|Shares Out. (in M):||57||P/E||20.0x||12.7x|
|Market Cap (in $M):||603||P/FCF||11.3x||9.0x|
|Net Debt (in $M):||406||EBIT||87||103|
On the surface, Central Garden & Pet (CENT) looks like a highly levered, non-differentiated producer of pet and garden products trading at over twenty times trailing earnings. However, under the surface, CENT is undergoing a major change and has virtually a whole new management team focused on streamlining operations. Earnings power will increase significantly in the next few years as management begins cutting fat and driving margin expansion. There is a significant amount of low hanging fruit to be harvested and the stock could appreciate 50 percent or so with just simple management blocking and tackling. Should management deliver on their expectations, there is significantly higher upside potential.
This isn’t a low risk situation as CENT carries a significant amount of debt. At 3.6x net debt/EBITDA and undergoing a major transformation, there isn’t a ton of room for error. That being said, CENT’s products are fairly recession resistant. For example CENT has performed well during recent economically stressed periods of time. From September ’01 to September ’02 sales only fell four percent and from September ‘08 to September ’09 they fell five percent. Increased commodity inflation, though, is a real risk. In FY 2011 EBIT was down 22 percent due mainly to increased input costs they were not able to pass through to customer.
CENT made 27 different acquisitions from 1997 to 2011 (and 40 since 1980) and each of those companies was left to function as effectively an independent business. Despite having similar brands and many of the same customers, these entities had very little synergistic relationships. Facilities were being severely under-utilized and some were at less than 40% utilization rates. At the end of September 2011, there were 66 facilities supporting $1.6bln in revenue while Scotts Miracle-Gro, for example, had 35 facilities and $2.3bln in domestic revenue. In addition, buying/procurement was not centralized preventing the company from benefitting from economies of scale. One senior management team member put it bluntly saying “there was an absence of processes.” The company had 26 different ERP systems. Sales and marketing was also a disaster where an insignificant customer might get 5-6 calls. Data was being collected by each entity and not being shared with the others. Several of their products were competing with each other. There were too many SKUs including at least one where a grand total of $500 worth of merchandise was sold in a year. What can only be described as a boondoggle of management was showing up in the numbers as five year trailing operating margins were 11.6 percent for the Pet segment and only 6.7 percent for Garden segment. This compares to the following five year averages of some comps:
Scotts Miracle-Gro (Global Consumer segment): 16.9%
Spectrum Brands (Home and Garden segment): 13.5%
Spectrum Brands (Global Pet Supplies segment): 11.8%
Uni-Charm Corp (Pet Caring segment): 14%
Enter Gus Halas who was hired as a consultant in 2009 and officially as CEO of Central Operating Companies in April of last year. While founder, Bill Brown, retains the CEO role, Halas is effectively controlling the operations of the company and attempting to transform the company from the boondoggle described above into one integrated, multi-brand company that has improved processes, reduced number of facilities, fewer SKUs, and a centralized process for all divisions. Note that Bill Brown still retains control of the company with super-voting shares and has been reluctant to give up control in the past. At present Gus seems firmly in control of the operations but there is a risk Bill Brown changes his mind.
Gus in his own words “was not looking for another career” and Bill Brown sought him out to help change the company. He was essentially retired after running T-3 Energy Services from March 2004 to March 2009. Gus was a consultant for a year at T-3 before becoming its CEO. T-3 stock went from $6.95 to a peak of $79 in June of 2008 before falling to $10 during the financial crisis. In his own words,Gus has been doing turnarounds for 30 years. It should be noted that Gus struck his options at $12.50 and $15 and not at the market price at the time of his hiring. He is very much aligned with shareholders on effecting this turnaround.
In just over a year, Halas has already made great strides in collapsing the silos and implementing a process. The back office teams are now all aligned by function and purchasing has been consolidated, they have closed six warehouse facilities, and SKUs have been reduced by 7 percent. As of the beginning of 2H 2012, management believes that have already taken out $15m in permanent cost reductions. They are spending more on marketing and further building their brands. Finally, Gus has built out a talented team and has hired people with branding experience.
