Best Buy: Scotts Miracle-Gro vs. Lowe’s

Lowe’s (NYSE: LOW) is one of the largest hardware stores in the United States. Scotts Miracle Gro (NYSE: SMG) is one of the largest suppliers of lawn care products and a key supplier to Lowe’s. Scotts has stepped into the weed space, and that could be a catalyst for the future that will dramatically change that showdown. Here’s what you need to know to decide if Scotts is a better buy than Lowe’s.

1. A look at the core

Lowe’s owns and operates big box hardware stores. Chances are you know the name of the company and it is in direct competition with larger peers Home deposit (NYSE: HD). Although the two companies have a similar number of stores, Home Depot’s revenue was 50% greater than Lowe’s last year and its operating margin was more than double. Lowe’s is, basically, No. 2 by a wide margin.

Image source: Getty Images.

Scotts, meanwhile, describes itself as the leader in lawn care in the North American market. You’re probably familiar with the company’s products, which include brands like Scotts, Miracle-Gro, and Ortho, among others. It supplies hardware stores like Home Depot and Lowe’s, as well as other retail giants like Walmart. In fact, these three companies alone accounted for about 60% of its revenue in 2018. So while it is a very different business than Lowe’s, it still relies heavily on the success of the hardware chain.

2. Repair or extend

The relationship here is an interesting one, as Lowe’s has made an effort to improve his performance in an effort to catch up with Home Depot. This includes closing stores and trying to increase efficiency. Only he just doesn’t seem able to achieve the same success. Motley Fool’s Travis Hoium recently reviewed the two companies, including review of inventory turnover, operating margin and free cash flow trends and named The Home Depot the “hands down” best company. Put simply, if you buy Lowe’s, you are buying a business that is a bit of a fix.

Scotts, meanwhile, has also been working on his business in recent years. But there’s a big difference here, as Scotts has grown into a new space: the hydroponic equipment used to grow marijuana. By some estimates, marijuana could grow into a $ 166 billion industry.

Equally important, Scotts’ efforts here do not tie it to a single producer; it sells to anyone who needs hydroponic equipment. It is a pickaxe and shovel game in the marijuana market, building on the solid foundations of its slow growing lawn care business.

The hydroponic operation, called Hawthorne, accounts for about 20% of revenue. There have been some negative short-term effects associated with this move (debt, for example, will be discussed below), but Scotts is expanding its business, not recovering from its weak position.

3. The history of debt

Scotts’ push into the hydroponics space was accomplished by acquisition and funded largely by debt. This raised its debt ratio to a very worrying level of about 9 times. Well aware of the problem, Scotts sold some non-core assets and used the proceeds to pay off debt. The debt to equity ratio is currently around 2.3 times, which is near the high end of the company’s historical normal range. Management has done a good job of fixing this problem, but the leverage still needs to be watched. This is all the more true as long-term debt is still around 70% higher than it was ten years ago, while annual revenues have only increased by around 9% in the past. during this period. And hydroponics activity is still fairly recent, so it remains to be seen if this will help the business to accelerate.

Low debt ratio graph (quarterly)

LOW debt ratio (quarterly) given by YCharts.

Lowe’s debt ratio is 6.6 times, up from 3 times at the end of 2018. The hardware chain has added long-term debt, increasing its debt by more than 300% over the past decade. However, the main reasons for the increase in the debt ratio are the one-time non-cash costs associated with its turnaround efforts. These charges reduce equity, which worsens the debt ratio. The company still covers its interest costs by a solid 6.5 times, so there is no particular reason to worry about leverage. However, that says a lot about the company’s relatively weak industrial position and the fairly significant efforts it is making to restructure its business. And while he can handle the leverage he has, he will eventually need to bring his debt ratio back to more normal levels to allay concerns about Wall Street leverage.

4. Dividends

Lowe’s offers investors a 1.9% return backed by 57 years of incredible annual increases. Historically, these annual dividend increases have been in the range of 10% to 20%, which is pretty tempting. Scotts doesn’t quite come close to that record, with only a decade of annual increases and recent annual increases in the single-digit range. It offers a yield of 2.2%. While that’s higher than what you’d get from Lowe’s or an S&P 500 index fund, it’s nothing to write home about. Notably, it’s well below the return of around 3.6% at the start of 2019, when Scotts’ indebtedness was still at a high level. Which leads to the next point: evaluation.

5. Assessment

The Scotts share price has risen an astounding 66% so far in 2019. Lowe’s, for reference, is up about 22%, roughly in line with the broader market. That said, Scotts’ price-to-earnings and price-to-sell ratios are both below their five-year averages. In part, that’s because the stock’s gain since the start of the year is roughly a recovery from the roughly 45% price drop that coincided with the investment in marijuana. Investors are obviously backing the pot story here after initial concerns, but Scotts doesn’t look too expensive today – although it’s not fair to call it a good deal, either.

Lowe’s, on the other hand, trades with P / E and P / S ratios above their five-year averages. There is some noise in there on the P / E due to the one-off charges mentioned above, but this hardware certainly doesn’t look cheap today.

And the winner?

Many businesses are cyclical, and Lowe’s appears to be in a low point right now, while Scotts’ fortunes appear to be improving again. Although Lowe’s has a long and impressive history behind it, Scotts appears to be the best stock today. However, after a huge rise in the stock price, it is difficult to suggest that investors run and buy Scotts. It’s probably best at this point to put it on the watch list to see how the relatively new hydroponics investment is going.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

About Roberto Frank

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