Boyar Value Group: Scott’s Miracle-Gro

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Boyar Value Group: Scott’s Miracle-Gro
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Below are Boyar Value Group‘s thoughts on the latest quarterly results of Scotts Miracle-Gro Co (NYSE:SMG).

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Recent Results

  • 4Q FY 2021 Results
    • Company wide sales decreased by 17% to $737.8 million (ahead of consensus at $680.8 million or a 23% decline) due to difficult comparisons with the prior year’s quarter robust growth and other quarterly dynamics (discussed below). SMG reported a loss of $0.82 a share in the quarter (ahead of consensus at $0.87 a share) compared with a profit of $0.06 a share in the year ago quarter.
    • In the U.S. Consumer business, sales decreased by 28% as it was facing an extremely difficult comp in the prior year when sales increased by 92%. Moreover, the current quarter had six fewer days than the year ago quarter. Excluding the calendar impact, U.S. Consumer sales were down by 23% (for more information on this, please do not hesitate to contact me directly).
    • Hawthorne Sales declined by 2% due to declines in its European and Canadian businesses. Excluding the calendar impact, Hawthorne sales increased by 5% including a more than 10% increase in sales of hydroponic products in the U.S.
    • Scott's Miracle-Gro’s 4Q FY 2021 gross margin of 17.4% represented a meaningful decline compared with the 24.3% in the prior year quarter. Decline of fixed cost leverage and higher distribution costs were the primary drivers of the gross margin decline, which was partially offset by pricing and decreased promotional activity net of increased material costs.
  • Full year FY 2021 Results
    • Company-wide sales in FY 2021 increased by 19% to $4.93 billion compared with $4.13 billion in FY 2020. Non-Gap earnings of $9.23 a share in FY 2021 were up from $7.24 a share in FY 2020.
    • Revenues within SMG’s U.S. consumer business increased by 11%, exceeding management’s most recent forecast calling for 7%-9% growth and on top of last year’s 25% growth in the U.S. Consumer segment. It should be noted that SMG’s initial sales outlook for FY 2021, which was communicated in late 2020 called for U.S. Consumer growth of flat to -5%.
    • Revenues within Hawthorne increased by 39% during the full year on top of a tough 64% comp in FY 2020.
    • Gross margins declined by about 270bps for the full year
      • Increase in commodity costs was the biggest reason for the decline
      • Distribution and mix (Hawthorne experienced strong growth and carries lower margins) also had an impact

Pricing (U.S. Consumer)

  • Scott's Miracle-Gro increased prices in the U.S. consumer business in August 2021 by 5% on average to offset higher costs from commodities such as urea, resin, grass seed and other commodities.
  • SMG has already communicated to its retail partners (i.e. it’s key customers like Home Depot and Lowe’s) that it will take additional pricing actions in January 2022 to deal with ongoing commodity headwinds. SMG intends to increase prices by a mid-single digit to a low double-digit rate. When combined with its August price increases, prices in FY 2022 are expected to be up in the high single digit % amount.

Outlook

  • SMG established its initial outlook for FY 2022, which consists of the following:
    • Company-wide sales are expected to increase by between 0% and 3%
      • U.S. Consumer sales expected to be between flat and -4.0%
        • Management seemed to express optimism that this projection for U.S. Consumer sales could be conservative and cited strong recent POS numbers to support its view (POS trends in 4Q and October were favorable)
      • Hawthorne sales are expected to increase by between 8% and 12% with most of the growth expected to occur in 2H FY 2012. The oversupply conditions are expected to provide a headwind in the near term though management notes these oversupply conditions are not as dire as 2018. In addition, management highlighted the perishable nature of the product, which would prevent the current supply issues from becoming a long-term issue.
    • Expecting 100-150 bps decline in full year company-wide gross margin in FY 2022
    • Adjusted EPS expected to be in the range of between $8.50 and $8.90 a share
    • SMG generated $165 million in FCF during FY 2021, but expects to generate ~$300 million in FY 2022
      • Capex, Inventory and outsized variable comp payout impacted FY 2021 FCF
  • SMG stated that it believed the longer-term outlook for its U.S. Consumer business is now in the 2-4% range with FY 2022 being a reset year.