The plan is to reduce CENT’s SKUs by 35 percent and focus management time, advertising spend, and salespeople’s efforts on the best brands. Gus expects this (along with demographic trends that favor both pet and gardening segments) to drive 10 percent top-line growth. Their plan is to steal back share that was lost by the lack of focus and dispersion of marketing dollars and time. A byproduct of SKU reduction and supply chain optimization is that management thinks they can take $120-140 million out of inventory which will be used to reinvest in the business, debt pay-down and buybacks.
Management has gone on record saying they expect a $30 million run rate reduction in costs by the end of 2012 and by $120 million over 2-3 years. $120 million on a $600 million equity would have a big impact.
Assuming they get to 10 percent company margins by 2015 and five percent annual top-line growth beginning in 2013 (half of management’s expectations for 10 percent top line growth), CENT could earn $1.90 a share in EPS and $225 million in EBITDA in 2015 vs $0.50 EPS and $114 million in EBITDA in 2011. On an enterprise value of $1bln, CENT would trade at 4.4x EBITDA and 5.2x P/E. There is significant upside optionality on top of these numbers if CENT grows faster and/or pays down more debt. CENT has bought back a lot of stock over the last few years and could continue to plow free cash flow into buybacks further increasing upside potential.
|Subject||a couple questions|
|Entry||07/16/2012 09:40 PM|
Looks interesting. I'd like to hear more about what it is that they actually make and sell. What are the products? Who are the customers? How proprietary are the products? How do they distribute the products? That kind of stuff. I think it makes a difference whether their products are used by a homeowner trying to grow their own fruit and vegetables, where a quality brand name may be worth a premium, versus some golf course buying seed by the truckload and willing to switch to a competitor for a 1% discount. Thanks.
|Subject||Fun with Margins|
|Entry||08/02/2012 05:13 PM|
I would be interested in how you get to your margins assumptions. Not that I have a better number -but I would highlight a few risks:
-as they reduce SKU count they are risking alienated the smaller, regional retailers who are attempting to differentiate themselves form the big box retailers
-building brands, outside of high end food (post the pet food poison scare a few years ago) is hard. (Wee wee pads made in China work)
-white label has been gaining traction (which mgmt cited at their last conference, but backpedaled on during this last call)
-retail distribution is highly consolidated -their customers have significantly more market power (see mgmt comments on inability to reduce inventory as per plan)
-white label is even more fierce in this segment
-competition is fierce and increasing marketing spend
Despite mgmt herculean attempts to restructure the company -the risks of which are probably baked into the numbers -thee above issues combined with a challenged consumer environment give me pause on assuming sustainable margin expansion
|Subject||RE: Fun with Margins|
|Entry||08/03/2012 06:20 PM|
Thanks for your comments. I will address them in order.
1. as they reduce SKU count they are risking alienated the smaller, regional retailers who are attempting to differentiate themselves form the big box retailers
Response: CENTA was selling SKUs that literally did $500 per year in business. There was no way that those types of SKUs were good for the retailer or the company. At the end of the day, retailers care about sales per square foot and thus would prefer to sell products that the manufacturer believes customers desire and that are supported with marketing dollars. As such, I don't think there is a whole lot of difference between the large and small retailers in terms of which of CENTA's products they want on the shelves.
2. -building brands, outside of high end food (post the pet food poison scare a few years ago) is hard. (Wee wee pads made in China work)
Response: My comments apply to both pet and garden. CENTA's current focus is not on specialty pet and garden products that sell for a premium price and generate higher margins. The company is perfectly happy being the value brand next . Now, when it comes to brands like Pennington, they are trying to build that brand as an alternative to Scott's. But, for the most part their focus is on the retail relationship that gets products on the shelves and provides customers with a choice. Accordingly, the Central story is more based on finding new distribution outlets and fixing the internal issues than building a well recognized brand. I presume your intent was to suggest that having a 2nd tier brand that does not have significant customer loyalty or brand awareness means that CENTA has no identifiable moat. Well, aside from the retail relationship and the fact that CENTA's products being on the shelf literally crowds out competitors, there is not much of a moat here. Having said that, this is not a Buffett stock. SMG is a Buffett stock and in no way am I suggesting that CENTA is going to become SMG. What I am suggesting is that if Gus Halas can pick the low hanging fruit in terms of cost savings, inventory reduction and new distribution channels, a return to mediocrity for CENTA leads to a much higher price.
