EUR 850.00 For Business Accounts Only

Morningstar | Scotts Miracle Gro Shares Jump 7% Due to Marijuana Regulatory Boosts; FVE Unchanged. See Updated Analyst Note from 07 Nov 2018

Scotts Miracle-Gro reported tepid fourth-quarter results to round out what has been a challenging fiscal year. Total segment profits fell 17% year on year to $6.5 million. During fiscal 2018, Scotts' faced near-term headwinds related to adverse weather in the U.S. consumer segment and California-based regulatory challenges in the Hawthorne segment. However, with near-term headwinds abating, we continue to view Scotts as well-positioned to maintain its market-leading position in home gardening. Additionally, we anticipate that the company will grow its Hawthorne business as more states legalize marijuana.

In its earnings release, management guided to an adjusted EPS midpoint of $4.20, which is in line with our forecast, and 14% above fiscal 2018 earnings. Shares rallied 7% on the higher guidance as well as Tuesday's election results that featured the legalization of marijuana in three additional states. Voters in Michigan passed a bill legalizing recreational marijuana use, while Missouri and Utah passed initiatives legalizing medical use. Having updated our model to reflect the fourth-quarter results and management's 2019 guidance, we maintain our $85 per share fair value estimate for narrow-moat Scotts.

In the U.S. consumer segment, fiscal year operating profit was down about 5% versus 2017 due to the unusually cold spring that weighed on second-quarter results. Assuming normal weather conditions, we expect revenue in this segment to increase about 1.5% in 2019, in line with management guidance of 1%-2% for the year. Over the longer term, we expect sluggish growth, averaging around 1% through 2027. A buoyant housing environment will be offset by more intense competition as the industry shifts to an increasingly online marketplace.

The Hawthorne segment, meanwhile, is showing some signs of improvement as the business generated a small operating profit, after two quarters of losses due to regulatory challenges resulting from California's delayed issuance of marijuana growing licenses.

California, which comprises over half of total segment sales, is issuing licenses at the local level. This approach has slowed down the issuance of licenses, in turn weighing on Hawthorne’s financial results. We expect these short-term impacts to fade as more licenses have been issued in California. We also expect California's marijuana market to decrease as a percent of total national revenue as more states continue to pass legalization. With these challenges fading, the Hawthorne segment is well-positioned for revenue growth. Additionally, the cost-cutting program undertaken to integrate the Sunlight acquisition is on schedule, underpinning our forecast for margin improvement from 12% in 2017 to around 19% by 2025.