SMG: Agriculture, or Marijuana value play?

September 5, 2018

SMG: Agriculture, or Marijuana value play?

When most folks start looking for opportunities to invest their hard-earned and saved dollars, they usually gravitate to the stocks that they hear about the most. It makes sense – most of us have a limited amount of time to pay attention to the market, and so we tend rely on the brief snippets of information we can glean by catching a few minutes of market news on CNBC or Bloomberg or by surfing market headlines on the Web. That usually means that if an industry or segment of the economy isn’t getting a lot of attention from the talking heads and “experts” that dominate market media, it isn’t going to catch even the slightest whiff from the average investor.

Agriculture stocks are one of those industries that everybody seems to understand plays an important role in the ebb and flow of the economy, but that nobody really cares to pay a lot of attention to. Let’s face it: these are companies that just don’t have the same kind of buzz or cool, cutting-edge appeal of the tech industry or the wide, volatile swings of other sectors like energy, biotech, or pharmaceuticals.



Yesterday I saw an interesting report that indicated the average age of farmers in the United States is advancing in troubling ways. With an average age of 58.3 years and climbing, the implication is that as the latest generation of farmers retire or pass away, the remaining workforce isn’t going to be large enough to serve the massive need associated with being able to feed and clothe the world. That isn’t just America’s responsibility, of course, but the same study indicates that the trend of advancing farmer age is consistent in other developed countries around the world.

The interesting side note to this trend as an investor is that even if the worst-case scenario doesn’t emerge, pressure on the agriculture industry to keep up with demand should provide some good long-term opportunities for the companies that can help the entire sector stage a comeback. While agriculture has been “out of favor” with investors in general for decades, this could be on of the best opportunities to find really great value in the years ahead.



Another trend that has been gaining a lot of traction throughout the world, and that is almost sure to have an impact on the farming sector is cannabis legalization. No matter whether you’re talking about the legalization of cannabis for recreational or medicinal purposes, or both, the odds are excellent that some of the really terrific growth opportunities will come from stocks that focus a significant portion of their business on cannabis. Scotts Miracle-Gro Company (SMG) may not be exclusively focused on cannabis – they are more generally known as the company that makes the fertilizer you probably buy at Lowe’s or Home Depot –  but through their Hawthorne Gardening Company, they provide products to help artisanal farmers grow cannabis. It’s a large enough portion of their current operations that a lot of the attention the stock has been drawing in the market lately has come from discussions about marijuana.

Depending on the measurement you use, the stock could be quite undervalued right now. The fact is that the stock began a strong downward trend in January of this year, falling from a peak around $110 to its current level around $75. That’s a decline of 46% over the last eight months. The stock has some fundamental elements; some that suggest a significant amount of strength in their business and management approach, and others that raise some red flags. To some extent, that means that value for this company is in the eye of the beholder. I’ll cover the numbers that I think are the most interesting and useful, and outline the parameters around the stock’s price action that I think could offer investors a good reward: risk opportunity.



Fundamental and Value Profile

The Scotts Miracle-Gro Company (Scotts Miracle-Gro) is a manufacturer and marketer of branded consumer lawn and garden products. The Company’s segments include Global Consumer. In North America, its brands include Scotts and Turf Builder lawn and grass seed products; Miracle-Gro, Nature’s Care, Scotts, LiquaFeed and Osmocote gardening and landscape products; and Ortho, Roundup, Home Defense and Tomcat branded insect control, weed control and rodent control products. In the United Kingdom, its brands include Miracle-Gro plant fertilizers; Roundup, Weedol and Pathclear herbicides; EverGreen lawn fertilizers, and Levington gardening and landscape products. SMG has a current market cap of about $87.4 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings were nearly flat, growing only 1.5%, while sales decreased almost 8%. The picture isn’t better in the last quarter, with earnings falling a little over 7% while sales declined almost 2%. Much of the decline in sales appears to have been attributed to revenues in the Hawthorne division that missed management’s targets and was blamed primarily on cannabis regulatory delays in California. As more states adopt more liberal regulations around cannabis production and sales, the industry’s reliance on California as a primary market is expected to decrease. More interesting is the fact that despite the earnings and sales declines, the company managed to improve their operating profile in the last quarter, as Net Income as a percentage of Revenues increased, from 6.7% over the last twelve months to 8.3% in the most recent quarter.
  • Free Cash Flow: SLB’s free cash flow is adequate, at a little more than $201 million. This number declined in the last quarter from about $300 million.
  • Return on Equity/Return on Assets: These numbers are very strong. ROE is 43.37 and ROA is 7.45.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for SMG is $9.58 and translates to a Price/Book ratio of 7.79 at the stock’s current price. The stock’s historical average Price/Book ratio is 7.2, suggesting the stock is overvalued by about 7.5%; at par with its average, the stock should be trading at about $69 per share. To provide a compelling bargain relative to its historical Price/Book levels, the stock would need to drop to around $55 per share. That doesn’t sound favorable from a value standpoint right now, of course, but an interesting counterpoint comes from analyzing the stock’s Price/Cash Flow ratio, which is 27% below its historical average. That gives the stock a long-term target price at around $95 per share – a level that was last seen in late January.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from January of this year until now; it also provides the basis for the Fibonacci retracement lines shown on the right side of the chart. In mid-August, the stock found trend support at around $72.50 per share and has start to rally a bit from that point. The size of the stock’s decline over the last eight months means that the trend’s retracement levels, which I usually like to use to provide a strong indication of trend reversal points to pay attention to, are further from the stock’s current price than normal; after all, the $87 price level, which where we can see the 38.2% retracement level, is about 16% above the stock’s current price. If the stock breaks that level, I would expect to see the stock push high enough to test its high at around $110 per share.
  • Near-term Keys: A break above $87 would mark a pretty clear indication of a bullish trend reversal; but I’m not sure that a move to that point is necessary in this case to provide a good, high-probability opportunity for a bullish investor. The stock’s intermediate trend line, as represented by a 50-day moving average (not shown) is around $80, and that usually marks an important resistance level during a downward trend. A break above that, to about $81 with strong buying volume should give the stock good bullish momentum to push to $87, and so could be a nice early sign to work with. Even a break below the trend’s support low at around $72 per share wouldn’t be a bad thing; given the prices I described in my Price/Book ratio analysis, a drop to $69 could be an interesting point to take a value-based position if the stock shows signs of stabilization at that level. A drop below $69 should be taken as a sign the stock could drop as low as the $55 price level I also alluded to; that could act as a signal to short the stock or to work with put options for the time being, with an eye to buying the stock at a deeper discount in the $55 price area.