Fool on the Street: The Straight Scoop From Scotts

Small-cap lawn and garden firm Scotts Miracle-Gro (NYSE: SMG  ) recently rained on investors by lowering full-year earnings guidance, as April turned out to be unseasonably wet and dry, depending on which part of the country you live in. However, as a long-term investment, Scotts has a number of healthy qualities, including a leading market share position, a growing business that is easy to understand, and a stock that, though it isn't dirt-cheap, offers reasonable value, given the company's recently provided outlook.

Last week, at the CIBC 7th Annual Consumer Growth Conference, Chief Financial Officer David Evans provided investors an update on Scotts' current outlook and strategy on how it plans to continue to grow in its core North American market.

The dirt on Scotts
Evans opened his presentation by highlighting just why he believes Scotts' "clear competitive advantages create a compelling investment story." For starters, the domestic market for lawn and garden care is growing a steady 4%-5% per year, and Scotts has grown its industry-leading market share from 49% in 2000 to approximately 53% in 2006. Competitors include Central Garden & Pet (Nasdaq: CENT  ) and the home and garden segment at Spectrum Brands (NYSE: SPC  ) , but archrivals have found it hard to match the brand awareness of the Scotts, Miracle-Gro, Ortho, and Roundup names, the last of which is licensed from seed giant Monsanto (NYSE: MON  ) .

North America accounts for about 70% of Scotts' total sales, and a leadership position has allowed the company to outgrow the market by posting 10% annual sales improvements over the past five years. Evans pointed out that net income has grown 23% annually over this time frame and the stock has more than doubled since 2001.

The forecast calls for growth
The future looks bright, as well, as Scotts is firmly aligned with a number of ever-expanding big-box retailers. Motley Fool Inside Value recommendation Home Depot (NYSE: HD  ) accounted for about 30% of last year's total sales, while Lowe's (NYSE: LOW  ) and Wal-Mart (NYSE: WMT  ) each made up another 15%. Such reliance on a select few clients is clearly a double-edged sword; a supply chain snafu, product dispute, or other disagreement could seriously dent sales. But so far, the relationships appear sound, and Evans mentioned that Scotts is constantly improving its logistical efficiency and product innovation to keep consumer demand high.

Evans also cited favorable demographic trends to support increased gardening activities going forward. Retiring baby boomers have more leisure time to work in their yards, and people in general are moving to warmer "Sun Belt" states, which means even more available outside time to take care of their lawns and gardens.

April was a wet blanket
April turned out to be a rough month for Scotts, as floods in Texas and droughts out West proved to be unusually extreme and kept consumers indoors. As a result, management lowered third-quarter earnings guidance to $1.93 and the full-year range to $2.35-$2.42. It still expects 6%-8% sales growth, but April represents a high-margin spring month for Scotts and the third quarter accounts for the bulk of annual sales and earnings.

Over the next five years, Scotts is targeting a similar level of top-line growth but expects 8%-10% operating income growth. Its Smith & Hawken retail stores continue to lose money, and international prospects remain less favorable than those at home, but Evans expects the company to be able to improve gross margins and return on invested capital, which has averaged close to 10% in recent years.

The Foolish bottom line
Based on current guidance, Scotts is trading at about 19 times earnings. A recent recapitalization makes it a slightly riskier investment, but given its steady-eddy track record and current outlook, I find Scotts a wonderful company trading at a fair price.

For related Foolishness:

Wal-Mart and Home Depot are both selections of the Motley Fool Inside Value newsletter. Want to find out which inexpensive moneymaking machines subscribers are snapping up today? Click here to be our guest for the next 30 days.

Fool contributor Ryan Fuhrmann is long shares of Scotts, Lowe's, and El Depot but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. The Fool has an ironclad disclosure policy.


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