Cannabis Should Still Spread Miracle-Gro on Scotts Stock

Will Healy

Updated Sat, Aug 4, 2018, 6:21 PM

Scotts Miracle-Gro (NYSE:SMG) fell in Wednesday trading following its third-quarter report. Although earnings beat estimates, revenue from its cannabis division, as well as the revenues from the overall company, did not sit well with investors. The CEO’s behavior on the call probably rattled investors further.

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However, this temporary setback could provide investors the chance to buy into the cannabis industry through SMG stock at a lower multiple.

Earnings Overshadow by Revenue Miss, CEO Behavior

For its third quarter, Scott’s reported earnings per share of $2.67. Wall Street expected EPS of $2.58. SMG stock reported EPS of $2.47 in the same quarter last year. However, revenues of $994.6 million fell below estimates. While this number represents a 2.2% year-over-year growth rate, analysts had expected $1 billion in revenue.

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Despite earnings and revenue, few will remember this earnings report for the numbers. Much of the news on the call revolved around Hawthorne, the division of Scotts operating in the cannabis industry. During the call, Scotts reported a 37% year-over-year revenue decline for Hawthorne. It also said Hawthorne would fall short of its $120 million income goal. This led to CEO Jim Hagedorn to express his feelings about Hawthorne using colorful language that attracted a high level of attention. Results of the call led to SMG stock falling by 3.5% in Wednesday trading.

Growth of SMG Stock Tied to Cannabis

Mr. Hagedorn’s excessive cursing on the conference call will not win him any “CEO of the Year” awards. However, his anger brings up an important point. Saying one owns SMG stock because they like pretty lawns is a lot like telling everyone that they read Playboy for the articles. Although lawn fertilizer will continue to sell, marijuana will serve as the company’s primary growth driver for now.

Hence, the lack of performance in this area should concern investors as much as it troubles Mr. Hagedorn. Investors can tie the lagging sales to its California market. California currently makes up over half of Hawthorne’s revenue. The state’s slowness in granting growing licenses to producers combined with a recent supply glut led to the sales decline. The company remains optimistic that growers will clear this hurdle and sales growth will resume. Hawthorne also continues to integrate a recent acquisition. Earlier this year, Scotts acquired Sunlight Supply, a provider of hydroponics supplies.

Should Investors Buy SMG Stock?

The question is: Where does this leave investors? Hawthorne’s dramatic sales decline appears unlikely to repeat. Mr. Hagedorn remains confident that New Jersey is moving toward full legalization. He also believes New York and Connecticut will soon follow suit. These moves would reduce dependence on California.

Analysts also forecast revenue and earnings growth to resume next year. Wall Street predicts earnings growth of 14.2% for next year and 11.75% for 2020. They also predict earnings for the current year to come in at $3.80 per share. This would take the forward price-to-earnings ratio to 20.7.

Such a multiple would likely not motivate investors of a pure-play lawn fertilizer company. However, such a valuation compares well to cannabis companies such as Canopy Growth (NYSE:CGC), Aurora Cannabis (OTCMKTS:ACBFF), or Cronos Group (NASDAQ:CRON). SMG stock offers investors the chance to profit from this industry while buying in at a multiple that will appear sane to more value investors. Given the mix of stability and growth that Scotts offers, SMG stock should perform well for now.

Final Thoughts on SMG Stock

The temporary sales drop seen by the Hawthorne division of Scotts allows investors to buy into the cannabis industry at a relatively low valuation.

No, a revenue miss bad enough to inspire the CEO to curse on a conference call will not reassure investors. However, Hawthorne’s poor revenue numbers will likely not repeat in future quarters. In fact, more states will probably legalize marijuana soon. This should help Hawthorne’s revenues move higher in the coming quarters.

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Also, the valuation of SMG stock remains low compared with most pure-play marijuana producers. For those who want to invest in cannabis while enjoying the stability of its more stable lawn fertilizer business, SMG stock stands as a viable option.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.