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Morningstar | Raising our Scotts Miracle Gro FVE to $100 on Improved Hawthorne Outlook; Shares Fairly Valued. See Updated Analyst Note from 19 Jul 2019

We revisited our outlook for Scotts Miracle Gro's Hawthorne segment to fully incorporate our cannabis forecasts. Hawthorne is the top supplier of hydroponic cultivation equipment and has an estimated market share of 40%-50%, depending on the product. We expect the cannabis industry to grow by 9 times through 2030 amid widening legalization and increased participation in the U.S. and Canadian markets. Having updated our model to incorporate our improved outlook, we raised our Scotts fair value estimate to $100 per share from $88. Our narrow-moat rating is intact. With the stock trading just above our fair value estimate, we view shares as fairly valued.

For the U.S., recreational and medicinal cannabis has penetrated just 8% and 21% of their estimated markets, and we forecast 25% and 15% annual growth through 2030, respectively. For Canada, despite recent recreational legalization, cannabis has penetrated just 12% of our estimated market, and we forecast a 20% annual growth through 2030.

We think Hawthorne is well-positioned to take advantage of increased demand for indoor gardening equipment stemming from the legalization of cannabis. We forecast Hawthorne’s revenue to grow about 5 times over the next decade. Scotts is currently pursuing a volume over price strategy by offering discounts on its Hawthorne equipment in order to gain market share within the hydroponics industry. As a result, Hawthorne should generate an increasing proportion of total company profits, growing from roughly 10% in 2017 to over 40% by 2028.

While Scotts’ brand recognition provides considerable pricing power, we continue to point to the retail industry’s shift to an online market that will apply some downward pressure to pricing, underpinning our negative moat trend. For Hawthorne, we see no strengthening or weakening moat sources and view the business as stable from a moat trend perspective. Although we see a slight weakening of Scotts' pricing power in the future, our narrow-moat rating remains firmly intact. We continue to think that Scotts' consumer gardening products will command enough pricing power for the firm to outearn its cost of capital over at least the next decade.

For more details on the cannabis industry and our market forecasts, please see our Observer, “Green Rush: Cannabis Market Will Grow by 9 Times by 2030 Amid Widening Legalization.”