Stay-at-home trends boost Scotts Miracle-Gro

Like many of my friends, I was out in the garden early this spring. While snowflakes were still falling I was raking and bagging. Next came mulch in the front and back flower beds. As the weather improved, a small vegetable garden in a newly built planter.  My wife expanded the hanging basket collection and I stocked up on bird seed.

The pandemic has limited options for travel and entertainment, so more people are seeing their home with fresh eyes. They are investing in improvements, sprucing things up with paint and new accessories and expanding gardens. It is something to do and something to enjoy in these unusual circumstances.

This has all been good news for Home Depot, Loew’s and Walmart, whose shares are up double digits this year.  Grocers  such as Metro, Sobey’s, Costco and Loblaws, have also been strong performers.

Digging a little deeper into the food chain are two companies that rarely make the news. However,  both make your garden grow and ensure your grocer has fresh produce. Their products are evergreen and their businesses are well established. Both have manageable debt and a history of rising dividends. Both have large market capitalizations which means they can withstand more turbulence and both will benefit from the stay at home trend.

Scotts Miracle-Gro Company (NYSE: SMG)
All figures in U.S. dollars

Background:  Scotts was founded in Ohio in 1888 to sell grass seed and its product lines have expanded over time. They now include a variety of lawn care products, including seeds, weed and pest control, potting and garden soils and mulch. Miracle Gro is a best-selling water-soluble plant food.

Scotts has powerful distribution channels which include partnerships with the largest North American retailers. This year I was all Scotts. The seed and mulch came from Home Depot, the Miracle-Gro from our local garden center and the 20-pack of suet for the bird feeder from Canadian Tire. Canadian Tire also sells Scotts brand grass seed and other products.

Scotts has another emerging business. It saw the potential of the cannabis industry and in October 2014, formed the Hawthorne Gardening Co., to provide fertilizers for hydroponic cannabis growers. As Canada’s cannabis industry has matured, Scotts has become a source of liquid nutrients, growing media and lighting for hydroponic growing. It employs 700 people in Canada.

Performance:  Scotts shares have doubled from their mid-March low of $76.50 to the current price $155.72 as of Aug 11. Year-to-date the shares are up 46.6%  versus a rise of 3.7% for the S&P 500 index.

Developments:  The shares rose 11% July 29 as Scotts released blockbuster third quarter results. It raised its full-year outlook, announced a special $5 dividend and increased its quarterly dividend by 7%.

“Our results continue to exceed our most optimistic expectations,” said Scotts CEO Chris Hagedorn. He added in a conference call that with two months left in its fiscal year, sales are up 23% and show no sign of softening.

“We continue to see gardening as the driving force, even though we are weeks past what would normally be the peak of that season,” Mr Hagedorn said. “We’ve seen strong double-digit improvements in every retail channel.”

Mr. Hagedorn said the company saw significant acceleration in sales beginning in May with little or no marketing.  Entering August, consumer purchases are up 23%  year-over-year with increases in every product category.

In the third quarter sales rose 28% to $1.49 billion, a record. The Hawthorne cannabis segment saw sales rise 72% to $303 million.  Net income was $202.8 million with earnings per share rising 13% to $3.57.

Consumer research has revealed customers spending more time in the garden as a way to cope with the uncertainties surrounding the coronavirus. About 10% of customers are new to the practice of growing and cultivating plants.

Scotts sees growth of 26 to 28% year-over-year. Hawthorne sales are expected to rise 55 to 60%. Looking ahead to 2021, Mr Hagedorn sees double digit growth for the Hawthorne segment as more states legalize cannabis, with overall company growth in the high single digits.

Dividend:  The 7% dividend increase to $0.62  quarterly gives a yield of 1.59% at current prices, It is payable in September as is the special dividend.

 Nutrien Corp. (TSX: NTR)  All figures in U.S. dollars except share price.

Background: Nutrien is the world’s largest producer of agricultural fertilizers. This includes nitrogen and phosphates which it sells in bulk and at the retail level to farmers.

The company is based in Saskatchewan and was formed in 2018 from the merger of Agrium Corp. and Potash Corp. The merger married Potash, a globally dominant  fertilizer producer, with Agrium’s retail network of about 2,000 stores. This network dominates in North America and Australia and is expanding in Latin America.

The merger provided a better way for the companies to compete with large fertilizer producers in Belarus and Russia.

Performance:  Nutrien’s shares are down 21.8% year- to-date, falling to a low of $36.30 in March, before rebounding to their current level of $49. Its  P/E ratio is 23 at the current price.

The company lost $69 million in the three months ended March 31 although revenue rose 12.6% to $4.19 billion.

Dividend:  The $1.80 dividend yields a high 5.03%. The current payout ratio is 113%, which means based on the last quarter’s earnings it is paying out more than its earnings support. That will change as conditions improve and in the meantime the payment seems secure.

Discussion:  Nutrien is a dominant, well-financed player with strong fundamentals in a business which is at the bottom of the cycle. It stands to rebound as conditions improve.

The consensus is that fertilizer prices are at historic lows, but are unlikely to fall further. The company believes prices will start recovering in the second half of this year. Results released  this week should provide better guidance.

In a recent research note, RBC Dominion Securities analyst Andrew Wong said he expects Nutrien to continue generating strong free cash flow as fertilizer prices gradually recover.

He notes that Nutrien is the most diverse and vertically integrated player in the business with an attractive earnings profile and a solid balance sheet. As oil prices recover, it should also gain as farmers plant more corn which is used for ethanol, a gasoline additive.

Mr. Wong expects Nutrien’s  payout ratio to fall to sustainable levels as higher prices generate cash and that it will buy back shares and increase dividends as conditions improve. He also expects Nutrien to acquire more retail outlets in North America and continue an aggressive expansion in Brazil.

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(This is an edited version of an article that appeared in the Internet Wealth Builder newsletter on Aug. 10, 2020.)