4 Hydroponics Stocks for Indoor Farming Investors
It’s exceedingly difficult to find insightful research these days, particularly for investment themes that are popular amongst the status quo. For example, everyone has an opinion about cryptocurrencies. If they don’t, someone will be giving them one soon enough. Real insights become diluted by drivel, and the fracas masks the con men coming out of the woodwork. That’s why it’s especially important to tread cautiously when dabbling in areas such as crypto, psychedelics, and cannabis.
One firm that always offers grounded insights is Key Investment Partners, an investment management firm focused on providing growth capital to early-stage cannabis companies. We’ve written about their ancillary cannabis investing thesis which proposes that pick-and-shovel stocks are the best way to invest in an industry with a high degree of regulatory risk.
More recently, Key Investment Partners released a report titled “Why do Bubbles Burst in Emerging Sectors like Crypto, Cannabis & Psychedelics?” which contained the below chart showing how much weed is being sold in America these days:
Just because people are buying lots of weed doesn’t mean you would have made mint investing in cannabis stocks.
“No to Marijuana Stocks, Yes to Weed Investing,” was the first article we ever wrote about cannabis stocks which warned about the proliferation of crappy stocks looking to cash in on the bubonic chronic boom. Since the day that article was published, the longest living cannabis benchmark, the Horizons Marijuana Life Sciences Index ETF (HMMJ), returned +12% compared to a Nasdaq return of +130% over the same time frame. Like solar stocks did for so many years, cannabis stocks have lagged while the industry has gone full steam ahead.
The Key Investment Partners paper concludes with some good advice – investors who do not have the bandwidth or resources to develop deep domain expertise in these emerging sectors should avoid them all together, or partner with a firm that knows the space (wink wink, nudge nudge). Today, we’re going to talk about four pick-and-shovel plays on indoor farming, something that’s been very popular for several reasons.
Cannabis and Indoor Farming
The best strain of weed ever grown was brought into this world using hydroponics, a popular method of indoor growing that uses water to provide nutrients to plants instead of soil. Even if you don’t puff the magic dragon, you probably know a bit about indoor farms because they’ve been sprouting up around the globe. Investors have been pouring money into the idea of localized food produced on small land footprints with superior yields. While it remains to be seen if localized agriculture is economically viable, indoor farming can be broken down into two categories:
- Indoor farms that grow stuff you eat
- Indoor farms that grow stuff you smoke
In our last piece on vertical farming – Vertical Farming Companies See Funding Drought – we talked about the need for investors to reap some of their own green before they commit more dollars. Point is, we don’t know the extent to which indoor agriculture is driving the demand for hydroponics equipment vs. all the cannabis grow rooms with delicious smells wafting out of them. Companies like ScottsMiracle-Gro decline to disclose what percentage of their indoor farming sales are attributed to cannabis, and perhaps they don’t know. An indoor farming equipment supplier we met with on our New Zealand agtech trip, Bluelab, said the supply chain doesn’t necessarily provide visibility into who the buyer is. This makes it very difficult to figure out where your indoor farming exposure is coming from – vertical farming or cannabis.
We know that lots of cannabis are being grown and sold. We also know that cannabis has always been grown and sold, and those black market growers purchase hydroponics equipment too, perhaps not at a commercial scale, but it still needs to be considered. As you entertain hydroponics as an investment theme, remember that if indoor farming turns out to never achieve widespread commercial viability, hydroponics stocks will be affected. In the meantime, the future looks bright for hydroponics in the U.S. which represents approximately 30% of the total global hydroponics market.
4 Hydroponics Stocks
This is not meant to be an exhaustive list of every Podunk over-the-counter (OTC) company with a team and a dream, but rather a list of stocks that provide good pure-play exposure to the hydroponics theme.
“Currently we are the largest hydroponics supplier in the country with 55 retail and distribution centers,” says GrowGeneration (GRGW), a $2.5 billion company out of Denver that’s growing like a weed. Check out the below yearly and quarterly revenue growth (Q1-2021 was missing so we doctored it – that’s supposed to be $90 million).
The company has strategic partnerships with the biggest brand names in the industry, and offers a direct-to-farm delivery service along with equipment financing. In 2020, around 60% of revenues came from consumables. Unlike other companies, GRGW isn’t afraid to talk about the cannabis hydroponics opportunity in their investment deck. The company is expanding by opening new stores and acquiring existing ones. This is one stock we’ll be coming back around to take a closer look at.
