Ancillary companies play a vital role in the marijuana business without ever coming into contact with the plant itself. These entities supply growers with nutrients, solvents, tools, and the equipment necessary to raise marijuana plants in large-scale production facilities. Pure play companies are riskier bets as market fluctuations in the price of cannabis can led to unstable cash flows. Meanwhile, products provided by ancillary companies are needed no matter what, and they often play a vital role in the broade agriculture sector as well.
In November, five states are set to vote on the legalization of cannabis, and full-out federal legalization could come by the end of 2021 with enough bipartisan support. Buying up shares of reliable ancillary companies before a marijuana "gold rush" is a great way to get in on the action. Today, let's take a look at two such stocks, GrowGeneration (NASDAQ: GRWG) and Scotts Miracle-Gro (NYSE: SMG), and determine which one is the better buy.
The case for GrowGeneration
GrowGeneration is a specialty hydroponic and organic gardening chain that operates 28 retail locations across the country and an e-commerce segment. In the second quarter of 2020, the company's revenue grew by 123% year over year to $43.5 million, which was its 10th consecutive quarter of sales growth. Simultaneously, GrowGeneration's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) more than doubled from Q2 2019 to $4.6 million.
By the end of the quarter, the company grew its earnings per share from $0.04 in the year-prior to $0.07. A 75% increase in earnings per share is quite impressive and should significantly help reduce the company's $300 million debt obligation. GrowGeneration has about $59.3 million in cash on its balance sheet as of Aug. 12.
It's good to see that the company can effectively expand its core business. Last year, GrowGeneration's revenue increased by 176% year over year to $80 million. This year, the company expects to generate up to $175 million in revenue and $18 million in adjusted EBITDA. For 2021, GrowGeneration projects up to $260 million in revenue and $28 million in adjusted EBITDA.
That's quite a lot of growth for a company with a market cap just south of $800 million. Aside from helping cannabis growers, GrowGeneration also provides nutrients, lighting, climate control systems, and greenhouse construction to clients in the agriculture sector. Our next company, which has a $9 billion market cap, also has plenty of enticing qualities.
The case for Scotts Miracle-Gro
Scotts Miracle-Gro is an international agricultural company that distributes and sells products for lawn maintenance, garden care, and indoor hydroponic growth operations. During the first nine months of 2020, the company's hydroponic product sales increased by nearly 60% on an annual basis and brought in $731.7 million. Simultaneously, the company's sales grew from $2.7 billion in over nine months in 2019 to $3.2 billion over the same nine months in the 2020 fiscal period.
For the full 2020 fiscal year, Scotts Miracle-Gro expects to grow its revenue by 30% (from $3.156 billion last year to $4.1 billion this year) and its earnings per share by 62% from $4.47 to $7.25. The company is more than profitable. In fact, Scotts Miracle-Gro paid $5 per share in the third quarter of 2020 via a special dividend and raised its quarterly dividend by 7%. The stock has an annual yield of 1.47%.
That's not all. The company is on track to generate over $700 million in adjusted EBITDA this year. Compared to its debt of approximately $1.7 billion, this yields financial leverage of fewer than three times net debt to EBITDA. A ratio of less than four or five indicates a company is at low risk of default.
Which ancillary is the better buy?
GrowGeneration is trading for approximately 74 times price-to-earnings and four times price-to-sales going forward, in terms of valuation. Meanwhile, Scotts Miracle-Gro is trading at 22 times earnings and two times sales. While the latter may seem like a cheaper buy, it is also essential to keep in mind that investors are paying for growth.
When we take into account GrowGeneration's 119% year-over-year revenue growth, compared to Scotts Miracle-Gro's 30%, it is evident why shares of the former are a lot more expensive. Overall, the decision here is a matter of taste. Both businesses are poised to benefit from future state (and even federal) decisions to legalize recreational and medical marijuana. Cannabis investors who are drawn toward value should choose Scotts Miracle-Gro, while GrowGeneration is a prime choice for exciting growth stocks.
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