Scotts Miracle Gro: A Short-Term Speculative Play With Big Potential

Mar. 5.12 | About: The Scotts (SMG)

By Joseph Hogue, CFA

Scotts Miracle Gro (NYSE:SMG) disappointed investors when it reported on February 7th with a loss of $73.9 million in the first quarter compared to a loss of $67.9 million during the same quarter a year earlier. Gross margins plummeted to 11.7% from 21.3% against a ten percent drop in sales volume and higher commodity costs.

The street has not taken the news well sending the stock down 11.0% since the report and down 14.5% over the last year. Short interest, those shares borrowed and sold as a bearish call on the company, is at 11.5% of float. Analysts are not taking a favorable view of outlook with 21 buy ratings compared to 41 hold and 5 sell ratings, a fairly bearish perspective given the market's skew to buy ratings.

Despite weakness over the last two quarters, there are four factors that could set the company up for a surprise quarter in the next two and lead to a dramatic rebound in shares.

Natural Gas Prices Relax Commodity Pressure for Fertilizers

Nat gas prices are at ten-year lows and could go lower given inventory cycling by storage facilities. The increase in shale drilling across the U.S. and the mild winter has contributed to a supply-demand imbalance that has caused many explorers to idle production. Natural gas is a key component in many fertilizer products and lower prices could ease pressure over the year.

Stable Consumer Spending

Personal consumption came in at a strong 2.1% growth in the fourth quarter GDP numbers, allaying some fears that the consumer was not participating in recent growth. Higher personal income also meant the savings rate ratcheted up to 4.6% rather than the 4.0% consensus expectation. This means that we may not see the drop-off in consumption that was feared due to a previous decline in the savings rate. Though high unemployment and lack of real wage growth will keep consumers subdued, there does seem to be some resilience which is good news for consumer-driven companies like Scotts.

Strong demographics

The baby-boom segment of the population is just reaching the traditional gardening years. Currently, the segment of the population accounts for roughly a third of the market but should increase and support consumer-packaged lawn & garden products over the foreseeable future.

Temperate Winter for Much of the U.S. Presents a Double Opportunity

The primary boost to earnings could come from the historically mild winter seen throughout most of the United States. There are two opportunities here that may not yet be reflected in share prices. First, the lack of extreme temperatures means some regions did not see the typical insect kill-off of most seasons. This could translate to higher sales of pesticides compared to last year which saw particularly cold winter months.

A mild winter may also move forward the planting & gardening season this year. An early spring has burnt off the remaining snow and left homeowners eager to cure the nasty brown mess that was once their lawn.

Investors earn a 2.6% dividend yield to wait out a rebound in the shares. The current price of $47.13 is well off 52-week high of $60.62 and only 17.9% above 52-week lows. The company will report second quarter earnings on May 4th but investors may have to wait for August and third quarter earnings to see the full upside potential.

Scotts may not be the strongest long-term play within the fertilizer space but the significant bearish sentiment and weather-related factors should work in its favor over the short-term.

While the short-term money may lie in SMG, stronger plays for long-term investors include other companies in the agricultural chemicals and seed manufacturers. These companies have a much larger scale than Scotts and will benefit from world demand growth.

Agrium (NYSE:AGU) is a global producer and marketer of retail, wholesale and advanced technologies in the agricultural chemical space. The company sells crop nutrients, crop protection products and seeds directly to growers. Wholesale operations consist of nitrogen, potash and phosphate for agricultural and industrial customers worldwide. Fourth quarter earnings more than doubled to $2.34 per share from $1.10 during the same quarter last year on continued demand from emerging market growth.

Monsanto (NYSE:MON) and other agricultural product companies stand to have a record year in 2012. Prices for corn and soybeans have remained fairly strong even as the USDA predicts record production this year. The company reported earnings per share of $0.23 for the first quarter versus just $0.02 during the same quarter last year and an increase of 28.7% for the last four quarters over the year before. The company should see continued growth from a strong push into Latin America and a shift in the sales mix to higher value-added seeds.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.