8 Stocks for Fans of Takeover Targets

UREA, THE NITROGEN-RICH compound people freely discard with each trip to the lavatory, now fetches more than $800 a ton on chemical markets, double its March price. No volunteer sellers, please. Today's vast output of commercial urea, 90% of which goes for crop fertilizer, is manufactured from ammonia and carbon dioxide.

Rising prices have done fine things for companies that make the stuff. Shares of Calgary-based Agrium (AGU), which this column first recommended in December 2003 at $15 and change, now fetch $99. Companies that must buy urea, however, have seen profits and stock prices crimped. Shares of Scotts Miracle-Gro (SMG), the world's largest seller of branded lawn and garden products, gained 170% from 2000 to the start of 2007, but have since lost more than 60%.

Urea's rise has worsened Scott's decline, but isn't the sole cause of it. Plunging house prices, swelling foreclosures and a broad consumer shift to cheaper brands have slowed demand for premium soil, mulch, bug spray and weed killer. A cold, wet March delayed purchases in the company's most recent quarter, sending sales 4% lower. A recall of a combination plant food and weed preventer, prompted by the Environmental Protection Agency finding it was mislabeled, helped send profits to 88 cents a share from $1.23 a year earlier.

Analysts' opinions on the stock are mostly sour. Of the 10 who cover it, just three recommend a purchase. Consensus estimates have sales increasing 4% this year ending Sept. 30 and adjusted earnings per share (which ignore one-time events like product recalls) falling to $2.02 from $2.37. Next year's fortune is surely difficult to forecast, but analysts expect 5% sales growth to lift earnings to $2.16 a share.

A growth stock, Scotts is not. But its price is beginning to look modest. Shares now fetch 9.5 times this year's earnings forecast, a discount of a third to the S&P 500 median. The company carries a rather full debt load, in part because last year as part of a "recapitalization" it borrowed to repurchase $245 million worth of its stock and pay $508 million ($8 a share) as a one-time dividend. Price/earnings ratios consider only the cost of buying a company's shares, not the true cost a corporate suitor would face in buying its shares and taking on its debt. For that reason, merger-and-acquisition analysts prefer to use enterprise value (the price of all shares plus debt, minus cash) divided by Ebitda, or earnings before interest, taxes, depreciation and amortization (a measure of underlying profit potential).

Scotts carries a trailing EV/Ebitda ratio of 7.8, safely below the S&P 500 median of 8.5. Forecasts for next year's Ebitda yield a ratio of 5.8, according to BMO Capital Markets, an investment bank. That, along with positive free cash flow and below-average operating margin (suggesting room for improvement following a buyout), helped earn Scotts a spot with seven other companies in a recent Takeover Targets screen. Use SmartMoney's stock screener and the full list of criteria to run the search for yourself anytime.

Note that our screen is meant to provide a whole-company approach to finding cheap stocks, not to predict takeovers. Investors who make a long-term bet on a recovery at Scotts might need patience. The company is now locking in painfully expensive urea supplies for next year. But a long wait for a rebound will at least come with some income along the way. Shares yield 2.6%.

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