All Eyes Are On Central Garden And Pet

| About: Central Garden (CENT)


CENT has defied all estimates by outperforming previous records.

One of the few companies expected to give high earnings this fiscal year.

Expectations expected to reach fever-pitch ahead of earnings.

Investment Thesis

An impressive earnings record is likely to continue into 2017. The addition of profitable segments indicates a company keen on diversifying its revenue streams and ultimately creating value for shareholders.

Central Garden and Pet Company (NASDAQ: CENT), a leading producer and marketer of lawn and garden and pet supplies, is expected to release its Q1 fiscal 2017 earnings on February 2, 2017. Going by its impressive performance in the last several quarters, the announcement is much awaited by investors.

The Q4 2016 results marked positive earnings for nine straight quarters, and expectation of this upward trend has driven the share price up 4.7% in the last five days. In addition, CENT has outperformed the Zacks consensus estimate in the past four quarters by 72.5%.

CENT's core business is production and marketing of garden brands such as weed control and soil supplements; pet brands such aquatics and equine products; and distribution of pet supplies and gardening products. Its past growth has been spurred by strategic acquisitions and internal investment.

What's in Store for Investors?

In Q3 2016, earnings per diluted share were $0.48, a gain of 26%. Recent acquisitions raised the consolidated sales by 12% to $515 million compared to Q3 2015. This was exclusive of $2.4 million earned from the sale of a manufacturing plan.

Operating income rose from $39 million to $45 million, attributed to cheaper raw materials, improvement in manufacturing and exit from the seasonal décor business which was constantly hurting the margins. This quarter also saw a strong focus on increasing innovation output. This includes channeling more capital into the dog and cat business to increase capacity and consolidating facilities to reduce operational costs. The Comfort Zone Brand also saw addition of two behavior modification products which recorded satisfactory earnings.

In Q4, acquisitions and organic growth gave CENT a 10-year high gain of 11%. Much of it was driven by the pet segment, which grew 21% after acquisition of IMS and DMC.

In line with cost-saving, the quarter saw a gain in growth margin of 60 basis points, and a decline in SG&A by 50 basis points. The acquisition of the largest pet bed manufacturer in the US (DMC) was part of identifying new opportunities for growth. The October purchase of Segrest will see expansion of the aquatics segment and secure CENT's place as a leading supplier of aquarium fish. Consolidated sales exclusive of acquisitions rose by 7%, while organic sales grew 2.6%. The exit from the holiday décor business saw a jump of 11.3% in consolidated gross profit, and an increase in gross margin by 120 basis points to 29.1%. Operating income rose from $1.3 million to $13 million the previous year same quarter.

Per segment sales grew 14.9% to $270.7 million. Operating income grew 23.8%. The garden segment saw a drop of $8 million, partially due to the effect of exiting the holiday decor business. Organic revenues grew 2.7% due to increased revenues from grass seeds and sales of other manufacturer's products. Apart from the Segrest acquisition, CENT also sold off the underperforming vet products business for $8.6 million.

In the last six months, CENT share price has grown by around 42% to trade at $33.16. Its 168% return in the past 1 year places it on Rank #1 on the Zacks Consumer Discretionary Index, with projected long-term earnings. Earnings have consistently beaten estimates including the Zacks Consensus Estimates of share price which has gone up 3.8% to $1.36 in 2 months.

The past year saw strategic restructuring and consolidation of segments to increase efficiency and accelerate innovation efforts. CENT is keen on establishing a customer-centric approach to appeal to a larger demographic and give better customer service. A large and diverse portfolio of brands gives it a foothold over its competitors and places it in a strategic position to benefit from positive gains.

Looking at the figures and comparing with other companies in the same industry, I believe CENT is undervalued. I will hereby use Blue Buffalo Pet Products (NASDAQ: BUFF), B&G Foods Inc. (NYSE:BGS) and Flowers Foods, Inc. (NYSE:FLO). At the time of writing this article, CENT is currently valued at $1.755B, while BUFF, BGS and FLO are valued at $4.850B, $2.942B and $4.161B respectively. CENT has a PS ratio of 0.9486, against 4.375, 2.057 and 1.082 for BUFF, BGS and FLO in that order. The trailing 12 months revenue is $1.829B, compared to $1.120B and $1.320B for BUFF and BGS. In my opinion, CENT is trading at a number that is lower than its true value. The earnings calls reflect a company that has set itself for growth in this quarter.

After looking at the past performance, I opine that the February announcement will likely be a continuation of the upward trajectory. The pet industry has recorded consistent growth over the last 3 years, and it is likely that is will be bigger in the coming years. The garden industry has also had steady gains despite adverse weather changes. With over half of the US population purchasing gardening equipment and over 60% owning a pet, the market looks set for growth in the next year. Value-accretive acquisitions and revamping of high-returns segments are likely to give a positive ripple effect on the stock in the coming year. My strong belief is that a long postion on CENT will be a worthwhile venture that will certainly pay off.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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