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SMG AT A GLANCE

P/E ► 19.5 AVG EV/EBITDA ► 11.8 AVG ROA ► 7.2% AVG ROE ► 24.2% AVG Debt to Equity ► 3.50 HIGH Current Ratio ► 1.68 LOW Interest Coverage Ratio ► 4.25 AVG

 

 

 

 

 

 

The Scotts Miracle-Gro Company (NYSE:SMG) is North America's leading producer of lawn care and gardening products. The company offers brands such as Miracle-Gro, Roundup, and Weed-B-Gon.

In North America, Scotts has a greater than 50% market share, by sales, in all but one of the product areas in which it participates.^[1] In addition to control over market share, Scotts spends approximately five percent of its revenues on advertising, making their brands highly recognizable to consumers. In fiscal 2007, Scotts spent $150.9 million in advertising expenses, which was a far greater sum than its competitors. ^[2] Spectrum's products, not only for its gardening category, with which Scotts competes. ^[3] Scotts is also well known for its close relationships with leading retailers; In FY 2007, 60% of its sales came from just 3 sources. These were Wal-Mart Stores (WMT) (15%), Home Depot (HD) (29%), and Lowe's(16%).^[4]

Scotts also faces challenges common to all companies in the agricultural chemical industry, including highly volatile input costs and fluctuations of demand for its products due to weather conditions. In FY 2008, Scotts has seen an increase of $21 million in raw material costs due to a global rise of prices since FY 2007. Scotts has also seen a decrease in revenue during times of unfavorable weather conditions such as extreme rainfall or droughts. ^[5]

Business Overview

Revenue and Net Income for 2007^[6]

Scotts is best known for its product Miracle-Gro, a brand of lawn fertilizer found all over the continental United States. They offer a range of products in the lawn and garden industry, including fertilizers, weed controllers, grass seeds, and other such items.

Business and Financial Metrics

Scotts experienced a revenue growth of 3.8% to $2.98bn in FY 2008. Operating income decreased significantly to $98 million from $277.1 million in FY 2008. Net income also declined by $124.3 million during the same time span. The decrease in net income was due to impairment charges, recall matters, adverse weather conditions in March, and the rising prices of commodities. Similarly, the decrease in operating income was due to impairment charges, recall matters,and product registration. ^[7]

Scotts saw its revenue grow 6.7% in FY 2007. Revenue in FY 2007 amounted to $2.87bn, up from $2.69bn the year before. Although operating income has increased by $24.6 million in FY 2007 from FY 2006, net income has decreased by $19.3 million during that same time span. The decrease in net income was attributed to poor weather conditions in FY 2007 along with costs due to refinancing, increased levels of debt, higher effective tax rate and an increase of the average interest rate. ^[8] In FY 2007, approximately 70% of its revenue came from North America.^[9]

Scotts has two major advantages in the North American market. The first is a strong, well-known brand image. Scotts invests 5% of its yearly revenues on advertising, a large amount when compared with its competitors, making it prominent in the mind of consumers. During the periods of FY 2006 and FY 20007, Scotts increased its advertising expense by $13.6 million. The second is its relationship with leading retailers. In FY 2007, most (60%) of its sales came from 3 sources: Wal-Mart Stores (WMT) (15%), Home Depot (HD) (29%), and Lowe's(16%). ^[10]

In recent years Scotts has begun to diversify its income base and transform the company into an all-around outdoor living provider through strategic acquisitions. Since 2001, they have invested $125 million in acquiring local lawn care businesses to create Scotts LawnService, which provides on-site lawn care for consumers. In 2005, they acquired Smith & Hawken for $68.5 (Million), an outdoor goods retailer known for high quality furniture. ^[11] And in 2006, they acquired Gutwein & Co. Inc. for $77 (Million), a producer of bird feed. ^[12]

Business Segments

‎Sales by Division in 2007^[13]

The company's revenues are broken down into 4 main segments:

• North America (69% total revenue): In FY 2007, Scotts saw an increase of 3.9% in net sales from FY 2006. Due to poor weather conditions in FY 2007, Scotts experienced a 5.6% decline in net sales in its lawns business. Other Scotts North American sectors were less affected by the weather conditions. Net sales in the gardening sector (growing media and plant food) increased 7.4% during that same span. Net sales in the wild bird food sector also increased 13.5%. Scotts' most popular products in North America are Miracle Gro, Ortho, and other core items. ^[14]

• Scotts LawnService (8% total revenue): A service where customers can call Scotts to care for their lawns for them. Scotts' services include residential lawn care, lawn aerationtree and shrub care, and external pest control services. ^[15] In FY 2007, Scotts experienced an increase of 12.1% in net sales in this specific category. This high growth can be attributed to an increase of 11.9% of customers. Operating income decreased 38% in FY 2007 due to higher spending in SG&A. The increased spending was attributed to the unfavorable weather conditions during the late winter/early spring period. ^[16]

• International (16% total revenue): Sales of core products in 25 countries around the world other than the United States. Scotts' main international locations are the United Kingdom and France. In FY 2007, net sales increased 15% from FY 2006. Scotts saw an increase of sales in every market including United Kingdom and France, which had increases of 11% and 2%, respectively. Sans the effects of currency volatility, net sales rose 5.5%. Scotts' international professional business experienced steady growth with a 9% increase from the previous year. In FY 2007, operating income increased 22.8% from FY 2006. The rise in operating income was attributed to a constant growth margin on higher net sales and control over growth in SG&A spending.^[17]

