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.
Demographic data about farmers in the United States doesn’t exactly encourage optimism, either. Not too long ago I found a 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 counter to this trend, besides the Trump administration’s push via tariffs and the trade war with China to level the playing field for American agriculture, 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. Moving into the late stage of the year, however means that seasonal factors including the upcoming winter cold could make some of the stocks in this sector difficult to work with.
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 find ways to add this growth area to their product mix. 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, which made up about 13% of their 2018 revenues, 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 cannabis, and that is expected to continue to drive growth through the rest of 2019 and into 2020. Is the stock a good value, or should the coming winter cold make you wait for a better seasonal cycle? Let’s take a look.
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 $5.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by about 16.5%, while sales grew a little over 17.5%. In the last quarter, earnings declined -14.5% while sales dropped about -1.65%. 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 an already healthy 12% over the last twelve months to 17.2% in the most recent quarter.
Free Cash Flow: SMG’s free cash flow is adequate, at a little more than $216 million. This number declined from about $300 million in March 2018, and translates to a modest Free Cash Flow of about 3.88%.
Debt/Equity: SMG has a Debt/Equity ratio of 1.94, which is pretty high. The company’s balance sheet validates that number as a red flag, since in the last quarter SMG reported more than $1.5 billion in long-term debt versus just $35.4 million in cash and liquid assets. Given the fact that Net Income has been increasing over the past year, I would normally expect liquidity to be improving, but instead of building cash the company seems to be plowing operating profits into stock repurchases; management approved a share repurchase program of about $500 billion through 2019, which I think is at least partially attributable to the stock’s impressive performance over the past year.
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 $14.52 and translates to a Price/Book ratio of 6.9 at the stock’s current price. The stock’s historical average Price/Book ratio is 8.04, suggesting the stock is undervalued by about 16.5%; at par with its average, the stock should be trading at about $116 per share. That isn’t quite as high as I’d normally like to see, and is counterbalanced by the fact that the stock is currently trading about -8.8% above its historical Price/Cash Flow average.
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 upward 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. The stock reached a trend high at around $115 at the end of July before retracing a bit and approaching the $100 level in early September. For the last five or six weeks, the stock has hovered in an increasingly narrow trading range between $104 (resistance) and $99 (support). A break above $104 could give the stock short-term momentum to about $110, or possibly to even test its 52-week high at around $114, which a drop below $99 could see if fall to as low as about $93, where the 38.2% Fibonacci retracement line sits.
Near-term Keys: I don’t think SMG’s fundamentals are quite strong enough to consider the stock’s undervalued status very compelling right now; the fact that Free Cash Flow has been declining for the past year and a half is a concern, along with poor liquidity while management props up the stock price makes me question the sustainability of the stock’s current price. I would need to see material improvements in cash and Free Cash Flow, along with progress towards reducing long-term debt, before I would be willing to take this stock more seriously as a value-oriented opportunity. If you prefer, however to work with short-term strategies, a push above $104 could offer an interesting opportunity to buy the stock or work with call options with an eye on the $110 level as a short-term price target. A drop below $99, on the other hand would act as a good signal to consider shorting the stock or working with put options with an eye on the $93 level for a bearish trade.