From Weed Killer to Profit Tiller

by Options Sensei |

As laws regarding recreational marijuana continue to loosen restrictions and expand applications, many traditional ‘vice’ companies such as alcohol and tobacco are looking to get in on what is expected to be a $300 billion business by 2025. As we’re about to see, this process creates some lucrative options trading opportunities.

Most recently, we saw Constellation Brands (STZ), the maker of a wide range of wine, bear and liquor under brand names such as Corona, Modelo, Mondavi and Black Velvet Whisky, lay down a $4 billion investment in Canopy Growth (CGC).

This gives Constellation a nearly 40% stake in CGC, which is the premier Canadian marijuana company with vertically integrated operations that control every aspect from growing, distributing, packaging and operating retail locations.

It makes sense for Constellation to diversify its product line, especially as studies show people replacing their alcohol consumption with marijuana. However, this move came at a hefty price; STZ paid a near 25% premium on the CGC’s then current price.

This buy also sent shares of CGC up some 35 percent, while STZ’s own stock sank 10 percent in the immediate aftermath of the announcement.  Note, the deal gives STZ the right to accumulate a majority stake at similar valuations.

Rules of Law

I think aside from the price paid, one of the reasons investors had issues with STZ’s deal is that the rules governing recreational marijuana remain murky. Not just across borders, but even within the US, where federal law is often at odds with state and local statutes.

I think this deal will ultimately play out well for investors, but it take a while for these two companies to create new product lines, such as pot infused beer and wine, and synergies that might initially have multiple conflicts.

I have a better, more natural, way to play the growth of  marijuana using an established, publicly-listed U.S. company whose products cross no legal lines.

From Weed Killer to Plant Pillar

Scotts Miracle Gro (SMG) has been a leader in the gardening sector for over 150 years providing everything some seeds, soil and fertilizer to irrigation and lighting systems.

All of these products would find a natural extension and new market in growing of marijuana from individuals and mom and pop shops to the eventual industrialization of the industry.

Scotts Miracle Gro is the ‘pick and shovel’ play of the marijuana industry.

Current CEO Jim Hagedorn, who is now a fourth generation leader and majority owner, has been a huge proponent of steering the company towards the marijuana market for several years saying in 2016 Forbes article,  “I’d like to invest half a billion in the pot business,” he yells over the roar of two engines powering his camouflaged Cessna Citation. “It is the biggest thing I’ve ever seen in lawn and garden.”

The company began investing heavily in hydroponic equipment and specialized fertlizers.  But SMG’s biggest customers, big box retailers such as Home Depot (HD) and Lowes (LOW) were not buying—for obvious reasons.

CEO Hagedon’s frustration came out during last month’s conference call, when he slammed the company’s cannabis-growing business in an expletive-filled rant.

Hagedom’s frustration was with weak financial expectations for SMG’s Hawthorne Gardening subsidiary, which would not meet internal targets for growth for the foreseeable future.

But Hagedorn said analysts should “bear with” SMG as “we’re working on” achieving the “synergy” promised with the acquisition of Sunlight Supply, but the CEO clearly was irritated at the lack of clarity: “When people ask me what do you think about those numbers that came back from Hawthorne, I said ‘it’s a f-ing negotiation’ – sorry for the language. It’s a f-ing negotiation and they’re gun-shy at the moment… Do not over-commit. Our credibility matters.”

In one sense, you have to appreciate the CEO’s passion and commitment and give him some short term latitude to achieve long term vision.

Hagedron could be the Elon Musk of the weed industry.

Right now, people are not excited about this vision or some of the risk it entails.  And that means a great buying opportunity.

The stock is off some 30% from the January high and now trades at just 16x forward p/e.

I’m going to buy some LEAPS, specifically:

The March 2019 Call with a 75 strike, for $7 per contract.

This gives me a highly leveraged and limited risk way to play what is surely going to a company that will grow like a weed as marijuana legalization and use continues to expand and go mainstream.

 Related: Is Silicon Valley Concealing a Bubble? Here’s What We Think. 

The post Options Trading: From Weed Killer to Profit Tiller appeared first on Option Sensei.