By: Steve Smith
When the ice thaws sales will bloom and shares should follow. Pent up demand and renewed confidence in homeownership sets up this company’s stock for renewal of a solid seasonal rally.
This is the second consecutive winter of widespread and prolonged deep freeze with record low temperatures being reported daily across the country. Heck, it’s been 40 degrees all week even down here in Florida. But we know eventually Spring will come. And when the weather turns warmer people will be anxious to engage in some healthy outdoor activity. For many homeowners and landlords, especially as they’ve seen the value of their properties increase the past few years, that means gardening and landscaping.
One company that stands to benefit is Scotts Miracle Gro (SMG) which is best known for its lawn, seed and fertilizer products that target homeowners. After hitting a new all-time high of $67.80 on February 6th it has pulled back and is approaching support near the $64 level. If past patterns hold to form this could provide a good entry point for establishing a bullish position heading into the seasonally strong month of March.
Indeed, last year after hitting a new high in mid-January the stock pulled back as the polar vortex gripped the nation and bottomed during the third week of February. It then went on to rally by 18% over the next five weeks hitting a fresh high during the first week of April.
As you can see the shares have been in solid multi-year uptrend. There is every indication this should continue. The $62-$64 level offers an attractive entry point.
Strong Fundamental Roots
What helped propel share to new highs was a strong first quarter earnings reported on February 4th in which the company delivered a solid 15% revenue growth and smaller than expected loss. But given that Q1 typically accounts for less than 10% of its annual sales and often results in a loss as the company spends to build inventory it is the forward guidance that holds greater import.
On this front the company was decidedly upbeat, tilting full year guidance to the upper end of the $3.40-$3.60 earnings per share expectations. The balance sheet is solid with good cash flow and a pretty attractive 3% dividend yield. It did note that its commercial segment, which accounts for 11% of total sales, would likely flat due to weak pricing in commodities such as corn and soybeans.
But the bulk of its business, which includes equipment and decorative products, goes to the residential and both corporate and public parks. It sells through a variety of outlets including 85 company owned retail stores along with traditional big box such as Home Depot (HD).
If the price action and numbers coming out of Home Depot and Lows (LOW) are any indicator homeowners seem to ready to spend this spring sprucing up and repairing the damage done through this cold winter with the confidence that the investment will pay off in higher home values.
This all sets up for a nice bullish play over the next month or two.
The company will report second quarter earnings on May 4th. I think the stock will rally in anticipation and I want to get out ahead of that event. I’m focusing on the April options which still let us capture all of the seasonally strong period that typically peaks the beginning of April but will be less costly than June options due their shorter time premium and the lower implied as they don’t include the earnings event.
I want to use a straight up purchase of calls to keep the upside potential open and gives the flexibility to maximize profits at any point prior to the April 17th expiration.
Buy the April $65 calls for $2 a contract.
I have a reasonable expectation for a 10% rally by the beginning of April and am setting my initial price target of $70 a share. This would mean the calls would have a minimum value of $5 or over a 150% return.
This is a limited risk position and no need to set an initial stop though I’d be worried if shares closed below $62. I’d start employing a trailing stop as shares move back above the $66 level.