Growing Profits In Garden Pet Products

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Central Garden & Pet (CENTA) manufactures and distributes products for two markets: pet supplies (approximately 60% of revenue) and lawn & garden (40%). The company began in 1980 as a pure distributor and has spent the last 40 years acquiring suppliers and competitors. It has made more than 60 acquisitions since 1992.

Central has also mustered some modest organic growth and received a big boost last year from increasing rates of pet ownership and home improvement during the pandemic.

Some of this benefit will wear off in the coming fiscal year, but some should persist while the company’s long-term growth rate settles back in the mid- to high-single digits. The valuation looks reasonable in a market where such values are very scarce.

Customers are mainly big box retailers. Its top five customers of Walmart (WMT), Home Depot (HD), Lowes (LOW), Costco (COST), and Petco (WOOF) accounted for 51% of Fiscal 2021 sales. The business is quite seasonal, with almost 70% of Garden sales and 60% of total sales occurring in the second and third fiscal quarters.

Historically the pet and garden markets have not fluctuated much, but the pandemic changed consumer habits, at least temporarily. After producing organic growth of just 1.5% in 2019, sales grew 10.7% organically in Fiscal 2020 and 12.5% in 2021. It is estimated that pet ownership increased approximately 20% during the pandemic, and Central’s results are consistent with these estimates.

CEO Timothy Cofer, previously Chief Growth Officer at Mondelez International, arrived after the company’s lackluster 2019, and his tenure so far has been a story of COVID-19-related upswells of demand. Recent trends imply that Fiscal 2022 will be more difficult. Pet segment growth slowed to 3% in the fourth fiscal quarter of 2021, and the Garden segment saw a 13% organic sales decline.

The company expects a very solid Fiscal 2022, guiding to EPS growth of at least 13% in the coming year. However, it has not provided an estimate for the revenue performance that EPS figure is based on.

The balance sheet is in good shape. Net debt is $750 million, about the same as total working capital. The valuation is modest at 16 times the low end of 2022 EPS guidance.

Depending on how quickly consumers revert to old habits coming out of the pandemic, there could be some downside to sales expectations, and presumably earnings, estimates.

However, some of the sales boost will endure. Those COVID-19 puppies and kittens aren’t going away, just growing up, but the Garden segment might get chopped back to its old trajectory, which Q4’s results implied is already starting to happen.

When we first introduced Central Garden & Pet two years ago we said it should be a good inflation hedge if prices rise faster in the future, and that thesis will be put to the test in 2022 as inflation across the consumer basket appears to be running approximately 6% with no signs of slowing down imminently.

With the COVID-19-related tailwinds abating, there is some risk that Central’s markets swing into a state of oversupply, which would make it difficult to raise prices. As the manufacturer for 80% of the products it sells, at least Central will not get squeezed between vendors and customers, but its large, powerful customers will not be pushovers when Central attempts to pass along its own higher costs.

We are also attracted to the non-cyclical nature of the pet and garden markets, particularly at the mid- to lower-end where Central plays. Consumers generally trade down from name brands during recessions. The economic recovery has been a little inconsistent coming out of the pandemic, and we think it makes sense to consider steady performers like Central, especially if you can get them at low multiples.

We model 9% compound EPS growth starting from a base of $2.75, which could generate EPS of $4.23 in five years. That figure, combined with a high P/E of 21, generates a high price of 89. For a low price, we apply a P/E of 12.7 to trailing EPS of $2.75, producing a low of 35. On that basis, the upside/downside ratio is 4.1 to 1.

Central Garden & Pet Company is listed on the Nasdaq under the symbols CENTA and CENT. The Class A CENTA shares are non-voting and typically trade at a discount.

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