Lowe's (LOW -1.16%) is one of the largest home improvement stores in the United States. Scotts Miracle-Gro (SMG -1.93%) is one of the largest makers of lawn care products and is a key supplier to Lowe's. Both companies sell things that get used regularly and, in many cases, are necessities for proper maintenance and repair of homes, offices, and industrial facilities.
Is one a better option than the other today for investors seeking out companies with solid businesses in turbulent times? Let's explore.
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The No. 2 home improvement retailer
Lowe's operates around 2,200 home improvement stores across the U.S. market. It is, however, the perennial second-place finisher to larger competitor Home Depot (HD -0.72%). To put a number on that, Lowe's market cap is roughly $80 billion compared to Home Depot's nearly $250 billion, despite having roughly the same number of stores.
Lowe's has been retrenching over the last couple of years, closing stores and focusing on cost-cutting. The main goal is to rationalize the business and improve margins so they are more in line with those of its main rival. That hasn't gone so well, with Lowe's operating margin of roughly 5.6% in 2019 still far behind Home Depot's 14.6%. In general, Lowe's margins have been in the mid- to high-single digits, while Home Depot's have been in the teens for the last four years. Clearly, Lowe's is not the best-run hardware store in America.
Lowe's also makes greater use of leverage than Home Depot, with a financial-debt-to-equity ratio of 0.22 times compared to 0.13 times. To be fair, both are very low figures, so there's no particular reason to worry about Lowe's financial health. In fact, it covers its interest expenses a solid nine times over. However, it still isn't as strong as its peer.
That said, Lowe's has increased its dividend for 57 consecutive years, with an average annualized increase over the past decade of roughly 20%. The most recent increase was in the mid-teens. The stock's current dividend yield is around 2% (for reference, Home Depot's yield is around 2.5%). Home Depot's dividend has only been increased for a decade, though at a much faster clip. Still, for long-term investors seeking out a dividend growth stock, Lowe's offers an enticing dividend story that shows a clear dedication to shareholders.
Valuation-wise, neither Lowe's nor Home Depot stands out as cheap. However, looking at price to forward earnings, which examines analyst estimates, Lowe's looks like a better deal. Its price-to-forward-earnings ratio of 16 is below its five-year average of 18. Home Depot's ratio is above its five-year average. Investors are expecting more from Home Depot, which, based on the recent performance of these two hardware stores, makes a great deal of sense.
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Slow growth (for now) as a retail supplier
How does Scotts Miracle-Gro fit into all of this? For starters, it counts Lowe's and Home Depot as two of its largest customers, with Walmart rounding out the top three. Together this trio represents roughly 60% of Scotts' sales, though only Lowe's and Home Depot individually make up more than 10% of sales each. Basically, the two hardware stores are huge customers for Scotts Miracle-Gro products.
Scotts' operating margins, meanwhile, have been in the mid-teens space in recent years. It has increased its dividend annually for a decade, with a 10-year average increase in the mid-teens, though more recent hikes have been in the mid-single-digit area. The yield of roughly 2% is in-line with Lowe's. Although Scotts' doesn't stand out dividend-wise, it certainly doesn't fall materially behind.
Where there's a bigger difference, however, is leverage. Scotts' financial debt-to-equity ratio is roughly 0.35 times, and it covers its interest expenses by roughly 6 times. So its balance sheet isn't quite as strong as the two companies to which it is a key supplier. That said, at this point, Scotts' leverage is hardly a huge concern. In fact, its financial position has greatly improved over the last year or so, since its financial debt to equity was closer to 0.7 times not too long ago.
LOW Financial Debt to Equity (Quarterly) data by YCharts
That brings up a key difference between Scotts, Lowe's, and Home Depot: All three are in relatively slow-growth industries that supply basic home improvement needs. Scotts, however, has recently entered into the hydroponic space, selling the gear that is used to grow marijuana. (Leverage spiked to 0.7 times because of acquisition activity.) This business, known as Hawthorne, made up around 20% of the company's sales in fiscal 2019. With marijuana expected to be a high-growth market for years to come, this business gives Scotts something of a growth flare that Lowe's and Home Depot both lack.
Valuation-wise, however, Scotts' doesn't look any better than Lowe's or Home Depot -- notably, its price-to-forward-earnings ratio of nearly 23 times is above that of Home Depot. Like the other two names here, Scotts' doesn't look particularly cheap today.
Which is best?
The unfortunate answer here is that, right now, neither Lowe's nor Scotts looks particularly compelling. Home Depot doesn't look any more attractive, either. However, for those with a growth bent, Home Depot and Scotts look like the better options than Lowe's. Home Depot is simply better run than its main rival, and Scotts has the marijuana angle to it.
But go in knowing that you will be paying at least full price, if not more, which materially reduces the desirability here as the broader market experiences increasing turbulence. In fact, most investors should probably hold off on all three names, and instead, put Home Depot (if you are looking for a targeted home improvement investment) and Scotts (for the marijuana growth story) on their wish lists until either market turbulence subsides or their valuations get at least a little more compelling.
