Scotts Miracle-Gro

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Scotts Miracle-Gro is a manufacturer and marketer of branded consumer lawn and garden products in North America and in other global regions, including hydroponic growing equipment for cannabis and indoor gardening.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Scotts Miracle-Gro operates through three main business segments: U.S. Consumer, Hawthorne, and Other.

U.S. Consumer: This segment sells products to end consumers through retail and online channels primarily in North America, which represents the vast majority of their business. They offer a variety of branded products, including fertilizers, pest control products, lawn care, and growing mediums. This segment also handles sales of grass seed, and other plant-growing products. It accounts for the largest portion of the company’s overall revenue, and is exposed to a high degree of seasonality.
Hawthorne: This segment mainly sells hydroponic and horticultural products used in controlled environment agriculture in North America. These products include lighting, nutrients, growing media, and other indoor growing systems. In this segment there is a degree of regulatory uncertainty and that is a big challenge the company faces.
Other: This segment includes the global production and distribution of lawn care, growing media, and other products outside of North America. The geographical presence spans from Europe to South America, to the Asia Pacific region. In the last year this segment saw significant losses.

Recent Trends and Industry Insights: The consumer lawn and garden market has seen a trend of increasing spending during the spring/summer seasons, especially with more people staying at home and focusing on their home surroundings and gardens. This industry typically follows seasonal demand and sales spikes are common in spring and summer. However, there is an increasing interest in hydroponic growing, leading to a growing demand for their products in the Hawthorne segment. The competitive landscape is fragmented with big brands as well as some smaller local brands. There is a mix of established players and new entrants, and competition for shelf space is high. The big players compete more on price while small players have competitive advantages due to having a unique product or business.

What Makes Scotts Miracle-Gro Different: Scotts Miracle-Gro is a leader in the lawn and garden market, primarily due to its established brands like “Scotts”, “Miracle-Gro”, and “Ortho.” This brand recognition and its expansive distribution network give them a level of market power. They also have the capacity to offer a diverse range of products, from the basics to more specialized ones. With the Hawthorne segment, the company’s focus on supplying the emerging controlled-environment agriculture market gives it a headstart in a potential high-growth area.

Moat Rating: 2/5 Scotts Miracle-Gro has a narrow moat, primarily based on its established brands and extensive distribution network. Although a strong moat, this is not a wide moat due to low switching costs, high competitiveness, and ease of substitutes.

Brands: The brands, like “Scotts” and “Miracle-Gro”, have high customer awareness and loyalty, and are highly advertised. They also enjoy a premium pricing on average.
Distribution Network: They have an extensive network of retailers and distributors, giving them the ability to push their products through. This is very costly for competitors to replicate.
Low Switching costs: Switching costs in the industry are low. Consumers can easily choose another brand or buy generic substitutes at a similar or lower price.
Competition: There is high competition in the industry, with both big players and local smaller brands. Any new business can easily create their products and market them locally.
Ease of Substitutes: There are many generic substitutes available, at lower prices. If consumers become overly price conscious, they will shift to the cheaper options, eroding margins.

Risks to the Moat and Resilience: Several factors threaten SMG’s moat and business resilience:

Weather Patterns & Seasonality: The weather strongly affects the lawn and garden segment, affecting revenue.
Commodity prices: Raw material costs can cause pricing pressures and increase input costs.
Competition: High competition can lead to price wars, lowering profitability, and also to less market share.
Regulatory Risks - In the Hawthorne segment, the company is dealing with legal and regulatory risks. The regulatory risk and scrutiny is increasing in recent times.
Slow Growth: The U.S. consumer business is growing slowly, because the market is becoming more saturated.
Supply Chain Issues The Company is still working through supply chain challenges which has affected pricing, sales, and margins.

The business has a decent level of resilience because the company is involved in consumer staple industries. They also have high brand loyalty. However, many external factors will determine their earnings.

