This Marijuana Stock Just Raised Guidance — Time to Buy?

Buy on the rumor and sell on the news. While long-term investors should, and do, usually ignore such maxims, it’s worth noting that such short-term trading movements do influence the timing of an entry point into a stock. These matters should concern potential investors in…

Scotts Miracle-Gro (NYSE:SMG) because they go a long way toward explaining what’s going on with the stock right now. Here’s a look at what happened and an investment appraisal for the company.

The rumor

The company’s second-quarter earnings release in May probably created a lot more than a rumor that its full-year guidance would have to be raised eventually. After all, overall sales were up 18% in the first half, with sales in the U.S. consumer segment (lawn and gardens) up 11% and Hawthorne (hydroponics for cannabis and indoor gardens) up a whopping 51%. However, at the time management merely maintained guidance for full-year U.S. consumer sales to be up 1% to 3%, while Hawthorne full-year sales guidance was only raised to 30% to 35% from 12% to 15% previously. Overall full-year sales were expected to grow just 6% to 8%.

The guidance looked excessively conservative, but management explained that its sales can be highly volatile and promised an update on full-year guidance in June.

Fast-forward to the update on June 8, and investors got the hike in guidance that the market had been merrily pricing in through May.

For reference, here are the key numbers from the update, and as you might expect from the opening line of this article, the market started selling off the stock in the days following the announcement.

Scotts Miracle-Gro Full-Year 2020 Guidance Current At May 2020 At November 2019
U.S. Consumer revenue growth 9%-11% 1%-3% 1%-3%
Hawthorne revenue growth 45%-50% 30%-35% 12%-15%
Total revenue growth 16%-18% 6%-8% 4%-6%
EPS $5.65-$5.85 $4.95-$5.15 $4.95-$5.15

DATA SOURCE: SCOTTS MIRACLE-GRO PRESENTATIONS.

COVID-19 pandemic is a plus for Scotts Miracle-Gro

There aren’t many companies that have prospered as a consequence of the pandemic, but Scotts is arguably one of them. When faced with extended lockdowns and social isolation measures, it’s perfectly understandable if consumers turned attention to gardening and smoking pot. Indeed, management said as much on the second-quarter earnings call.

It’s all led to bumper sales growth at Scotts, with CEO Jim Hagedorn noting that sales were up 19% on a year-to-date basis in early June with “a nearly 40 percent increase in consumer purchases of Miracle-Gro branded soils and more than 30 percent increase in plant food.” Meanwhile, the company remains on track to hit its operating margin guidance of 10% for 2020.

A temporary high?

Based on the midpoint of management’s EPS guidance and the current stock price of around $131, Scotts trades on nearly 23 times 2020 earnings. Inevitably, investors’ minds will turn to the question of whether that’s a reasonable valuation for a company experiencing a sales boost that might not repeat in the coming years.

It’s a difficult question to answer, because it’s far from clear if the new interest in gardening and growing pot will be lasting, or whether sales will drop back next year.

Two reasons to get excited

That said, investors have cause for optimism for two reasons. First, during the sales update, Hagedorn referenced strong sales growth for Hawthorne in emerging markets like “Michigan, Oklahoma and Florida” in addition to “older markets like California and Colorado.” In other words, Hawthorne is seeing growth by geography as well as organic growth due to the effects of COVID-19.

Second, going back to the first-quarter earnings — which ended on Dec. 28 — Scotts also saw…

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