself, scratching their heads.
Scotts got a huge boost during the pandemic as an estimated 20 million U.S. households took up lawn care and gardening or resumed those pursuits. The company has estimated that about 75% of those households will stick.
The company is projecting sales growth of 7% to 9% for the consumer business in the current fiscal year ending on Sept. 30, but expects a “slight decline” in the coming year. Longer-term, the company sees 2% to 4% annual sales growth in the division.
Andrew Carter, a Stifel analyst, sees Scotts generating low-double-digit annual earnings growth after profits normalize in the 2022 fiscal year. The stock, he argues, looks cheap, trading at a roughly 13% discount to the consumer-staples group.
It’s unusual to find a company like Scotts with two leading consumer-oriented businesses that have favorable demographic underpinnings and whose stock trades below 20 times forward earnings.
Cannabis still a driver
In 2015, Scotts started a hydroponics business that sells lighting, nutrients, and other products, mainly to marijuana growers who favor the controlled conditions of greenhouses. (Hydroponic farming doesn’t involve soil.) The division, called Hawthorne, is now the industry leader by a wide margin, enjoying 60% sales growth in the nine months ended in June, to $1.1 billion, or about 25% of total revenue.
Hawthorne’s growth, however, is expected slow, to a range of zero to 15%, in the current period because of an oversupply of marijuana in California, which accounts for about half of Hawthorne’s sales.
Still, Hawthorne’s multiyear prospects look strong, as just 18 states have legalized recreational adult use of marijuana—it remains illegal at the federal level. Analysts see 15% sales growth in the coming fiscal year and 10% to 15% annually longer term.
Hydrofarm (HYFM), the No. 2 player in hydroponics, is less than half the size of Hawthorne and is valued at $1.8 billion, or more than 40 times estimated 2021 earnings. Analysts value Hawthorne at more than $4 billion.
The bottom line
I have each of these stocks in my portfolio and it has been excruciating to see companies that are doing well and still supported by massive tailwinds not having their stock price reflect it.
If you’re even remotely interested in exploring any of these companies to add to your portfolio, I don’t think I would wait much longer to do your own homework and see if it’s right for you.