Central Garden and Pet: Every Dog Has It’s Day

With the markets at all-time highs, it is becoming increasingly difficult to find many potential investments while perusing the new lows list. Most companies on the list are either mortgage REITS or have some connection to mining raw materials. One of the few companies on the list that doesn’t fall into that category is Central Garden and Pet.

The clever descriptions of the company’s current state of affairs, (like the one in our title) are endless. As we have said many times before, most stocks that show up on value screens are cheap for a reason, or perhaps many reasons. Central Garden and Pet certainly fits that category. We wrote an analysis of some of the things that may go right in the future and posted it on Seeking Alpha. The article can be found here for the next 30 days.

What we find interesting is that the typical response we get from readers of our analysis is that it is interesting, is “cheap”, but there are no signs that any of our analysis is coming true or will come true.  Their conclusion is usually, “I want to wait for signs of improvement before I take any action.” It has been our experience that investors who wait for signs of improvement end up paying a much higher valuation for the company and therefore have a lower expected return than investors who took a “leap of faith” and bought at a lower valuation, but with much less clarity. Warren Buffett is often quoted as saying “investors pay a high price for certainty.” The implied message being that investors will get better returns by paying a lower price for uncertainty. Yet when those situations seem to present themselves, few investors actually put their money where Warren’s mouth is.

Here is the basic premise:

CENT is a classic growth-by-acquisition consumer products company that has hit a wall and experienced substantial declines in operating margins. This decline is due to a combination of lack of attention to operating costs and “merger synergies” and an increase in commodity costs that the company has been unable to fully offset with price increases. Like all investments in turnaround stocks, investors have to be of the opinion that the future will look better than the present and also accept the fact that there is no way to know if they are correct until it happens. While the four analysts that have estimates for CENT believe some kind of turnaround is near (FY14 EPS of $0.72 with a very wide $0.60 to $0.91 spread!!!! vs. FY13 EPS of $0.44), the fact that the company’s stock is trading for a modest 9X those estimates and a 14% ($50M in FCF) free cash flow yield indicates that investors are much more skeptical that a sustainable turnaround is near. What follows is an analysis of how a better future could be in store for CENT if just a few things modestly break its way. This analysis also presents a case for why CENT might be an attractive acquisition candidate by another serial acquirer, Spectrum Brands (SPB).


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About Tim Heitman