Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Scotts Miracle-Gro (SMG 4.39%) stock is having a tough time in 2018.
Entering the year north of a $108-a-share valuation, Scotts plunged over 15% in January after reporting fiscal Q1 2018 earnings. Nor did the news get better for Scotts investors in Q2, when the stock took another 8% dip into the red earlier this month. Analysts at Merrill Lynch immediately double downgraded Scotts Miracle-Gro stock in response to the company's Q2 news.
But then, a miracle happened. This morning, analysts at SunTrust Robinson Humphrey announced they're upgrading Scotts stock -- all the way to buy.
Here's what you need to know.
Down, but not out
Thanks largely to these two sell-offs in January and May, Scotts Miracle-Gro shares have underperformed the S&P 500 by more than 20 percentage points over the past 12 months, generating a negative 7% return for investors. And yet, according to SunTrust, Scotts stock has now "bottomed," and at its new valuation of less than 19 times earnings, has some "potential for upside," reports StreetInsider.com (subscription required).
SunTrust cites two main reasons for why it thinks this is likely.
Examining Scotts stock's price history, SunTrust concludes that the stock often experiences a "counter seasonal trend of outperformance," rising not during the spring planting season (as you might expect), but rather from June to January. In fact, SunTrust notes that the stock has outperformed the S&P 500 from June to January in the past 11 of 15 years.
The pot trend is your friend
A second reason SunTrust likes Scotts Miracle-Gro is that it believes the stock can serve as a "call option on cannabis legalization trend."
Here at Fool.com, my fellow contributor Sean Williams has been singing Scotts' praises since 2017. Sean explains that while Scotts is best known as "one of the largest lawn and garden care companies on the planet," it also has "a burgeoning hydroponics business" that's been benefiting from the growing movement to legalize marijuana. Scotts' Hawthorne Gardening subsidiary "gobbled up General Hydroponics in 2015, and bought a majority interest in Gavita the following year." It also recently acquired America's No. 1 hydroponics company, Sunlight Supply, in a $450 million deal that should turn Scotts Miracle-Gro into a $600 million annual player in hydroponics going forward.
Between Scotts' depressed stock price and its potential to grow with the marijuana market, SunTrust believes the stock could bounce off its recent lows below $80 and hit as much as $100 a share within a year.
What do the numbers say?
Is that likely? Let's take a quick look at Scotts' latest earnings report and see what it has to say.
In fiscal Q2 2018, Scotts Miracle-Gro reported a 7% decline in companywide sales, "primarily due to slow start to lawn and garden season" after a long winter. Despite this decline in sales, Scotts managed to eke out a 5% increase in earnings per share.
Much of Scotts' problem is tied to the long winter, and a resulting "start to this lawn and garden season [that's] been delayed to a greater extent than we have seen in recent memory. Consumer purchases entering May are down double digits from a year ago," said CEO Jim Hagedorn.
The good news is that Hagedorn added, "However, in the markets like California and Florida, where the weather has cooperated, consumer purchases are in line with last year's results. ... We've begun to see momentum picking up in the Midwest and Northeast in recent weeks as the weather has turned more favorable, making us optimistic that we can quickly make up ground and finish the season as strong as possible."
That's the good news. The bad news is that the company has been having particular problems with its marijuana-tied Hawthorne business segment and, in contrast to the rebound it predicts in lawn and garden, Scotts expects "those challenges to last for the balance of the year and now believe Hawthorne sales will likely be, at best, flat in 2018 on a year-over-year basis including the impact of acquisitions."
The upshot for investors
That assessment doesn't sound particularly propitious for a Scott's Miracle-Gro-is-a-call-option-on-marijuana buy thesis. Indeed, it kind of sounds like the argument in favor of buying Scotts stock as a marijuana stock is falling flat.
Meanwhile, as I look at Scotts stock today, I see a company with an 11% projected growth rate, a $4.5 billion market capitalization (weighed down with $2.2 billion in net debt), and thus an enterprise value of $6.7 billion. Ordinarily, for a stock this expensive, I'd want to see Scotts generating somewhere in excess of $600 million in free cash flow or GAAP income (and preferably both). Instead, Scotts generated just $290 million in free cash flow, and less than $250 million in GAAP earnings over the past 12 months.
Long story short: I'd rather be short this stock than long.