• Corporate (7% total revenue): Goods sold by retailer Smith & Hawken, a company acquired by Scotts in October 2004. Their products include high-end outdoor furniture, pottery, garden tools, gardening containers and live goods, which are sold in 61 retail stores throughout the United States.^[18] In FY 2007, Scotts experienced an operating loss of $90.5 million, while experiencing an additional loss of $91.0 million in FY 2006. ^[19]

Key Trends and Forces

Business Hurt by Rising Raw Material Prices

Scotts has been affected by the global rise in raw material prices. Overall Scotts has seen an increase of raw materials costs of $21 (Million) from FY 2007 to FY 2008. ^[20]The price of urea, a key component in fertilizers, has risen over 60% from 2007 to 2Q08.^[21] The price spiked an additional 20% when China enacted a 135% export tariff on fertilizer products. ^[22] The price of diesel, another key component, has also risen 12%. ^[23] Rising oil prices also put pressure on consumer spending, curbing their appetite for goods such as lawn care products. The increases in raw material prices are putting a serious dent in Scotts bottom line, as the costs of goods sold skyrocket while pricing remains stable.^[24]

SMG Exposed to Weather Fluctuations

Since the company specializes in lawn care products, seasonality has a dramatic impact on revenues. Generally, 70-75% of sales occur during Q2 and Q3.^[25] For example in FY 2008, SMG generated combined revenues of $2128.9 (Millions) in the second and third quarters. On the other hand, SMG only produced $852.2 (Millions) in its first and fourth quarters. ^[26]The timing of Scotts' product lineup is relatively undiversified, meaning any sort of seasonal disruptions can cause harm to revenues. The huge effects of seasonality were seen in 2008, when an unusually wet and cold April caused sluggish sales in the important second quarter. ^[27] Compared to 2Q2007, SMG generated $35.3 (Millions) less in 2Q2008. ^[28] These problems were exacerbated by extreme heat and droughts in the summer, which discourage purchasing of lawn care products. As evidence, when compared with revenues in 3Q2007, SMG generated $72.5 (Millions) less in 3Q2008. ^[29] Any sort of severe weather conditions, such as prolonged drought, have serious potential to damage Scotts' revenues.

Environmental Regulations and Legal Issues

In March, Scotts had to recall four products due to labeling issues and non-declaration with the EPA. The recalls associated with this legal trouble cost Scotts approximately $31million. ^[30] The company withdrew its Miracle-Gro Shake 'n Feed Plus Weed Preventer and Scotts Bonus S MAX, as well as Scotts TurfBuilder MAX and a product mostly used by its LawnService business.^[31] Adding to its woes, the company admitted to having "certain discrepancies in its registration records with respect to several additional products in June. ^[32] While the recall had a negligible impact on the revenue of the company (almost $2bn in FY 2007), these recalls have the potential to cause serious damage to Scotts' critical brand image.

Competition

Scotts three main competitors are:

• Spectrum Brands (SPCB): In FY 2007, SPCB generated revenues of $1,994.5 in millions. Offers a large variety of products, such as batteries, pet items, shaving items, and lawn and garden care products.
• Bayer AG (BAYRY): In FY 2007, BAYRY generated revenues of €5,826 in millions. Better known for its work in medicine (ie. Bayer aspirin), Bayer also has a large division centered on lawn care products such as grass seeds. Bayer operates primarily in Europe.
• Central Garden & Pet Company (CENT): In FY 2007, CENT generated revenues of $1,671.1 in millions. Offers a wide variety of products similar to Scotts such as pet care and garden care products.

The table below compares some of the top-level product offerings of Scotts Company and its main competitors.

References

1. ↑ SMG Form 10-K page 5
2. ↑ SMG Form 10-K page 27
3. ↑ SPCB Form 10-K page 136
4. ↑ SMG Form 10-K page 5
5. ↑ SMG Form 10-K page 13
6. ↑ SMG Form 10-K page 10
7. ↑ SMG Form 10-K page 34
8. ↑ SMG Form 10-K page 30
9. ↑ SMG Form 10-K page 14
10. ↑ SMG Form 10-K page 5
11. ↑ "Scotts Completes Smith & Hawken Acquisition"
12. ↑ "Scotts Completes Acquisition of Morning Song"
13. ↑ SMG Form 10-K page 11
14. ↑ SMG Form 10-K page 31
15. ↑ SMG Form 10-K page 4
16. ↑ SMG Form 10-K page 32
17. ↑ SMG Form 10-K page 32
18. ↑ SMG Form 10-K page 4
19. ↑ SMG Form 10-K page 32
20. ↑ SMG Form 10-K page 63
21. ↑ "Scotts F2Q08 Earnings Call," 3/31/08
22. ↑ Morningstar "Slow Spring, Recall Hurt Scotts' 2Q," 5/6/08
23. ↑ "Scotts Miracle-Gro declines to low on downgrade," 6/19/08
24. ↑ "Scotts Reports Solid Growth," 07/31/08
25. ↑ SMG Form 10-K page 9
26. ↑ SMG Form 10-K page 90
27. ↑ Morningstar "Slow Spring, Recall Hurt Scotts' 2Q," 5/6/08
28. ↑ SMG Form 10-K page 90
29. ↑ SMG Form 10-K page 26
30. ↑ Forbes "Scotts Miracle-Gro declines to low on downgrade," 6/19/08
31. ↑ CBS,com, "Scott's Product Recall"
32. ↑ Columbus Dispatch "Scotts has new issues with its records," 6/14/08
33. ↑ SMG Form 10-K page 18
34. ↑ SPCB Form 10-K page 2
35. ↑ BAYRY Form 10-K page 40
36. ↑ CENT Form 10-K page 24