We came across a bearish thesis on Scotts Miracle-Gro Co (SMG) on ValueInvestorsClub by jet551. In this article, we will summarize the bears’ thesis on SMG. Scotts Miracle-Gro Co shares were trading at $74.06 when this thesis was published, vs. closing price of $70.98 on Aug 30.
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Scotts Miracle-Gro is a major player in the consumer lawn and garden industry, known for its flagship brands like Scotts, Miracle-Gro, Ortho, and Roundup. The company has a strong presence in the U.S., where its consumer segment accounts for 80% of its revenue. SMG’s products are widely distributed through key retailers, including Home Depot and Lowe’s, which collectively represent 43% of its sales. The business is highly seasonal, with the majority of its revenue generated in the spring and summer months. SMG also ventured into the cannabis industry through its Hawthorne hydroponics subsidiary, which now constitutes about 12% of its sales. However, this diversification has introduced significant challenges.
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The core U.S. consumer business, which has been the backbone of SMG’s success, is now facing serious headwinds. Over the past three years, the company has experienced declining revenue in this segment due to shrinking volumes. To achieve its ambitious 2024 growth targets, SMG is banking on a 10% volume growth, which seems increasingly unrealistic given current market conditions. The company is also under pressure from retailers to reduce prices, further straining its margins. Additionally, SMG’s attempts to expand into organic products have not resonated with consumers, and its competition is gaining ground in the more popular gardening and organic segments. This shift in consumer preferences, particularly among younger generations who are less interested in traditional lawn care, poses a long-term challenge to SMG’s growth.
The company’s foray into the cannabis market through Hawthorne has been a costly misstep. SMG invested heavily in this segment, spending around $1.5 billion on acquisitions. However, the anticipated demand from cannabis legalization did not materialize, leading to significant losses. In 2023, Hawthorne’s revenue fell dramatically, and the business reported a $50 million loss. Despite restructuring efforts, the outlook for Hawthorne remains bleak, with continued cash burn expected. Shutting down Hawthorne could improve SMG’s EBITDA, but this would be a significant blow to the CEO, who has familial ties to the subsidiary.
Compounding these operational issues is SMG’s over-levered balance sheet. The company’s net debt has ballooned to approximately seven times its EBITDA, severely limiting its operational flexibility. SMG has been forced to undertake significant cost-cutting measures, including mass layoffs and the closure of distribution facilities, to manage its debt. These actions have led to a loss of talent and have hindered the company’s ability to innovate, which is crucial given the shifting market dynamics.
Despite the challenges, SMG has set aggressive targets for 2024, including high single-digit revenue growth and a significant improvement in EBITDA. However, these targets appear overly optimistic given the company’s current struggles. The company’s reliance on one-time measures to boost cash flow, such as selling receivables and compensating employees with stock, raises concerns about its financial health.
Given the operational challenges, over-levered balance sheet, and unrealistic growth targets, SMG’s stock appears overvalued at its current levels. As these issues become more apparent, a significant downside in the stock price is likely, making it a strong candidate for selling.
SMG is not on our list of the 31 Most Popular Stocks Among Hedge Funds. As per our database, 28 hedge fund portfolios held SMG at the end of the second quarter which was 29 in the previous quarter. While we acknowledge the potential of SMG as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for an AI stock that is as promising as SMG but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.