Scott's Miracle Gro (SMG) has been investing heavily in their hydroponics business, clearly to tap into the cannabis space.
Similar providers are benefitting from the growing industry, without the direct risk of handling cannabis products.
Solis Tek is one of these, with a stable business that has remained quiet with the markets despite increasing sales and lean costs.
Scott's Miracle-Gro Company (NYSE:SMG) isn't the most exciting investment story, but it's been a major winner for investors who caught on two years ago when the stock was below $60. The stock recently peaked at $100. For a $5 billion retail company, that's not bad at all.
What's to notice about this fertilizer player?
SMG, one of the most respected fertilizer and gardening product providers in the U.S., is investing in the future of cannabis.
But SMG is taking a low-risk approach. Scott's has instead been investing heavily in their "Hawthorne Gardening" subsidiary, which focuses exclusively on hydroponic gardening products – this is the rock bed of the cannabis growing industry.
To be precise, SMG has poured upwards of $500 million into Hawthorne since its inception in 2014. Five of their last six acquisitions have been companies in the hydroponics vertical; in growing mediums, nutrients, lighting, and systems.
Their apparent goal would seem to position them for a strong hydroponics push, both retail and enterprise-facing. The company clearly believes Hawthorne will be a key long-term component of its business. Scott's is simply buying potential growth, and already Hawthorne makes up 13% of its $2.8 billion top-line.
That should be no surprise to anyone following the burgeoning cannabis industry in North America. Seven of 50 states have now legalized recreational cannabis, and 29 have or soon will legalize cannabis in some form, primarily for medicinal use. Legal cannabis was a $7 billion industry in 2016 in the United States, according to New Frontier Data, of which over half ($4.7 billion) came from medical cannabis sales.
Shockingly, illicit cannabis sales in the U.S. were estimated at $46 billion last year. The market for cannabis already exists, it's just coming out the shadows. New Frontier estimates that legal sales will jump to $24 billion by 2020.
But it's still a contentious product, with the federal government maintaining that cannabis is a controlled substance. While the Obama administration turned a blind eye to cannabis' legal status in some states, new Attorney General Jeff Sessions has hinted at a crack-down on pot. Sessions famously quipped that he thought the Ku Klux Klan "was okay until I found out they smoked pot," according to the New York Times.
It's an exciting space to invest, though it's clearly not risk-free with the federal government still looming. Wisely, SMG avoids the higher risk aspects of handling the substance, instead focusing on the lower-risk opportunity to simply supply the booming hydroponics industry.
Don't Sell Pot, Sell Shovels
There are obvious similarities between today's proliferation of "pot stocks" and the California Gold Rush of 1849. Not every prospector will make it. But the companies supplying those prospectors? That was where the smart money went in 1849 – the same is true today. Following the big money, like SMG, it's clear why they're investing heavily in the ability to "sell shovels" to cannabis handlers. SMG's Hawthorne subsidiary and gardening segment accounted for about 13% of net sales last year, or $365 million, and the company reported 30% revenue growth from Hawthorne over the previous year. This was Hawthorne's second full year in business.
Solis Tek (OTCMKTS:SLTK) takes the same approach. The company is a manufacturer of digital lighting equipment (called "grow lights") for the hydroponics industry. Solis Tek is one of these custom light providers, producing ballasts, reflectors, and HID lights, with some of the most respected custom products on the market; Dope Magazine dubbed Solis Tek 2016's "Best Lighting Company."
It may not sound as sexy as medicinal pot growing companies, but the market potential, and Solis Tek's current growth and financials, are fundamentally sound. That's the point – Solis Tek reduces risk by "selling shovels", not prospecting for gold like their growing and handling counterparts Aurora Cannabis (OTCMKTS:ACBFF) or Medical Marijuana, Inc. (OTCMKTS:MJNA), for instance.
Solis Tek brought in $8.564 million in sales last year, up from 2015 by 11%, and gross profit of $3.124 million.– impressive for a company of its size and age - and has over the last six months been expanding the top line while tightening up product costs, a recipe for success as margins improve.