The company that refers to itself as “a 40 year-old startup” is more forthcoming about how “a majority” of their 6,000 different products are being used by cannabis farmers.” “Hydrofarm Holdings Group (HYFM) is an attractive stock for anyone wanting to play the cannabis theme without taking on regulatory risk,” was our conclusion when we wrote about them last November in a piece titled “Investing in Hydroponics with Hydrofarm Stock.” Similar to GRGW, approximately two-thirds of Hydrofarm’s net sales are generated from recurring consumable products including growing media, nutrients, and supplies. This is particularly important when all the capital equipment expenditures die down once all the
grow rooms indoor farms get built across the United States.
The company would be a whole lot easier to follow if they slapped their quarterly/yearly results in a deck instead of expecting people to watch webcasts, or sift through press releases. A generic investor deck would probably make sense as well. (See the GrowGeneration investor deck for inspiration.) Retail investors should only invest in what they can easily understand and follow. Not everyone has a team of overworked and underpaid MBAs at their beck and call.
The biggest stock in our list, ScottsMiracle-Gro (SMG), isn’t a pure-play, but still worth mentioning given their traction in hydroponics. Last January, we wrote about The Impact of Cannabis on ScottsMiracle-Gro, noting that their indoor farming and hydroponics segment (Hawthorne) accounted for around 20% of total revenues, the rest being the U.S. consumer. In looking at Scotts’ latest Q2-2021 results, we see the percentage staying the same, but the number growing. Remarkably, Hawthorne reported their fifth consecutive quarter of sales growth in excess of 60%, with the momentum expected to continue. Says the company:
We feel comfortable once again increasing our sales guidance for Hawthorne to a range of 30 to 40 percent growth on a fiscal year basis.Credit: ScottsMiracle-Gro
One takeaway so far is that hydroponics is experiencing lots of growth across all industry participants. Is there enough total addressable market (TAM) left to allow growth to continue? Keep reading to find out.
The last name in our list, iPower (IPW), also happens to be the smallest with a market cap of just under $200 million. We don’t invest in companies under $1 billion in size, but given iPower’s recent initial public offering (IPO), we decided to give them a brief mention. We say brief because their business model looks fragile. They talk about their website, www.Zenhydro.com, which sells 23,000 different stock keeping units (SKUs). Then, they say this:
In addition to iPower’s website, www.Zenhydro.com, we sell our products through third party e-commerce channels including Amazon, eBay and Walmart.com. Approximately 75% of our fiscal 2020 sales revenues were derived from sales on Amazon and other third-party platforms.iPower S-1 Filing
iPower goes on to say that more than 50% of their sales come from Amazon, and that Google and social media advertising are the primary ways they drive traffic to their own marketplace. We could whip out Porter’s Five Forces and start talking about “threat of substitutes,” but we’re pretty confident we know the answer already. This isn’t the sort of company we’d invest in, regardless of size.
GRGW vs HYFM vs IPW vs SMG
A subscriber recently asked us what it meant to approach a company “like an MBA case study,” something we often do. It means taking a limited set of information and using it to make an informed decision in a reasonable amount of time (usually, the time it takes to write a 1,500-word research piece). Weak business model aside, iPower doesn’t meet our minimum market cap requirement of $1 billion, so they’re dropped. ScottsMiracle-Gro isn’t a pure-play in hydroponics with the majority of their revenues coming from a fickle animal – the U.S. consumer. That leaves us with Hydrofarm and GrowGeneration, both of which we like based on what we’ve seen so far. Here’s how all four hydroponics companies stack up using our simple valuation ratio – market cap / annualized revenues.
|Company||Market Cap||Revenue Data||Annualized Revenues||Valuation Ratio|
None of these companies would be considered richly valued, and all are in the same ballpark except Miracle-Gro which only attributed 20% of Q2-2021 revenues ($383 million) to their indoor farming and hydroponics segment. If we annualize this number and compare it to the other three companies, we see ScottsMiracle-Gro clearly in the lead with over $1.5 billion in indoor farming and hydroponics revenues.
- ScottsMiracle-Gro – $1,532 million
- Hydrofarm Holdings – $445 million
- GrowGeneration – $360 million
- iPower – $39 million
If we add up all the hydroponics revenues for all four companies, we get $2.376 billion, or about a quarter of the estimated $10 billion U.S. hydroponics market in 2021. That’s quite a bit of penetration and not a lot of blue ocean.
As these companies aggressively consolidate the fragmented market through acquisitions, growth will eventually stall, and consumables will become an increasingly important part of their business models. Until then, expect the land grabbing to continue.
There are plenty of other companies selling hydroponics equipment. If you remove all those that trade on OTC markets, those that are also plant-touching, and those with a market cap under $1 billion, the list of suitable candidates gets quite small. Of these four hydroponics stocks, GrowGeneration seems the most compelling. In a future piece, we’ll dig into the company a bit more and see if it merits a place in our own portfolio of tech stocks.
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