Scotts Miracle-Gro Earnings: Stock Dives After Management Cuts Outlook on Hawthorne Weakness

We reduce our fair value estimate to $110 per share from $115 after updating our model to incorporate Scotts Miracle-Gro’s SMG fiscal 2023 second-quarter results. Our narrow moat rating is unchanged.

Scotts shares plunged 8% on the day on management’s reduced guidance largely due to lower results in the Hawthorne business. At current prices, we view Scotts’ shares as materially undervalued with the stock trading in 5-star territory and more than 40% below our updated fair value estimate. Additionally, shares trade just above our downside scenario, which produces a $60 per share fair value estimate. Our downside scenario assumes revenue continues to decline as Scotts sees volumes fall across both segments, with margins remaining below historical levels. Accordingly, for long-term investors, we see the current share price as a strong opportunity to pick up shares of the company with a solid margin of safety.

We also cut our Capital Allocation Rating to Poor from Standard, based on our framework that assesses the balance sheet, investment decisions, and shareholder distributions. Scotts has a weak balance sheet due to overinvestment at peak cyclical conditions in both the U.S. consumer and Hawthorne businesses. This led to elevated debt levels and we expect debt will remain above management’s long-term targets over the next few years.

Further, in our view, management’s investment strategy in both the U.S. consumer business and Hawthorne has hurt shareholders. In general, we think management took a near-term focus, investing heavily at peak cyclical conditions instead of positioning the business for long-term success. As a result, we do not have confidence management’s investment will add long-term value to shareholders.