Lowe's (LOW -2.71%) is one of the largest hardware stores in the United States. Scotts Miracle-Gro (SMG -0.99%) is one of the largest providers of lawn-care products and a key supplier to Lowe's. Scotts has gotten itself into the weed space, and that could be a catalyst for the future that changes this matchup in a big way. 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. It's highly likely that you know the company's name and that it competes directly with larger peer Home Depot (HD -2.63%). Although the two companies have a similar number of stores, Home Depot's top line was 50% larger than Lowe's last year, and its operating margin was more than twice as high. Lowe's is, basically, No. 2 by a wide margin.
Scotts, meanwhile, describes itself as the leader in lawn care in the North American market. You probably know 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, along with other retail giants like Walmart. In fact, those three companies alone made up roughly 60% of its top line in 2018. So while it is a very different company than Lowe's, it is still highly dependent on the hardware store chain's success.
2. Fixing vs. expanding
The relationship here is interesting, because Lowe's has been working to improve its performance in an effort to catch up to Home Depot. That's included closing down stores and trying to increase efficiency. Only it just doesn't seem to be able to achieve the same success. Motley Fool's Travis Hoium recently took a look at the two companies, including examining inventory turnover, operating margin, and free cash flow trends, and declared Home Depot the "hands down" better company. Simply put, if you are buying Lowe's, you are buying a company that's a bit of a fixer-upper.
Scotts, meanwhile, has been working on its business in recent years, too. But there's a big difference here, because Scotts has been expanding into a new space: hydroponic equipment used to grow marijuana. By some estimates, marijuana could grow to be a $166 billion industry.
Equally important, Scotts' efforts here don't tie it to one grower; it sells to anyone who needs hydroponic equipment. It is a picks-and-shovels play on the marijuana market, building on the solid foundation of its slow-growth lawn-care business.
The hydroponic operation, called Hawthorne, makes up around 20% of the top line. There were some near-term negatives associated with this move (debt, for example, will be discussed below), but Scotts is expanding its business, not playing catch-up from a position of weakness.
3. The debt story
Scotts' push into the hydroponic space was made via acquisition and funded largely with debt. That bumped its debt-to-equity ratio up to a very troubling 9 times or so. Well aware of the issue, Scotts sold some noncore assets and used the proceeds to pay down debt. The debt-to-equity ratio is currently around 2.3 times, which is toward the high end of the company's normal historical range. Management has done a good job of addressing this issue, but leverage should still be monitored. That's especially true given that long-term debt is still around 70% higher than it was a decade ago, while annual revenues have only increased around 9% over that span. And the hydroponic business is still pretty new, so it remains to be seen if it will help the company hit the accelerator.
Lowe's debt-to-equity ratio is 6.6 times, up from 3 times at the end of 2018. The hardware chain has been adding long-term debt, increasing its debt load by more than 300% over the past decade. However, the biggest reasons for the rise in the debt-to-equity ratio are one-time noncash charges associated with its turnaround effort. Those charges reduce shareholder equity, which makes the debt-to-equity ratio worse. The company still covers its interest costs by a solid 6.5 times, so there's no particular reason to worry about leverage. However, this says a lot about the company's relatively weak industry position and the fairly material efforts it is making to restructure its business. And even though it can handle the leverage it has, it will eventually need to get its debt-to-equity ratio down to more normal levels to appease Wall Street leverage concerns.
Lowe's offers investors a 1.9% yield backed by an incredible 57 years' worth of annual increases. Historically, those annual dividend hikes have been in the 10% to 20% range, which is pretty enticing. Scotts doesn't really come near that record, with just a decade of annual hikes and recent annual increases in the single-digit range. It offers a 2.2% yield. Although that's higher than what you would get from Lowe's or an S&P 500 Index fund, it's nothing to write home about. Notably, it's much lower than the roughly 3.6% yield at the start of 2019, when Scotts' leverage was still at a high level. Which brings up the next point: valuation.
Scotts' stock price has increased an incredible 66% so far in 2019. Lowe's, for reference, is up around 22%, roughly in line with the broader market. That said, Scotts' price-to-earnings and price-to-sales ratios are both below their five-year averages. That's partly because the stock's year-to-date gain is pretty much a recovery from the roughly 45% price decline that coincided with the marijuana investment. Investors are obviously getting behind the pot story here after early concerns, but Scotts doesn't look overly expensive today -- though it wouldn't be fair to call it a bargain, either.
Lowe's, on the other hand, is trading with P/E and P/S ratios that are above their five-year averages. There's some noise in there on the P/E because of the one-time charges noted above, but this hardware store certainly doesn't look cheap today.
And the winner?
Many companies are cyclical, and Lowe's looks like it is currently working through a low point, while Scotts' fortunes appear to be improving again. Although Lowe's has a long and impressive history behind it, Scotts looks like the better stock today. However, after a huge stock price advance, it's hard to suggest that investors run out and buy Scotts. It's probably better at this point to put it on the watch list to see how the relatively new hydroponic investment plays out.