Scotts Maintains Guidance

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Scott’s Sales growth of 6% was in line with our estimate, but EPS of $2.17 handily surpassed our estimate of $1.94 in light of positive progress on gross margin as well as below-the-line items. Relative to our estimate, a higher gross margin rate and the benefit of lower interest expense and a favorable tax rate contributed $0.11 and $0.09 to earnings per share, respectively.

Despite the solid earnings beat, management reaffirmed—rather than raised—its full-year earnings guidance, calling for EPS in the range of $3.05 to $3.20. While we perceive this approach can be attributed in part to conservatism, it also reflects the reality that the most significant point-of-sale months for the company lie ahead. Moreover, given the slow start to the season, point-of-sale growth in the range of 5% to 7% will likely be necessary for the company to achieve its full-year sales growth guidance of 2% to 3%.

Even so, we believe positive progress on gross margin and contributions from below-the-line items create earnings flexibility and, in turn, upside earnings potential. We increased our 2014 and 2015 EPS estimates by $0.05 each, to $3.20 (up 15%) and $3.55 (up 11%), respectively. Separately, given an alreadystrong and improving financial position, Scotts is closer to returning more cash to shareholders, and management implied that a special dividend could be in the offing later this year. We continue to like the story given the strength of Scotts’ brand portfolio, its distinctive operating capabilities, the company’s improving profitability metrics, and its strong financial position and free cash flow generation.

Key Highlights (Details Below)  Second-quarter EPS above on gross margin and below-the-line items  Pricing, cost, and productivity create earnings flexibility  Earnings estimates increased slightly Reported. Scotts reported fiscal second-quarter (March) EPS of $2.17, compared with our estimate of $1.94, consensus of $1.98, and $1.60 a year ago. Reported sales increased by 6%, to $1.08 billion, versus our estimate of $1.07 billion and consensus of $1.09 billion; gross margin was 40.1%, up 290 basis points and above our forecast of 39.2%; and SG&A expense (as a percentage of sales) was 19.6%, down 70 basis points and 50 basis points below our estimate. Outlook. Despite the solid earnings beat, management reaffirmed—rather than raised— its full-year earnings guidance, calling for EPS in the range of $3.05 to $3.20.

While we believe this approach can be attributed in part to conservatism, it also reflects the reality that the most significant point-of-sale months for the company lie ahead. Moreover, given the slow start to the season, point-of-sale growth in the range of 5% to 7% will likely be necessary for the company to achieve its full-year sales growth guidance of 2% to 3%. As a result, we only raised our 2014 and 2015 EPS estimates by $0.05 each, to $3.20 (up 15%) and $3.55 (up 11%), respectively.

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