Financials: Scotts Miracle-Gro’s financials reveal a company that is going through a time of restructuring and transition. Here is a breakdown of the key trends and metrics:

Revenue: The company’s revenue decreased by 10% in FY23 due to a decline in sales volumes. There is more expected volatility in the next few years. In particular, the Hawthorne segment has been significantly impacted due to an oversupply of cannabis and reduced spending on hydroponic equipment.
Margins: The company’s gross margin improved to 28.2% in Q4 FY23, up from 23.8% in 2022, due to the cost-cutting initiatives. It is important to note that a huge part of the improvements are from the company’s cost-cutting initiatives. Although the gross margins have improved, the operating margin remains low.
Operating and Net Income: The company’s net income has been volatile, mainly due to goodwill writeoffs and restructuring costs.
Invested Capital: Invested capital remains stable for both Home Depot and Lowes for the years examined.
ROIC: Return on invested capital (ROIC) for the company has been volatile over the past few years and is in general low. It is currently under their cost of capital. This has been improving recently.
Debt: Scotts has a high level of debt, resulting in high interest payments. The company is working to deleverage the company’s balance sheet and reduce interest payments.

Understandability: 2/5 While the basic idea of selling lawn and garden care products is easily understood, the company’s operations, especially the complexities involved in acquisitions, restructuring, and hydroponics are difficult to comprehend. It is not easy for the average investor to correctly assess the future prospects of this business, which makes the company more complicated to understand. Also the company’s financials are somewhat complicated due to a lot of one-time restructuring charges. The company’s complex interactions with macro economic factors further reduce understandability.

High complexity for a non-financial business: Unlike consumer staples and manufacturing businesses, it is not as easy to understand the business metrics of Scotts. There are some unique issues regarding leases, contingent liabilities, etc that can be complicated for non financial professionals.
Acquisitions Scotts has a history of acquiring smaller businesses that contribute to revenue and value. It is hard to understand how they interact and how they change the company as a whole.
Restructuring: Recent restructuring efforts have involved a large number of one-off expenses that make it harder to analyze.
Hydroponics Understanding the hydroponic business is also challenging and is not an area of expertise for the average investor.
Financial Volatility: The company’s results and their financials tend to be quite volatile, depending on a lot of external factors, like weather patterns and commodity prices. It is hard to predict if the company’s financials are reflective of its long term results.

Balance Sheet Health: 3/5 Scotts Miracle-Gro’s balance sheet is moderately healthy, but shows signs of being stretched because of high debt levels.

Current Assets: The ratio of current assets to current liabilities is 1.3, indicating that SMG has a decent level of assets to cover its near-term obligations. But, it should be noted that the current assets are mostly inventories, which can be written down in bad times.
Debt: The company’s total liabilities at around $4.5 Billion, exceeds the company’s total assets. This has led to high interest payments. They are working on deleveraging the balance sheet.
Cash Flows: The company has negative free cash flow and is focused on improving the situation. The company’s profitability is below their cost of capital and they are actively trying to address the situation.
Solvency and Capital Structure: The company’s credit rating is not the best, reflecting some worries about the company’s financial health. They do not have significant amounts of cash. In order to stay afloat, the company has been issuing debt to pay for existing debt which is worrying.
Assets: In 2023 the net tangible assets for the company was roughly $1.5 Billion, with goodwill and intangibles making up the rest of the asset base.

Recent Concerns and Management’s Outlook:

Scotts’s earnings in 2023 were greatly affected by weaker demand in its hydroponics segment. They are making changes to increase their market share, and diversify to other product categories.
The company is taking measures to improve the efficiency of operations, reduce its debt, and streamline its product portfolios. The company has also said they will reduce advertising spending.
Management expects the company to turn cash flow positive in 2024. The guidance for 2024 suggests that profitability will improve with focus on cost-cutting initiatives.
Management has stated that they expect the consumer market to continue to be volatile. They expect the growth in their hydroponics segment to be limited for some time.