Central Pet and Garden: Gem Of A Stock

Warren Buffett has famously and provocatively advised investors to think of a punch-card with 20 slots and therefore, to only select 20 “home-run” stocks in one’s lifetime. After all, a few undiluted great ideas can lead to riches.

With this philosophy in mind, I am wholeheartedly recommending Central Garden and Pet (CENT). It is an easily understandable unglamorous business and I am permanently devoting a very significant amount of my portfolio to it.

I was drawn to this small cap stock off of a P/B ratio screen, as it is trading at a mere 46% of book. Cynically, I expected a free falling business overflowing with debt (for this kind of garbage, see Doral Financial Corp. (DRL)).

Instead, the long term debt/equity ratio is a little higher than I usually like at 0.79, but otherwise this one is a gem with a P/E of 5.8.

Listen to the most recent management presentation and you’ll immediately hear how management is running the company as if they are buy and hold stockholders. Focusing on the long-term, it is no surprise that CENT’s 5-year stock performance is 339%.

I love the fact that CENT is trading at 28.8 times free cash flow. Without free cash flow, it’s difficult for a business to pursue new opportunities, acquire other businesses, pay down debt, or save cash for a rough year.

On the more descriptive side of things, I had my doubts. Pet and garden supplies are non-essentials, and the market can fluctuate greatly based on the weather as not too many people are keen on buying new outside toys for their pets or new gardening supplies when it is rainy for a month or more.

However, for long term investors, the weather will average out over time. Surprisingly, pets are being bought at higher rates, which we could attribute to the high-tech/high-touch phenomenon first described by Megatrends 2000 author John Naisbitt. People have shown a need to have more outdoorsy and physical sensory experiences in an age when technology is growing increasingly dominant.

Central Garden also does not supply any live pets themselves but merely accessories, thus eliminating the cost of feeding and caring for live pets before they get sold.

Central Garden is indeed a pet supply innovator winning 9 out of 33 new product awards at the 2007 Global Pet Expo.

WalMart (WMT), Home Depot (HD), Lowes (LOW) and PETCO are all consistent customers of Central, which has a variety of products with considerable brand loyalty—this is Central’s barrier to entry.

This stock won’t be selling at under 50% of book for long.

Disclosure: Author has a long position in CENT

CENT 1-yr chart:

Comments

[Alan Brochs...:]

I am not sure where you are getting your PE metric from. In 2006, the company earned .85, and in 2007 and 2008, it is expected to earn .83 and .98 respectively. The PE is 16.5 on a forward basis, a bit higher trailing.

Also, the P/B ratio reflects the high amount of intangibles relative to equity as well as the high levels of debt. A quick look at the balance sheet also suggests that inventories have been rising well in excess of sales growth.

2007 Apr 12 06:20 AM

[twhite113:]

The Book Value mentioned here, doesn't take into account CENT's special stock dividend back in early February. This also accounts for the author's mistaken p/e. It's a very misleading article. Unless somehow I am missing something.

2007 Apr 12 10:11 AM

[Aaron Krawitz:]

"The Book Value mentioned here, doesn't take into account CENT's special stock dividend back in early February. This also accounts for the author's mistaken p/e. It's a very misleading article. Unless somehow I am missing something."

Update: The above comment is correct, the seemingly fire sale P/E and book values do not yet take into account the stock dividend's effects. The post stock dividend P/E is approximately 17, while the post stock dividend calculus still finds the price trading at a (more modest) discount to the book value.

This is still a value stock but the recent numbers make it less so. Thank you for the corrections.

2007 Apr 15 10:13 PM