EUR 850.00 For Business Accounts Only

Morningstar | Scotts Miracle-Gro Reports Improving Hawthorne Results to Start Fiscal 2019; Raising FVE to $86. See Updated Analyst Note from 30 Jan 2019

Our key takeaway from Scotts Miracle-Gro's fiscal first quarter 2019 was the improving Hawthorne results. Subsequently, we have slightly increased our near-term outlook for the Hawthorne segment. Although management maintained an adjusted EPS guidance range of $4.10-$4.30 for fiscal 2019, we now forecast Scotts to come in at the high end of the guidance range, versus our previous forecast just below the midpoint. Our long-term outlook remains intact, leading to only a slight increase in our fair value estimate to $86 per share from $85. Our narrow moat rating is unchanged.

The Hawthorne business struggled in fiscal 2018 due to regulatory challenges in California related to the delayed issuance of marijuana growing licenses. The delay caused growers to hold off on purchasing growing equipment, which led to an oversupply throughout the entire marijuana growing industry. While fiscal first-quarter 2019 segment operating margins of 3.1% are still well below our long-term expectations, it was better than any quarter during fiscal-year 2018. Further, we are encouraged by management's expectations for organic growth in the second half of 2019 as regulatory headwinds are starting to abate.

As growing licenses were issued and inventory levels are falling throughout the entire supply chain, we expect that continued demand growth will allow the industry to return to balance in 2019. Further, new states, such as Massachusetts, recently legalized recreational marijuana and issued growing licenses, which has boosted demand for Hawthorne's products. Over the long-term, we continue to think that Scotts is well positioned to benefit from the increased legalization of recreational marijuana.

In the U.S. Consumer segment, sales were up 9% year on year to $137 million during the quarter, however, we note that the first quarter typically accounts for well under 10% of total sales each year.

We also note that Scotts has begun to embrace the shift to a greater proportion of online sales in the gardening industry with Amazon retail accounts for all of its major brands and plans to enhance its own retail website. We are in favor of Scotts' strategic change to embrace online sales as we forecast that many lighter and cheaper to ship products, such as home defense products, will continue to see a greater proportion of sales made online.

That said, we continue to forecast greater online sales will somewhat deteriorate the company's pricing power as Scotts will likely face greater competition online from lower priced products. While Scotts' shift online will help preserve the company's market share, the weaker pricing power in an online environment underpins our negative moat trend rating.