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Here's My Top Stock to Buy in February

By Maxx Chatsko - Feb 5, 2018 at 8:16AM

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Scotts Miracle-Gro stock got crushed in the final days of January. That was a gift for long-term investors.

Gardening might be the last thing on your mind this February, but I would still entertain the idea of adding Scotts Miracle-Gro (SMG -1.81%) to your portfolio. The home lawn-care specialist has been growing like a weed for much of the past several years. But the announcement of fiscal first-quarter 2018 results at the end of January sent shares tumbling, after a warning that growth will slow in the year ahead.

That one little admission sent the stock from levels near the 52-week high to within shouting distance of the 52-week low -- in a matter of two days. It's easy to understand Wall Street's knee-jerk reaction. Scotts Miracle-Gro stock was relatively expensive, but that was justified by awesome growth. No awesome growth, no justification, and, well, look out below.

While there may be some disappointment in the short term, the long-term growth potential of Scotts Miracle-Gro hasn't changed. That's why it's my top stock to buy in February.

A gardener with a hand shovel planting tulips.

Image source: Getty Images.

Slowing growth spooked Wall Street

Because of the seasonal nature of the consumer lawn-care industry in North America, there's rarely any excitement in the fiscal first quarter of each year and Scotts Miracle-Gro always reports a net loss. That has been somewhat mitigated in recent years by the company's relatively young Hawthorne segment, which has amassed a growing armament of season-proof hydroponic (indoor) products.

The portfolio includes in-home gardening products for city dwellers and rooftop gardens, but the major drivers of growth and Wall Street's enthusiasm have been products destined for the marijuana industry -- indoor lighting, potting systems, watering systems, and the like. The importance of the industry to the segment -- and the company overall -- has even earned Scotts Miracle-Gro the label of "marijuana stock."

Unfortunately, the high-growth Hawthorne segment was the source of Wall Street's disappointment at the end of January. Although segment acquisitions pushed total sales up 7%, the segment's revenue dropped $12 million if acquisitions are excluded. That's a total swing of $25 million, or about one-third of the segment's quarterly revenue. 

Metric

Fiscal First-Quarter 2018

Fiscal First-Quarter 2017

% Difference

U.S. consumer revenue

$125.9 million

$126.2 million

(0.2%)

Hawthorne revenue

$76.7 million

$63.7 million

20.4%

Total revenue

$221.5 million

$207.4 million

6.7%

Selling, general, and administrative expenses

$108.2 million

$104.1 million

3.9%

Net loss

($21.2 million)

($64.9 million)

N/A

Data source: Scotts Miracle-Gro.

Management then warned that although it sees the drop in Hawthorne revenue as a temporary concern, the headwinds have continued in the first month of the fiscal second quarter because of "slower than expected adoption of regulatory changes in California." As a result, Scotts Miracle-Gro lowered its full-year sales growth guidance to a range of 2% to 4%, down from the previous range of 4% to 6%. It didn't change its earnings outlook.

That's hardly a show-stopper (I mean, c'mon, sales in fiscal 2017 grew just 5% year over year), but Wall Street is singularly fixed on a rising top line, so the stock went tumbling. The good news is individual investors with a long-term focus can adopt a broader worldview than Wall Street -- and there's a lot to like. 

Fiscal 2018 will be the first full year that Scotts Miracle-Gro is focused exclusively on the American consumer market and its Hawthorne unit. Previously, operations in Europe and Australia contributed nothing but weak margins and falling revenue while sucking up precious bandwidth from management. Jettisoning the non-U.S. segment allows the company to pour more time, attention, and investment into the strongest and most important parts of the business.

Shareholders have already seen the beginnings of great things from the new focus. Last year Scotts Miracle-Gro released a new RoundUp product line that notched $40 million in revenue. Not bad for its first year on the market, but additional brand expansions this year hold promise that the growth isn't done.

A hand drawing a chart showing growth on a chalk board.

Image source: Getty Images.

RoundUp is hardly the only brand harboring organic growth opportunities. A partnership with Bonnie Plants will allow Scotts Miracle-Gro to grow in the high-margin edible plants and organic gardening markets. The company's TomCat brand grew consumer sales volume 60% in the most recent three-year period. And a willingness to experiment with "craft" brands has the potential to expand the company's reach in new markets and households.

It's also worth remembering that Hawthorne will continue to grow, even if that occurs at a slower than expected pace in the year ahead. The hydroponics industry is still very much in its infancy -- and ditto for the American marijuana industry. There are plenty of opportunities for growing market share through acquisitions -- and then growing sales and earnings by piggybacking on an expanding market.

Investor takeaway

Sure, Scotts Miracle-Gro announced that its prized Hawthorne segment is experiencing unexpected headwinds to start off fiscal 2018. That could be problematic if the trend is sustained for several consecutive quarters or an entire year, but given the sheer volume of opportunities in the fledgling hydroponics industry, that doesn't appear to be a likely scenario. Plus, it's not the only source of revenue and earnings growth for the company -- something Wall Street conveniently ignores.

Long story short, the recent collapse in the share price looks like a gross overreaction, which is another way of saying this is an awesome opportunity for long-term investors.

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The Scotts Miracle-Gro Company
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