2023-04-21 09:38:55 ET
Summary
- The Scotts Miracle-Gro Company has not seen the same levels of revenues as in 2020 and 2021 as inflation made people rethink their spending.
- Despite net sales expected to fall, the company seems optimistic about the ability to generate strong free cash flows.
- The thing that might draw investors to SMG is the dividend yield it has, and that is also why I think it's worth a hold rating.
Investment Summary
The Scotts Miracle-Gro Company ( SMG ) is a prominent North American provider of branded consumer products for lawn and garden care. Their vast range of offerings includes grass seed, fertilizers, mulch, soil, pest control products, and plant foods. Some of the well-known and widely-used brands owned and marketed by the company are Scotts, Miracle-Gro, Ortho, and Roundup.
This business model has made the company able to generate steadily increasing revenues as they are able to pass down costs to customers given the large market share they have managed to gather up. In 2022 the revenues took a hit as people were making different priorities regarding where money should be spent as the effects of inflation were felt. But it seems revenues are turning around and getting back to increasing once again. I think that the relative stability of the company and the ability to collect a handsome dividend makes this company a hold for now though.
A Strong Dividend Play
SMG has been able to give out a very generous dividend over the last several years . Right now the dividend yield is around 3.58% and the company has been able to continuously increase the dividend as well given the strong cash flows they have had and continue to have I should say. In the last 12 months, they managed to generate close to $300 million in levered cash flows meaning a margin of around 7.6%.
I think that this proves the capability the company has to provide value to shareholders not just with shares appreciating in price.
Pair that with no significant share dilution in the last 10 years and I think we are looking at a company that will be able to provide a strong foundation to a portfolio.
But what's to say this dividend is sustainable and will continue? Well, looking at the last earnings report from the company they maintain a very optimistic view on the free cash flow levels despite net sales being estimated to fall in the low single-digits. In the next 2 years, they actually believe they can generate over $1 billion in free cash flows, which would be a very significant jump. I think SMG has a strong enough track record that shows they are willing to pass on profits to shareholders in the company, and with the expected cash flows in the next few years, I believe the dividend will be sustainable and the company will be able to buy back a significant chunk of the shares outstanding.
Risks
One of the risks I see with investing in SMG is perhaps the slowing sales they are expecting. It's quite optimistic of the company expects slowing sales whilst keeping up better than ever free cash flows.
If the sales are less than expected then I think there is a good chance the share price follows as the estimated cash flows will be lower and the dividend opportunity here slowly starts to disappear then.
Looking at the balance sheet briefly I think the very small cash position puts the company in a difficult position where if there are any challenges in the coming years then they will have a difficult time acting quickly. It also greatly limits their possibility of investing when other companies in the industry might start growing faster than SMG and eventually starts taking market share away.
The long-term debt of the company is also a concern in my opinion. It has slowly been built over the last years and sits now at over $3 billion. With under $30 million in cash, there is a large discrepancy here that I think can cause a lot of worries and present an ample risk to investors.
Financials
The Scotts Miracle-Gro Company's balance sheet as of December 31, 2022, shows a decrease in total assets to $4.53 billion, compared to $5.24 billion in the previous year. Some part of this decrease can be accounted to the goodwill moving from $681 million to $254 million instead. I don't pay too much attention to goodwill so the decrease in assets at a closer look seems not that bad. The inventories are decreasing YoY which I think is quite healthy as the company does expect the sales to take a hit. So slimming down inventories is a good move by the company. What I don't see as a very good thing on the assets side is the very small portion of cash the company has. A large amount of debt which will be discussed more below makes me worried about the company facing issues paying some of this back without the dividend taking a hit or share buybacks stopping.
The company's total liabilities increased from $4.41 billion to $4.47 billion, with long-term debt increasing from $3.08 billion to $3.19 billion. I think the debt is a major thorn in the side of SMG. It's grown over the last few years to a significant portion and even if the company achieves its projected free cash flows it still won't be enough to make a large enough dent in the debt. If they manage to generate $1 billion in cash flows over the next 2 years, that means they still need to be on that level for 4 more years consequently in order to pay back debt without any going to shareholders. I usually favor a company that is able to very quickly get rid of all it's debt. Doesn't mean they have to, but it gives me confidence the company is in a flexible position financially. The interest expenses were around $137 million in 2022 which I think is very coverable by SMG when they generate more then 2x that in free cash flows in the same year. But hiccups in the margins could highlight some of the potential frailty as the net debt/EBITDA is already at around 6.6 using 2022 numbers.
Valuation & Wrap Up
Since the company is projecting its sales to fall, most notably the Hawthorne segment expected to decrease between 20-30% YoY in 2023, which means the forward p/s is increasing which is rarely a good thing, currently sitting at 1.07. Looking at the forward p/cf it still doesn't look cheap despite the optimistic outlook, at 20 it puts it way above the sector's average of 8. I think there is a case to be made that revenues start to recover eventually as the company endures this lowered demand. For 2023 I think it is likely we see a YoY decrease in sales, and the outlook for 2024 will be crucial to more clearly see return of both top and bottom line growth.
Investors who wish to get some exposure to the fertilizer industry more towards the agricultural side instead of the consumer gardening market that SMG serves might want to consider American Vanguard Corporation (AVD). A company that has a much more favorable valuation and at least a positive bottom line to support a dividend and share buybacks. It's perhaps a different route to take but I think it might offer more of a growth prospect over the next few years, compared to SMG.
What makes me prone to still keep a hold rating for the company is the strong cash flows that I think can be used to keep the dividend up and provide some value to shareholders. When the bottom line then becomes more profitable I also think there might be a run to companies like SMG that might have fallen out of favor as the tech sector seems to have gotten all the love recently.
For further details see:
The Scotts Miracle-Gro Company: The Dividend Is The Biggest Positive