Three consecutive years of top-line growth. An 83% year-over-year improvement in earnings per share in 2016. Consistently healthy levels of operating cash flow. How does a company get rewarded for that solid performance? A year-to-date drop of 8% in 2017. That's the calculus of Wall Street analysts, anyway.
The stock in question is The Scotts Miracle-Gro Company (SMG -1.25%), which has slipped since early May after revising its full-year 2017 financial guidance. That decision was forced by weaker-than-expected performance in the U.S. consumer market, by far its largest. But the punishment of the stock may be based more on short-sighted reactions than long-term foresight. Perhaps digging into the three biggest opportunities for the company will help to convince you that the market's reaction was overblown.
1. Continued growth in reputable brands
It may not seem like much, but management's long-term plan includes a focus on core products and brands already in the company's portfolio. That includes Miracle-Gro, Scotts, Ortho, Roundup, TomCat, and The Hawthorne Gardening Company. Some of these have existed since inception, while others were acquired later (some recently). They all have one thing in common: growth potential.
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The Scotts Miracle-Gro can leverage the strong reputation of its brands to launch new products -- an often-overlooked advantage of its legacy platforms. For instance, the new "Roundup for Lawns" is expected to notch first-year sales of roughly $40 million, which is a tremendous start that establishes a solid base for future revenue growth. Moreover, the brand will launch new formulations in 2018.
Investors can have confidence in this type of organic growth thanks to a strong history of execution. The TomCat brand of animal repellent products has witnessed 60% growth in the three years The Scotts Miracle-Gro has owned it. Meanwhile, a new partnership with Bonnie Plants offers opportunities to sell existing products alongside rising sales of organic seeds and plants. The ability to continue growing brands, year in and year out, is a testament to the company's efficient distribution network and sales channels.
2. Hydroponics
When management pulled the trigger on acquiring The Hawthorne Gardening Company, a leader in hydroponics, it assumed that a CAGR of 8% would be needed to justify the transaction. In the last three years (including those as an independent company), organic sales growth has achieved a CAGR of greater than 20%. The portfolio generated approximately $275 million in revenue in fiscal 2016.
Hydroponics drove growth during the fiscal second quarter of 2017, achieving year-over-year revenue gains of 22% and year-to-date gains of 13%. Of course, the company's big bet on the industry has investors betting that The Scotts Miracle-Gro may just become a serious supplier to the booming marijuana business.
And thanks to the divestment of its European and Australian business segment, the company could eventually shuffle its reported business segments to separately report hydroponics results. That would make it easier to track growth -- and could grab the attention of Wall Street.
3. Doubling down on U.S. market
During the fiscal second-quarter 2017 conference call, management announced that it has agreed to sell the company's European and Australian business segment for $250 million. That may seem like a low-ball figure -- and investors may be right. But more importantly, the divestiture offloads what has been the biggest headache for The Scotts Miracle-Gro in recent years.
Consider that the segment's sales have fallen from $336 million in 2014 to just $274 million in 2016. The two remaining segments -- U.S. consumer and "other" -- have both managed to grow consistently in that time.
Selling the segment also allows management to more fully focus on its core market: the United States. Additionally, that means there will be more bandwidth and capital expenditures available to invest in products and brands that are achieving real growth. In other words, investors should view this as addition by subtraction.
What does it mean for investors?
Whether through boring old legacy brands or exciting new technologies such as indoor farming, The Scotts Miracle-Gro is well positioned to capitalize on some big opportunities in the coming years. Meanwhile, divesting the weakest part of the business will pay big dividends down the road for investors. Long story short, when investors take the long-term view, the recently sliding share price figures to be only a short-term concern.