But it's the quarterly numbers that tell the real story over the last few months as sales have begun to ramp.
Since mid-2016, sales have climbed steadily, from just under $2 million in the third quarter of last year, to $2.9 million in the first quarter of this year, a 55% increase in 12 months. And the company has reduced the costs of its goods sold: gross margins improved from 34% to 38%.
Annualized, Solis Tek is looking at a run rate of about $12 million based on first quarter sales, which would, if sustained, suggest a significant increase over 2016.
Most importantly, Solis-Tek's revenue is making its way to the bottom line – or can be in short order. As a measure of gross profit, the company was profitable in the first quarter of 2016 and short of profitability by just $35K in the second quarter of last year. Excluding share-based compensation expenses (a non-cash charge) and amortization in the first quarter of 2017, the company was just $20K shy of positive earnings, on $2.9 million in revenue.
It's simply a matter of flipping the right switch.
Although the company has said little about this push, Solis Tek has also expanded horizontally by recently launching its own line of nutrient products to its hydroponics customers, much like SMG's historical garden-care business. This is an appealing vertical due to attractive margins historically on similar products. Solis Tek commenced test marketing "Terpenez" late last year, which is a proprietary product designed to assist plants with oil and resin production. Early results should trickle in this year, an attractive opportunity as the industry expands. In addition to its availability in the existing national network of hundreds of hydroponic retail stores who carry Solis Tek products today, it has gone mainstream and is available online at Wal-Mart Stores (NYSE:WMT) and Amazon (NASDAQ:AMZN).
Clean capital structures aren't easy to come by among small-cap stocks, but SLTK management have done a quality job of keeping things squeaky clean, with 36 million common shares outstanding and no warrants or preferred equity weighing on the stock.
Comparing to Peers Makes For a Very Compelling Long Case
Capitalizing on this same smart-money trend, Kush Bottles (OTCQB:KSHB) likewise avoids the risk of directly handling cannabis products and instead supplies packaging solutions for the cannabis industry. Their income statement is remarkably similar to Solis-Tek: $8.2 million in fiscal 2016 revenue, with gross profit of $2.7 million for the year.
As a $100 million market capitalization company, KSHB trades at 12 times last year's revenue.
At $53 million, SLTK trades at just 6x last year's revenue, despite a remarkably similar top-line.
What Kush has done quite well in the past year is tuck-in acquisitions that bring with them incremental revenue streams and diversification. On May 4, the company announced the $1.5 million acquisition of CMP Wellness, a distributor of vaporizers and accessories that did $4.4 million in revenue in the last 6 months. Days later, they tucked in the webstore Roll-Uh-Bowl.com for undisclosed financial terms.
Kush clinched their CMP acquisition with a unique combination of $1.5 million in cash and 7 million shares in stock. Smaller private players are willing to sell, and at attractive terms for their larger, public counterparts. A similar low-cost roll-up strategy from Solis Tek could potentially be nicely rewarded.
While most traders won't look beyond the glitz of medicinal or recreational cannabis growers and distributors, there's big opportunity for those willing to examine those peripheral systems suppliers. At some point in every gold rush, the shovel salespeople start making money – whether the diggers do or not.
About One Equity Stocks
One Equity Stocks is a leading provider of research on publicly traded emerging growth companies. Our team is comprised of sophisticated financial professionals that strive to find the companies and management teams that will outperform the market and deliver investment returns to our subscribers. We are not a licensed broker dealer and do not publish investment advice and remind readers that investing involves considerable risk. One Equity Stocks encourages all readers to carefully review the SEC filings of any issuers we cover and consult with an investment professional before making any investment decisions. One Equity Stocks is a for profit business and usually has a financial relationship with issuers we cover. In the case of SLTK, we have been compensated $9,000 for research services. We expect to receive additional compensation in the future. One Equity Stocks nor any of its principals or affiliates has a position in SLTK.