3. white label has been gaining traction (which mgmt cited at their last conference, but backpedaled on during this last call)
Response: These comments also apply to garden and pet. First off, I don't think Gus backpedaled on the last call regarding private label. Private label is actually both an opportunity and a threat. At any time WMT can decide it wants to private label certain pet or garden goods and crowd out CENTA. However, it is always possible that CENTA would be chosen as the supplier of those goods. While that relationship would likely be characterized lower margins, I would suggest that what Gus is doing is positioning CENTA to be a much better partner who can offer reliable deliveries and quality products precisely so that CENTA"s retail partners don't look elsewhere. Most retail companies appreciate a supplier that takes the logistical burden off of their hands. While nothing is certain, my premise is that as CENTA becomes a more reliable partner who actually has some money to spend on advertising, the private label threat will be less of an issue. Until then, private label could be a threat. But I would point out that as long as I have been following the stock, there have been limited customer losses due to the retailer taking production in-house.
4. retail distribution is highly consolidated -their customers have significantly more market power (see mgmt comments on inability to reduce inventory as per plan)
Response: I would suggest that the reduction in the inventory reduction goal is not indicative of CENTA's reduced standing among its retailers. I know Gus mentioned that retailers are trying to hold less inventory, but the impact of that is not unique to CENTA. Additionally, the one dynamic that is not obvious upon first glance is the important role that CENTA plays in the mind of the retailers. For example, in garden SMG is the 800 lb gorilla. SMG spends millions on advertising and has very high brand awareness. People come to the store looking for SMG's products. This gives SMG a lot of power with HD and LOW. The way that power is offset is through partnerships with CENTA. If SMG has the only product on the shelf, it would be able to dictate terms to LOW and HD. But, by having CENTA"s products as an alternative, the balance of power shifts back a bit. In summary, I believe (and have confirmed this with LOW) that being the second product on the shelf actually means CENTA plays a very important role with the retailers.
5. -competition is fierce and increasing marketing spend
Response: Another dynamic that is not immediately obvious is how much SMG's spending helps CENTA and drives sales for the entire category. Just like Tempur-Pedic's huge marketing spend brings people into the mattress store, SMG's spending brings people into the gardening aisle. Again, this is how CENTA benefits from being the other, lower priced brand on the shelf. Especially in a tough consumer environment a person who walks in planning to buy Scott's may be happy to leave the store with a cheaper Pennington product. I don't disagree that competition is stiff but I have seen no evidence that SMG is capable of squashing CENTA and in reality, all CENTA has to do is maintain share as it fixes its internal issues and margins will improve.
Unless you have been following the company for a while, it is hard to understand the degree to which CENTA has been mismanaged. There is a ton of low hanging fruit on the cost side that can be picked irrespective of what happens with the US economy. CENTA does not need a lot of top line growth to raise its margins to a higher but still mediocre level. From there, I believe you have a free option on Gus doing anything right to drive revenue growth. So, while the stock looks expensive and levered on a trailing basis, the way to get a multi-bagger is to look around the corner and try to see what the company looks like in 3 years. In this case, I think you see higher margins, possibly some nice revenue growth, and a bunch of free cash flow used to pay down debt, an act that is highly beneficial for equity holders.
|Subject||RE: RE: Fun with Margins|
|Entry||08/04/2012 08:43 AM|
Thank you the idea.
Few things about Gus, if you could elaborate:
1) Gus seems to have success at T-3, as you mention here. However, I am trying to understand whether Gus has experience turning around a business like CENT. In fact, I am wondering about the rationale why the Chairman, Brown brought him in as a consultant. Please share your thoughts on this subject.
|Entry||01/07/2013 02:05 PM|
What's your take on today's announcement? thanks.
|Subject||This sums up my thoughts well|
|Entry||01/16/2013 08:33 AM|