Insights

Why Scotts Miracle-Gro Shares Dropped as Much as 7.5% Today

What happened

Shares of Scotts Miracle-Gro (NYSE: SMG), a lawn care specialist and provider of hydroponic products to the marijuana space, fell as much as 7.5% in morning trading on Aug. 3. The company’s fiscal third-quarter earnings update was the cause of the downbeat mood on Wall Street. The reading was pretty rough across the board.

So what

On the top line, Scotts Miracle-Gro saw a 26% year-over-year sales decline. Its consumer business witnessed a sales drop of 14% while sales at the company’s hydroponic operations, known as Hawthorne, plunged a painful 63%. Those are not good numbers, but they also weren’t unexpected. Indeed, the company’s $1.19 billion in sales was roughly in line with Wall Street’s expectations. Adjusted earnings came in at $1.98 per share, down from $3.98 a year ago. Although that was not a strong comparison, it was actually better than the $1.70 per share which analysts had been projecting. Basically, it was a tough quarter, and while not a shock, per se, it was still a tough read.

The big problem for investors, however, was likely related to the company’s outlook. Here management trimmed guidance, with sales expected to be lower by between 8% and 9%. The adjusted earnings outlook declined to between $4 and $4.20 per share, down from the previous range of $4.50 to $5 per share offered up in June. The June guidance, notably, already represented a reduction from earlier guidance. The company is dealing with weaker-than-expected demand, particularly in its Hawthorne operations, and rising costs. Management is working to adjust to a changed environment, but it clearly appears to be behind the curve right now. Investors reacted to all of this news as you might expect.

Now what

There’s one more negative thing here, however. Management made a point of highlighting that it was looking at ways to improve its performance and strengthen its balance sheet. That last item is worth watching, given that Scotts Miracle-Gro recently amended a credit facility to give itself more financial flexibility. That’s not a particularly good sign. Management pegs the company’s ratio of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) at roughly 5.1 times. The amendment allows that figure to go up to 6.5. Meanwhile, management hopes to get the ratio down to 3.5 times over the next two years. That’s a laudable goal, but there’s clearly a lot of work to do between 5.1 times debt to EBITDA and 3.5. Investors generally need to pay extra attention when companies start talking about leverage problems, so this stock probably needs to be watched closely for a while.

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Scotts Miracle-Gro. The Motley Fool has a disclosure policy.

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