Scotts Miracle-Gro: Cannabis Angle Is Already Fully Priced In

Summary

Scotts Miracle-Gro guides to grow its topline in the year ahead 2% y/y.

Supply chain issues led Scotts Miracle-Gro to aggressively grow inventory, causing a drag on free cash flow.

Looking ahead, SMG stock is richly priced at more than 20x forward free cash flow.

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ArtistGNDphotography/E+ via Getty Images Investment Thesis

Scotts Miracle-Gro ( SMG ) clearly benefitted from the stay-at-home economy, with its top-line growth rates over the past 15 months soaring higher before ending lower in Q4 2021.

In an open and frank discussion, Scotts Miracle CEO highlights the company’s vision to return to solid sustainable growth, while highlighting its desire for profitability and prudent capital allocation, including buybacks.

All that being said, the shares are not cheap enough to entice this investor to get involved here. Revenue Growth Rates Highly Choppy For Scotts Miracle-Gro

Source: author’s calculations; **company guidance

As you can see above, Scotts Miracle’s revenue growth rates have been all over the place of late. And this has a meaningful impact when it comes to valuing the company. As we look ahead to fiscal 2022, Scott Miracle is guided to grow its top-line by approximately 2% y/y.

For a company that just finished fiscal 2021 with a positive 19% of revenue growth for the year as a whole, its guidance for the year ahead of 2% y/y of revenue growth is hardly attractive enough for new investors to get involved here.

That being said, if we consider just how strong Q4 2020 was for Scott Miracle, with its topline growing by 79% y/y, for Scotts Miracle to come up against that tough revenue comparison and only be down 17% y/y, is certainly noteworthy.

Hence, there’s more to the story than meets the eye. Why Scotts Miracle? Why Now?

One part of the bullish thesis behind Scotts Miracle is that through its US Consumer segment, Scotts Miracle can reach a new generation of consumers that’s focused on homeownership. Thus, during a recent earnings call , management noted that this segment is expected to grow by 2% to 4% annually long-term.

The crown jewel of the investment thesis that gets investors particularly excited is its Hawthorn segment. This segment has exposure to cannabis, as, through its hydroponic gardening products, end-users grow cannabis. ( Source ): Fiscal 2020 (the prior year)

Observe above how strong fiscal 2020 finished, particularly the Hawthorn segment, which was up 61% y/y.

And now note below how that trend continued strong into fiscal 2021: ( Source )

Thus, as you can see here, there’s clearly a growth story coming out of its Hawthorn segment. Source: author’s calculations What’s more, as you can see above, for Q4 2021, the Hawthorn segment now accounts for nearly half of Scotts Miracle’s total revenues. Thus, it’s not inconceivable that very soon, Scotts Miracle’s underlying business will be driven mostly by its Hawthorn segment, with exposure to cannabis. Next, let’s analyze its profit margins. Scotts Miracle’s Profitability Margins Are Thin ( Source )As you can see here, during the bountiful period of fiscal 2020, Scotts Miracle’s free cash flow margins were 12%. That’s essentially as good as it’s ever going to reach.Meanwhile, for fiscal 2021, Scotts Miracle’s free cash flow margins contracted to 3%.Yes, there have been supply disruptions that led the company to a massive ramp-up in inventory to ensure that customers had access to products. However, even in a normalized environment starting the second half of 2022, it’s difficult to imagine how Scotts Miracle could return to much more than 8% free cash flow margins.Thus, over the next 12 to 18 months, in the best case, Scotts Miracle’s free cash flow would probably reach $400 million. SMG Stock Valuation – Not That Cheap Scotts Miracle is valued at approximately $9 billion, meaning that it’s priced at approximately 23x forward best-case free cash flow.And while I get the story that cannabis is the attractive angle that would get investors positively enchanted towards this investment, I’m still not convinced that paying more than 20x forward free cash flow for a business that’s not likely to sustainably grow at more than 10% CAGR on a long-term basis is all that cheap. The Bottom Line Scotts Miracle benefitted from the COVID bump as consumers took to gardening. The big question that remains outstanding is how much of that increase in consumer passion for gardening will Scotts Miracle be able […]

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