Scotts Miracle-Gro has a dominant franchise in the consumer lawn and garden market, and it has a fast-growing hydroponics business catering mainly to the marijuana industry.
A beneficiary of the stay-at-home trend during the pandemic, Scotts (ticker: SMG) has seen its stock fall over 40% from an April high to a recent $146. Investors have worried about lower consumer demand in 2022 and narrower profit margins.
Yet the stock looks inexpensive, trading for 17 times projected earnings of $8.61 a share in the company’s fiscal year ending in September 2022. The dividend yield is 1.8%.
“Scotts has a fantastic consumer franchise,” says Jon Boyar, a principal at Boyar Value Group, which holds the stock. “At the current stock price, you’re effectively getting the hydroponics business for free.” He values the two businesses at more than $200 a share.
A split of the businesses would probably boost the stock, but the company has said it isn’t interested in such a move now. “It could get to the point where strategically it makes more sense,” says Jim King, head of public and investor relations at Scotts.
|Market Value (bil)||$8.1|
|Net Debt (bil)||$2.1|
|Top Holder||Hagedorn family (26%)|
Note: Fiscal year ends in September. E=estimate
Sources: Bloomberg; company reports
It would be tough for activists to target Scotts and try to force a breakup, because the Hagedorn family controls about 26% of the stock. Scotts has a market value of $8.1 billion, plus $2.1 billion of net debt.
“We think the stock has overcorrected and will probably step up our share repurchases as a result,” King says. The company has a $750 million buyback authorization and has allocated $250 million for the coming months.
Its brands, like Turf Builder lawn fertilizer and Miracle-Gro plant nutrients, have market shares that range from the mid-40s to the mid-60s, better than
Scotts got a huge boost during the pandemic as an estimated 20 million U.S. households took up lawn care and gardening or resumed those pursuits. The company has estimated that about 75% of those households will stick.
“Everyone was stuck at home and staring out of their windows at their lawns with stimulus checks in hand,” says Joe Altobello, a Raymond James analyst. “It’s not surprising that millions of households entered the category.” He has a Strong Buy rating and a $200 price target on the stock.
As millennials embrace homeownership, it’s creating a new generation of Scotts customers, and they’re taking up gardening and lawn care at higher levels than baby boomers, the company says. Another plus is the migration of Americans to the Sun Belt, where the growing season is longer than in the Northeast or Midwest.
On an earnings conference call in August, CEO Jim Hagedorn noted that Scotts “picked up a nearly decade’s worth of growth in a year” in its consumer business during the fiscal year ended in September 2020, as sales grew 24% against an average of 2% annually in the prior 10 years.
The company is projecting sales growth of 7% to 9% for the consumer business in the current fiscal year ending on Sept. 30, but expects a “slight decline” in the coming year, Hagedorn said. Longer term, the company sees 2% to 4% annual sales growth in the division.
Andrew Carter, a Stifel analyst, sees Scotts generating low-double digit annual earnings growth after profits normalize in the 2022 fiscal year. The stock, he argues, looks cheap, trading at a roughly 13% discount to the consumer-staples group.
The stock’s weakness reflects a deteriorating near-term profit outlook. The company’s earnings are expected to fall to $8.61 a share in fiscal 2022 from an estimated $9.20 a share in the current year.
Commodity inflation for inputs like resin and urea is depressing margins, which fell five percentage points in the most recent quarter. Scotts increased prices by an average of 5% in August to offset the commodity increases and may take further increases.
Without potential catalysts until the 2022 spring planting season, some investors see little reason to buy now, Altobello says.
In 2015, Scotts started a hydroponics business that sells lighting, nutrients, and other products, mainly to marijuana growers who favor the controlled conditions of greenhouses. (Hydroponic farming doesn’t involve soil.) The division, called Hawthorne, is now the industry leader by a wide margin, enjoying 60% sales growth in the nine months ended in June, to $1.1 billion, or about 25% of total revenue.
Hawthorne’s growth, however, is expected slow, to a range of zero to 15%, in the current period because of an oversupply of marijuana in California, which accounts for about half of Hawthorne’s sales.
Still, Hawthorne’s multiyear prospects look strong, as just 18 states have legalized recreational adult use of marijuana—it remains illegal at the federal level. Altobello sees 15% sales growth in the coming fiscal year and 10% to 15% annually longer term.
Hydrofarm Holdings Group (HYFM), the No. 2 player in hydroponics, is less than half the size of Hawthorne and is valued at $1.8 billion, or more than 40 times estimated 2021 earnings. Altobello values Hawthorne at more than $4 billion.
It’s unusual to find a company like Scotts with two leading consumer-oriented businesses that have favorable demographic underpinnings and whose stock trades below 20 times forward earnings.
Those are the seeds for what could be a growth story for investors.
Write to Andrew Bary at firstname.lastname@example.org