In this Market Foolery podcast, host Chris Hill is joined by Foolish investor-at-large Tim Hansen to discuss a trio of topics. First, they review Home Depot's (NYSE: HD) disappointing quarter. The home-improvement retailer may be Amazon-proof, but it's not entirely weather resistant.
Next, they debate whether Scotts Miracle-Gro (NYSE: SMG) is as good a "picks and shovels" play as it appears for folks looking to invest in the looming legal marijuana gold rush. And finally, they get politely incensed at the number of 2017's highest-paid CEOs who did a terrible job en route to their massive paydays. Case in point: Snap's (NYSE: SNAP) Evan Spiegel topped the compensation list with a $500 million package in a year when his company wound up $720 million in the red.
A full transcript follows the video.
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This video was recorded on May15, 2018.
Chris Hill: It's Tuesday, May 15th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, it's investor at large, Tim Hanson. Thanks for being here!
Tim Hanson: Always a pleasure!
Hill: I'm happy that you're here on a day when we're going to be talking about public companies that are in one of your areas of, maybe not expertise, but certainly one of your areas of interest, and that's gardening. You're a legit gardener in my book.
Hanson: Thank you! I appreciate that!
Hill: Lest anyone think this is just going to be some big lovefest about gardening, we're also going to be talking about the list of best-paid CEOs that came out recently, so we'll have a little bit of fun with that.
Hanson: Gardening and sarcasm, two things I do well.
Hill: [laughs] Let's start with Home Depot, their first quarter report that came out this morning. Their profits were better than expected. Overall sales were down a little bit. Their same-store sales were down a little bit. The stock fell, I don't know, it was down 1.5%, something like that. This really did seem like one of those situations where, not that Home Depot was ducking any responsibility, but they were just saying on the conference call, very matter-of-factly, "Yeah, the weather in April was pretty bad, and we got affected by that."
Hanson: Yeah. Sometimes we laugh at companies that blame the weather, because there are some companies that shouldn't be affected by weather that use the weather as a convenient excuse. But in the case of Home Depot, it's a very reasonable explanation, and one that we've seen in other companies in this space. It stayed colder longer, and obviously that prevents a lot of things from happening in the springtime. You don't get out in the garden as soon, so you're not buying seasonal items, maybe you're not doing some repairs around the house in preparation for the warmer weather, re-staining the deck, things of that nature.
But, overall, they maintained guidance for the year, so they expect those sales to show back up again. Home Depot has been a multi-year tremendous retail story. At a time when Amazon is really causing weakness in a lot of parts of the retail sector, Home Depot has done a wonderful job of leveraging not only the proximity of all their stores to Americans to sell to DIY people, but their professional business is growing really nicely. Also, they're quietly building a pretty good e-commerce business, as well.
So, a lot of tailwinds for Home Depot. Particularly, the housing starts continue to go up. That's a huge tailwind for Home Depot, especially as millennials and people start moving out of their parents' basements, that should benefit Home Depot for years to come. I think it's a pretty interesting stock to take a look at.
Hill: When you look at the same-store sales and they break it out by month, you really see the effect of the bad weather in April, which was much colder and snowier than we typically see. In February, same-store sales were about 5.5%. March, almost 6%. And that falls off a shelf to about 2%.
Hanson: Yeah, it was a legit excuse. Like I said, Scotts Miracle-Gro earnings not too long ago, and their results were much poorer, because obviously, from a seasonal perspective, they're almost pure-play gardening. And they reported the same problem. So, it's a credible explanation. They maintained guidance for the year. And Home Depot has been doing a lot of things right with regards to being a retailer.
Hill: We'll come back to Scotts in just a second. One more thing in terms of the rest of the fiscal year for Home Depot. We've talked before about, look, when there are weather events, particularly in the winter, like significant events, blizzards, that sort of thing -- if you're a restaurant, if you're a coffee shop, if you're Starbucks or Chipotle or whoever, and you're losing sales due to weather, you're not getting those back.
Hanson: Yeah. You don't buy two cups of coffee on Tuesday because it was closed on Monday.
Hill: I mean, I do. But I'm making a couple of trips every day. But, with auto companies, when they're dealing with adverse weather, look, if you need to buy a new car and you can't get out because there's bad snow or whatever, there's bad weather, well, you're going to go back the next week or a couple weeks later. Is Home Depot in that second category? Because it kind of seems like, look, if you need gardening supplies, if you need to do repairs around the house, maybe you don't get out there in April when it's snowing. But, those are sales that just get pushed off by a few weeks.
