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Morningstar | Raising Scotts Miracle-Gro FVE to $87 on Higher Near-Term Profit Outlook; Shares Fairly Valued

Scotts Miracle-Gro reported solid fiscal second-quarter results, as higher profits in the U.S. consumer segment and a continued recovery in the Hawthorne business drove 25% year-on-year operating income growth to $290 million. Although management reaffirmed full-year adjusted EPS guidance of $4.10 to $4.30, we have increased our near-term outlook. We now forecast fiscal 2019 adjusted EPS to come in above management's range at $4.40 per share. Having updated our model to reflect these changes, we've increased our fair value estimate for Scotts Miracle-Gro to $87 per share from $86. Our narrow moat rating remains intact.

In the U.S. consumer business, segment operating profit grew nearly 12% year on year to $320 million, driven by higher volumes across nearly all U.S. lawn care and weed control product categories. In the company's earnings release, management called out a 20% year-on-year increase in Roundup products. There is still a long-term risk that some consumers may turn away from Roundup over public scrutiny from the lawsuits against Bayer. However, we maintain our base case that this will not have a material impact on Scotts, as the company sells alternative nonglyphosate based herbicides like GroundClear. As such, we think Scotts is well-positioned to make up any potential lost sales with its other herbicide products should consumers shun Roundup.

In the Hawthorne business, revenue increased 5% year on year, excluding the impact of acquisitions. Operating margins were 7.1% versus negative 11.5% in the prior-year period and 3.1% in the first quarter of fiscal 2019. In our view, this signals that the cannabis industry is continuing to recover from oversupply conditions in 2018 resulting from California's issuance of marijuana growing licenses at a slower-than-expected pace. We expect further operating margin expansion as market conditions continue to improve.