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Why the Bears Are Wrong About The Scotts Miracle-Gro Stock

In mid-June home lawn and fertilizer care specialist The Scotts Miracle-Gro Company (NYSE: SMG) lowered its full-year fiscal 2017 outlook, citing a more than 10% drop in mass retail sales compared to the year-to-date checkpoint from the previous year. That was caused by challenging weather this spring in core markets across the United States. 

The company lowered adjusted EPS to a range of $4.00 to $4.20, down from the original $4.10 to $4.30. Meanwhile, revenue growth was expected to top out at 4%, down from 7% at the high end of the original range. Investors wasted no time sending shares lower on the news, leading to the largest drop in stock price in three years.

SMG data by YCharts.

While shares have rebounded, the seeds of doubt have been planted in the minds of some investors. So, ahead of fiscal third-quarter 2017 earnings, let's review why the bears are wrong about The Scotts Miracle-Gro stock.

Image source: Getty Images.

The simple bull argument

Seasonality is nothing new for the company. One quick look at quarter-to-quarter performance for a full year will demonstrate that point pretty quickly. It makes sense given that many regions in the United States experience all four seasons Mother Nature has to offer. So, when spring's arrival is delayed thanks to colder or wetter weather, it can affect the company's performance.

Perhaps there's an argument that more volatile weather will become more routine thanks to climate change, but that doesn't have to be bad for business. It could result in longer periods for home gardeners to do their thing, or simply shift the start of activity to later in the year. In other words, the slower-than-expected retail sales experienced in 2017 are likely a short-term, one-time problem for The Scotts Miracle-Gro.

That's good news because the company has been positioning itself to capture several long-term growth opportunities (and climate change could result in an additional opportunity). Specifically, management has laid out three strategic pillars:

  1. Focus on the core
  2. Reconfigure portfolio
  3. Be "shareholder friendly"

It's executing brilliantly, short-term headwinds or not.

Focusing on the core is easy to do when it includes several of the top brands in lawn care, landscaping, and pest control, including Scotts, Miracle-Gro, and Tomcat, respectively. Brand recognition and a reputation built on performance and quality allows higher margins. It also allows new product formulations to quickly gain acceptance. For instance, the new "Roundup for Lawns" weed control product is expected to bring in first-year sales of $40 million -- with additional formulations on the way in 2018.  

Meanwhile, The Scotts Miracle-Gro has expanded into craft brands that are more familiar to households committed to organic lawn and gardening practices. The company acquires, invests in, or partners with smaller brands and provides them access to its retailer network, then shares in the increased revenue for the brand. Sometimes, it can even pair its own products with those of craft brands, as it has done with Bonnie Plants. It's proven to be a great strategy for tapping into the opportunity provided by organic lawn care practices. 

Reconfiguring the portfolio is another way to focus on core brands, but it also provides a separate strategy for building new business around future growth opportunities. Shareholders are probably well aware that The Scotts Miracle-Gro is not afraid to pull the trigger on acquisitions large and small. It has been furiously adding supporting pieces to its wholly owned subsidiary, The Hawthorne Gardening Company, which focuses on a killer growth opportunity: hydroponics.

Image source: Getty Images.

While focused on providing innovative products and solutions for indoor and urban gardening products, some have pointed out that Hawthorne is well-positioned to capitalize on emerging opportunity of growing medical marijuana. That's true, but the company has yet to even identify marijuana as an opportunity. Nonetheless, Hawthorne grew organic sales 17% from less speculative revenue streams in the nine months from October to June compared to the year-ago period. 

Management has accomplished all of this in a shareholder friendly way. It has consistently increased its dividend, which currently yields 2%. This fiscal year, it will spend $250 million to $275 million on share repurchases. That helps to offset any dilution from mergers and acquisitions -- a strategy it will deploy to counteract dilution from the sale of its international business. 

That specific transaction will bring in $250 million in the fiscal fourth quarter of 2017, all of which will be used to repurchase shares and fund additional acquisitions. That will offset expected dilution of $0.20 per share by the end of fiscal 2018. 

While that may seem like a poor use of the proceeds, the divestiture is important for the long-term health of the company. The international business had been contracting for several years and was accompanied by lower margins than its American business. Viewed another way, selling the unit allows management to focus on its core businesses, reconfigure the portfolio, and maintain its shareholder-friendly growth. And isn't that exactly the point?

What does it mean for investors?

Management cannot control the weather, but it can continue to execute against its long-term strategy for growth. So far, The Scotts Miracle-Gro has done nothing to make investors question its ability to deliver. When it reports fiscal third-quarter 2017 results this week, I'd expect much of the same.

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Maxx Chatsko has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.