Hanson: Yeah, I would say that's the right way to think about it. It's deferred business, rather than business that disappeared. If people aren't buying a home, if they didn't get a chance go out to open houses over the weekend because of poor weather, that's not going to cause them to go like, "You know what? Forget that whole home buying thing. We didn't get around to it last weekend, let's just wait." So, yeah, I think this business will show back up in the next quarter. Obviously, they already have some visibility the next quarter since it is the next quarter, and they maintained their guidance for the year, so that probably tells you all you need to know about that particular secular trend.
Hill: And probably safe to assume that whenever Lowe's reports their report --
Hanson: It'll rhyme, yeah.
Hill: -- their April is probably going to look a lot like Home Depot's. You mentioned Scotts Miracle-Gro, which is a company we don't talk about very often. It is a stand-alone public company, ticker symbol SMG. You had mentioned how they reported recently, kind of a tough spring for them as well. But, you mentioned something to me this morning about Scotts Miracle-Gro being a way to play the growth in the marijuana industry.
Hill: And somebody on Wall Street may have tapped your phone or something, because sure enough, a firm came out this morning and upgraded Scotts Miracle-Gro to a buy, put a buy rating on it, specifically for that reason.
Hanson: I think a lot of marijuana legalization stocks, obviously, have been part of a market where there's been a lot of hype, there's a lot of overvaluation, there's a lot of outright fraud, so on and so forth. A lot of pump and dump schemes have been in this space.
Hill: A lot of penny stocks.
Hanson: A lot of penny stocks. But obviously, as marijuana is legalized in places, there are business opportunities associated with it. What makes Scotts interesting is that the core business is a very stable, branded gardening business, which is Miracle-Gro, Scotts Turf Builder, those sorts of things. This is a business that generates a lot of free cash flow every year, has pricing power, people use the products every day, so on and so forth.
Then, attached to it, they've quietly been using that free cash flow and taking on some debt to build a vertically integrated greenhouse growing business, which can easily be applied as a picks and shovels play on marijuana agriculture, were people to start growing that in significant quantities. It's things like hydroponics, seed starting kits, indoor soil, lighting, air filters, things of that nature.
It's a couple hundred million dollar revenue business now, and if you look at the potential growth rates in the industry, this is one of those opportunities where marijuana as a commodity, predicting the price there and the demand and the supply is very difficult. If you know that growers are going to be coming into the industry, the people who supply the growers with the things they need should do pretty well. And like I said, they've assembled a pretty interesting portfolio of brands to service that market.
Hill: Far more brands than I would have expected, and some of them I've never heard of.
Hanson: They're niche. Niche to the gardening community.
Hill: I mean, Roundup, which, controlling weeds that you don't want.
Hanson: On the retail side, yeah.
Hill: Ortho. But, a phenomenal brand which I had never heard of until you mentioned it this morning is something called Black Magic.
Hanson: This is gardening for the cool kids. Black Magic. They sell the products at Home Depot, and it's seed trays, seed starting soil, everything you need to get started. I start my own seeds. I actually experimented with Black Magic products this year, not to grow marijuana but tomatoes and cucumbers and whatnot. But, it's a hellaciously cool brand. It has a great logo. If they have T-shirts, I want a T-shirt.
Hill: Yeah. First of all, you tell me. "I'm going to do some shopping this weekend." "Where are you going?" "I'm going to Black Magic."
Hanson: Get some Black Magic.
Hill: There are so many ways you can go. That could be an amazing pizza place.
Hill: It could be any number of things. But, the fact that it's built right into the Scotts Miracle-Gro umbrella of brands is fantastic.
Hanson: You know what's neat is -- the majority of acquisitions in corporate America fail to create value. That's pretty well-known, particularly as they get big. But, what's interesting about Scotts and acquiring these small, niche gardening brands, is that they have distribution. They can put Black Magic into Home Depot at a higher price point than Miracle-Gro, and all of the sudden, you have a very interesting share of the shelf space in that retail environment, which is, you have a premium product, you have a mainstream product, you have a discount product, and you're touching the gardening process at beginning, middle and end.
The last time I went to the store, I had to buy seed starting soil, potting soil, I got peat moss. All that is taking share of my wallet, and I'm giving it to one parent company. So, I think it's a good strategy. Some analysts in the past have been concerned about the leverage they've taken on in order to execute it. But, I think they have more than enough cash flow to pay for it all, and I think it'll be pretty interesting. If marijuana legalization doesn't come to the masses, it's still a pretty reasonable valuation.
Hill: And you look at the track record so far. Putting the products aside, look at the job this company has done in terms of capital allocation, and they've built up a nice track record.
