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Scotts Miracle Gro Poised to Profit From Cannabis Industry

Scotts' leadership in hydroponic equipment provides broad cannabis industry exposure.

Seth Goldstein: Scotts Miracle Gro is one of the best ways to play the growth of the cannabis industry.

We’ve recently raised our outlook for Scotts based on our initiation of the cannabis industry, where we see legal sales growing 9 times larger by 2030.

As a result, we’ve increased Scotts’ fair value estimate to $105 per share. With the stock trading just above our $105 fair value estimate, we view shares as fairly valued. However, Scotts is worth watching as a pullback could provide an attractive entry point for long-term secular growth.

We’ve also maintained our narrow economic moat rating based on the intangible asset moat source, which stems from Scotts’ portfolio of well-recognized brands. While Scotts’ brand recognition provides considerable pricing power, sales should increasingly shift toward the online marketplace. This will apply some downward pressure to pricing and underpins our negative moat trend rating. However, even amid a modest deterioration of pricing power, the company should maintain a material price premium to comparable products, supporting economic profits for at least 10 years into the future.

Rachel Elfman: Scotts’ Hawthorne segment is the top supplier of hydroponic cultivation equipment to the U.S. and Canadian cannabis markets. In Scotts’ latest quarterly earnings, Hawthorne’s organic revenue was up nearly 50% year over year. We think Hawthorne will continue to grow rapidly and take advantage of increased demand for hydroponic equipment stemming from cannabis legalization. Hydroponic equipment is used in greenhouse and indoor cultivation, which currently accounts for nearly 70% of all cannabis grown in the U.S. and Canada.

We forecast Hawthorne will contribute about 10% of total company profits in 2019, and we expect segment sales to grow about 5 times over the next decade. By 2028, we anticipate that Hawthorne will generate 40% of total company profits, while Scotts’ moaty consumer segment should still account for the majority of profits.

Although we view shares as fairly valued, it is worth following Scotts since it provides indirect cannabis exposure without betting on a single cannabis company.

Rachel Elfman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.