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Is The Scotts Miracle-Gro Company (NYSE:SMG) Expensive For A Reason? A Look At Its Intrinsic Value

Key Insights

  • Scotts Miracle-Gro's estimated fair value is US$53.52 based on 2 Stage Free Cash Flow to Equity

  • Scotts Miracle-Gro's US$71.25 share price signals that it might be 33% overvalued

  • Analyst price target for SMG is US$87.67, which is 64% above our fair value estimate

Today we'll do a simple run through of a valuation method used to estimate the attractiveness of The Scotts Miracle-Gro Company (NYSE:SMG) as an investment opportunity by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

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Check out our latest analysis for Scotts Miracle-Gro

Is Scotts Miracle-Gro Fairly Valued?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF ($, Millions)

US$567.0m

US$480.0m

US$351.0m

US$283.0m

US$246.3m

US$225.5m

US$213.6m

US$207.0m

US$203.8m

US$202.9m

Growth Rate Estimate Source

Analyst x2

Analyst x1

Analyst x1

Est @ -19.39%

Est @ -12.95%

Est @ -8.44%

Est @ -5.29%

Est @ -3.08%

Est @ -1.54%

Est @ -0.45%

Present Value ($, Millions) Discounted @ 10%

US$515

US$396

US$263

US$192

US$152

US$127

US$109

US$95.8

US$85.6

US$77.4

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$2.0b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 10%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$203m× (1 + 2.1%) ÷ (10%– 2.1%) = US$2.6b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$2.6b÷ ( 1 + 10%)10= US$983m

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$3.0b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$71.3, the company appears reasonably expensive at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Scotts Miracle-Gro as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 10%, which is based on a levered beta of 1.354. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Scotts Miracle-Gro

Strength

  • Debt is well covered by earnings.

Weakness

  • Dividend is low compared to the top 25% of dividend payers in the Chemicals market.

Opportunity

  • Expected to breakeven next year.

  • Has sufficient cash runway for more than 3 years based on current free cash flows.

  • Good value based on P/S ratio compared to estimated Fair P/S ratio.

Threat

  • Debt is not well covered by operating cash flow.

  • Dividends are not covered by cash flow.

Next Steps:

Valuation is only one side of the coin in terms of building your investment thesis, and it is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value lower than the current share price? For Scotts Miracle-Gro, we've put together three additional items you should assess:

  1. Risks: For example, we've discovered 3 warning signs for Scotts Miracle-Gro (2 don't sit too well with us!) that you should be aware of before investing here.

  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for SMG's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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