Hanson: Yeah, it's not a huge company, but they've done a solid job.
Hill: If you've ever wanted to invest in Black Magic --
Hanson: Now's the time.
Hill: -- now you actually can.
It's nice that some of the CEOs of public companies are making a good living, because I was really worried about some of them. And congrats to Evan Spiegel, the CEO of Snap, who, as it turns out, was the highest paid CEO in 2017. He made just over $500 million.
Hanson: That wasn't all cash, though, was it? No!
Hill: No, much of that came from a huge stock grant that vested when Snap went public.
Hanson: I mean, that'll be worthless soon.
Hill: [laughs] But here's the thing. When you juxtapose the just north of $500 million that he made in 2017 with the $720 million loss that Snap took in 2017, I can't help but think, there's a way to decrease that loss. You looked at the list. What stood out to you?
Hanson: This came from The Wall Street Journal. What they were pointing out was, was it nine of --
Hanson: Eight of the top 20 --
Hill: Eight of the top 20!
Hanson: -- don't even have their jobs anymore! They included Steve Wynn, who obviously resigned in shame for that. Then, Hunter Harrison, who passed away after trying to steer CSX. After successfully turning around some other railroads, he was attracted to CSX by an activist investor. He had health problems and passed away. Still pocketed something on the order of $100 million or something along those lines.
It was just fascinating. You like to think, at any company, that you have a pay-for-performance culture, right? That the people who are making the money are the people who are helping grow value for the business. And obviously, CEOs make a lot of money. And the fact that the turnover is so high for doing a bad job -- these people mostly lost their jobs for cause. They were doing a terrible job! And they were making well into nine figures!
Hill: That's the thing that always has me scratching my head. Because you're right. All kidding aside about Evan Spiegel, in general, rather than CEOs being paid a tremendous amount of cash, we'd much rather see their interests align with the interests of individual shareholders like you and me. But, I don't think I will ever stop shaking my head at some of the pay packages that are put together for CEOs who don't perform, to the point that you made, and also some of the parachutes. Even people who are being fired for cause, it's like, "Oh, yeah, but we're also going to give you this enormous bag of money on your way out the door."
Hanson: Yeah, it's crazy. In sports, there are obviously some overpaid athletes, but they got overpaid because at some point, they were probably underpaid, or their talents were marketable. There's some connection there between the compensation and their relative ranking among their peer group. With CEOs, there's almost no correlation between skill and pay when it comes to C-level management. None. So, why any board of directors feels the need to overpay a CEO to keep them or to hire them when you could probably find someone of equal or greater ability for less money if you're just willing to work a little harder continues to baffle me. And you have all sorts of corporate executive headhunting firms that make a lot of money looking for these people. And yet, there's no science to it! I mean, I like to measure things and be very quantitative --
Hanson: Yeah, and I believe in meritocracy, so on and so forth. And this is a thing that continues to annoy me about management teams, is how much money they think they're worth when it's demonstrably not true that they're worth that money.
Hill: You just reminded me, when you mentioned professional athletes, of the great line that Chris Rock had about the difference between being rich and being wealthy. It was, "Shaquille O'Neal is rich. The owner of the team who signs his paychecks, he's wealthy." How's The Fool 100 Index doing?
Hanson: Well. The index is beating the market year-to-date. We had our reconstitution at the end of March. We'll have another one at the end of June. But, yeah, it's been a nice time to be in large-cap technology stocks. I think the Fool analysts here in-house have done a really nice job of identifying the cream of the crop there. And that's helped the index stay ahead of the S&P 500 this year.
Hill: If you want more information on The Fool 100 Index, it's always right there on the main page of fool.com --
Hanson: I mean, if you're a Foolish investor, I would say it's a fun index to compete against. I benchmark all of our services and stuff against it now, because it's stylistically a little bit of a better comparison if you're investing Foolishly, in recommendations of ours and so on and so forth. You can make your life a little harder by trying to beat The Fool 100 instead of the S&P.
Hill: [laughs] Nice. You can also go to fool100.com for more information on The Fool 100 Index. Tim Hanson, I'll let you get back to gardening.
Hanson: Thank you, sir!
Hill: Thank you!
Hanson: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon and Starbucks. Tim Hanson owns shares of Amazon and Starbucks. The Motley Fool owns shares of and recommends Amazon, Chipotle Mexican Grill, and Starbucks. The Motley Fool has the following options: short May 2018 $175 calls on Home Depot and long January 2020 $110 calls on Home Depot. The Motley Fool recommends Home Depot and Lowe's. The Motley Fool has a disclosure policy.