Is a miracle happening?

This column is intended to help improve investors’ investment skills, providing commentary on the markets and specific situations that might help people make money. At the Value Investor Conference in London in May there were a number of good ideas and I wanted to share one here, adding my added value to the presenter’s analysis. Scotts Miracle-Gro (US: SMG) was new stock to me, so I will outline some of the steps I take when looking at a new company.

It was recommended by my friend Jonathan Boyar of Boyar Asset Management who has a good track record in identifying hidden value.

The generic description of Scotts, which I basically took from the Sentieo platform, is: Scotts Miracle-Gro Company (ticker SMG) is a manufacturer, marketer and seller of branded lawn and garden products, as well than indoor and hydroponic products. some products. The Company operates through three segments.

The consumer segment (65% of sales) includes the company’s consumer lawn and garden business located in the geographic United States, which owns a number of well-known brands, including Scotts lawn and grass seed products and Turf Builder; Miracle-Gro soil, plant food and insecticide, and more. The Hawthorne segment (29% of sales) includes the company’s indoor gardening and hydroponics businesses. The Other segment (6% of sales) includes the company’s consumer lawn and garden businesses in geographies outside of the United States and sales of the company’s products to commercial nurseries, greenhouses and other professional customers.

Hawthorne provides services to the cannabis industry, making him a potential candidate for a spinoff at some point, according to Boyar. As the following chart clearly shows, volumes increased during the pandemic as people stayed home and spent more on their gardens (sound familiar?). Historically, the US consumer segment has been a low growth business with revenue growth of 0-2% and management is now targeting 2-4%.

Analysis of income changes

Revenue Trend Analysis (%)
2020 2021
Volume 29.2 16.9
Pricing 1.9 1.5
Foreign exchange rates -0.2 0.8
Net sales 30.9 19.2

The reason the stock caught Boyar’s interest is that the shares had fallen significantly. Since its presentation, there has been a profit warning and they have fallen further.

To put that performance in context, stocks started to pick up in 2019, as the longer-term chart shows more clearly.

Both stock price charts offer a simple conclusion: the stock rose a lot and then gave it back. Boyar believes the change from the pandemic – people spending more time at home and in their gardens – will last. In the meantime, the stock has returned most of the gains.

At this point, if I was still a hedge fund investor, I would have stopped looking at the stock, as it seems unlikely to offer the kind of special situation appreciation I was looking for. I wouldn’t disagree with Jonathan that people were going to spend a little more time and more money in their gardens, but is that enough to move the needle? The forecast retracement suggests that may not be the case.

|There has also been a significant retracement in the 2022 and 2023 estimates. Some of the damage in 2022 is attributable to weather conditions which almost always have a one-year impact. 2022 EPS estimates fell from 6.60 in mid-2020 to 9.60 in mid-2021 and are now back to where they started. Estimates for 2023 fell from 10.00 to 6.00, a hard-hitting 40% drop that explains why the stock price has more than halved. Before looking at evaluation, let me go through Jonathan’s thesis.

The company has seen good growth during the pandemic and it estimates that over 20 million new customers entered the category during the pandemic. Its surveys suggest that 86% intend to stay, and more than half intend to spend more.

Jonathan explained the 59% drop in the share price at the time as a combination of concerns about

  • Increased capital investment
  • Gross margin pressure
  • Capital allocation uncertainty
  • Poor Hawthorne performance due to cannabis oversupply issues
  • Difficult comparisons
  • Bad weather causing a slow start to the 2022 gardening season

Jonathan is bullish on capital allocation, with the CEO and his family owning 26% of the business and having a good track record of paying special dividends and buying back shares – there’s also a generous quarterly return . He also sees significant advantages in the cannabis market where they have the number one brand in their category.

Boyar intrinsic valuation of Scotts
Value ($M unless otherwise specified)
US Consumer @ 14 x 2024E Ebita 10,981
Hawthorne @ 15 x 2024E Ebita 4,000
Other @10 x 2024E Ebita 219
Business expenses @ 8 x amount 2024E -1,602
Net debt 2024E (average amount) -2,050
Net value 11,548
2024E shares outstanding (millions) 59.9
Estimated intrinsic value (per share) 192
The implied rise in the estimate of intrinsic value 87%
Source: Boyard research

The shares are now lower and therefore its potential higher. As I write this with the stock at $77 (£92.25), its target upside is 149%. Sounds a bit ambitious. I disagree with some of the elements of its intrinsic valuation, so let’s go through that and then look at some conventional multiples.

The first point to note is that it uses the 2024 estimates as the basis for its assessment. There is nothing wrong with that, but to arrive at an estimate of intrinsic value today, I would prefer to include a discount to reflect the time value of money. We are in the middle of 2022 so I would generally use a 2023 estimate unless there is a specific reason to use 2024.

It uses a multiple of eight times for business expenses. I prefer to use the same multiple as for individual companies as a whole. In my adjusted chart I argued that the average Ebitda was 14.2x which brings the valuation down a little over $1 billion and I think that’s the most appropriate multiple to utilize. I’m guessing they use the same multiple for business spend across all groups and the multiple is lower because they feel there’s more opportunity for cost reduction, especially if there’s an acquisition potential, which would be fair treatment.

Boyar Rating Adjustment

Calculated values Several EBITDA ($M) Value ($M)
X M$ M$
American consumer 14 784.4 10,981
Hawthorne 15 266.7 4,000
Other ten 21.9 219
Business expenses 8 -200.25 -1,602
Reassessed 14.2 -200.25 -2,837
Average net debt 2024 -2,050
Sum 10,313
Source: Behind the balance sheet

The company has 55.4 million shares outstanding and the Boyar count is slightly higher, which probably accounts for potential dilution from stock options etc., which is the right approach if you are:

1) using the 2024 forecast and

2) looking at the potential multiples to take away.

I would typically build the valuation using shorter term metrics and then maybe build an upside scenario using the later forecasts and acquisition multiples and factor that in as an acquisition scenario – this could be my bull case. Sometimes if the bullish case is based for example on a change in profitability driven by an external factor, it can be even higher – the change in earnings AND an acquisition is more of a blue sky scenario and I tend to shy away from me proud of these.

To put Boyar’s valuation in context, here is the graph of the EV/EBITDA multiple over time.

Its five-year average is around 13x (13.4x or 12.9x excluding the Covid-related jump in H1 2020). If you put Boyar’s 2024 estimate at 13x, that reduces their target to $9.3 billion and still gives a target of $155/share, which is double the current share price. Sentieo posts a consensus 2023 EBITDA of $670 million. Out of 13 times, it gives

  • an EV of $8.7 billion
  • less debt of just over $2 billion at the end of last year
  • A target price of $120, still more than 50% upside.

Sentieo has a sharp increase in net debt which is inconsistent with the Boyar data above which appears to reflect the historical level. There is seasonal output that suggests it would be more appropriate to take average net debt in the calculation.

I think this warrants further work, particularly on the nature of cost inflation in material inputs (petroleum inputs in chemicals and packaging, for example). The stock should be watched for further downgrades, but it’s the one I put on my watchlist.

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