5 Year Objectives

  • Scott's Miracle-Gro stated that it had exceeded all its objectives under is prior long-term plan including FCF of $1.5 billion, total shareholder return of 10-12%, enterprise growth of ~4% to 6%, etc.
  • With SMG at the end of its prior 5-year plan the Company detailed five strategic pillars to drive growth over the next five years including:
    • Pillar 1: Higher levels of sustainable growth for the U.S. Consumer Business
    • Pillar 2: Further growth in DTC
      • DTC currently accounts for approximately 10% of total revenues
      • More than just selling items on the website
        • Working with retailers to help them sell more online
        • Investing to improve technology
      • Also focusing on online native brands
        • Success with Aerogrow should help with other niche brands
    • Pillar 3: Live goods (plants, herbs, flowers, etc.)
      • SMG wants to be known as a gardening company rather than just a gardening supply company
      • SMG believes it can do better
      • Looking to pursue other opportunities with AFC (Alabama Farm Cooperative) that have significant potential
      • Investing in DTC capabilities for live goods
    • Pillar 4: In terms of the Hawthorne business, SMG stated that it is imperative to put the commercial grower at the center of everything it does. Therefore, SMG must continue to drive innovation and grow its technical solutions.
      • Competitors will not be able to replicate the Hawthorne model
    • Pillar 5: Participate in innovative growth in the cannabis industry
      • To this end it set up Hawthorne Collective to make investments in other cannabis businesses with ultimately an option to convert to an equity stake as regulatory issues permit. Examples of this include the Company’s investment in RIV Capital and Dewey Scientific
      • Management stated a desire to step up M&A as potential deals are becoming more attractive.
  • SMG believes that it could double the size of its business in 5 years if it is able to capitalize on its various opportunities.

Hawthorne Separation?

  • Although nothing is imminent, Scott's Miracle-Gro management expressed a desire to separate the Hawthorne business for the first time
  • When asked about management’s growing confidence in a potential Hawthorne separation, CEO Hagedorn stated, “Dude, like, I could go on for an hour on that one.”
  • Separation likely to occur in the next 1-2 years

Balance Sheet, Free Cash Flow and Capital Allocation

  • Scott's Miracle-Gro’s leverage at the end of 4Q FY 2021 was 2.7x, which is below the Company’s targeted range of 3.5x
  • SMG has committed to repurchasing $300 million in shares in FY 2022
    • $113 million in shares were purchased in FY 2021
  • SMG also expects to pursue M&A in both U.S. Consumer and Hawthorne

Miscellaneous

  • Succession planning and ESG initiatives a priority for the Company
    • Mike Lukemire, current COO, transitioning to a strategy role at the company
      • Two executives are taking over for Mike to run U.S. Consumer (Josh Peoples and Dave Swihart
  • SMG’s core business will benefit from favorable demographics for years to come
    • 30-year-old couple has the potential to stay with the Company’s products for 20 year or longer
  • Many commodities are at multi-year highs
    • SMG believes that they will likely flatten out

Scott's Miracle-Gro: Valuation

We continue to estimate an intrinsic value for Scott's Miracle-Gro of approximately $244 a share, representing ~50% upside from current levels. At current levels, investors are effectively acquiring a branded consumer products business with good growth opportunities at a private market value and acquiring a cannabis/hydroponics business at just ~1x sales, but whose value is significantly higher in our opinion. Indeed, valuing Hawthorne at just 2.5-3.0x our projected FY 2024 sales amount produces nearly $80 a share in additional value relative to the current share price. Management’s growing confidence in separating Hawthorne coupled with a commitment to return a significant amount of value to shareholder via buybacks in the near term (~$300 million) should go a long way toward narrowing the discount between the Company’s share price and our estimate of its intrinsic value.

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Jacob Wolinsky is the founder of ValueWalk.com, a popular value investing and hedge fund focused investment website. Jacob worked as an equity analyst first at a micro-cap focused private equity firm, followed by a stint at a smid cap focused research shop. Jacob lives with his wife and four kids in Passaic NJ. - Email: jacob(at)valuewalk.com - Twitter username: JacobWolinsky - Full Disclosure: I do not purchase any equities anymore to avoid even the appearance of a conflict of interest and because at times I may receive grey areas of insider information. I have a few existing holdings from years ago, but I have sold off most of the equities and now only purchase mutual funds and some ETFs. I also own a few grams of Gold and Silver
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