After an impressive run-up in price, shares in Central Garden & Pet Company (CENT) are taking a breather, retracing from their 52-week highs, and currently trading at $37.8 per share.
The company has benefited from the change in consumer behavior as restrictions were placed to combat the spread of COVID. We have seen that strength translate to retailers such as The Home Depot (HD), Tractor Supply (TSCO), and competitor Scotts Miracle-Gro (SMG), all showing impressive year-to-date results and pointing to an industry enjoying the tailwinds from a shift in discretionary spending towards categories such as gardening and pets, as consumers find themselves with more time spent at home.
As it relates to CENT, the company’s Q3 was its best-performing quarter in its history driven by robust consumer demand. The company ended the quarter with $495M in cash and a leverage ratio of 2.4x, within management’s targeted range.
While the company still expects strong demand in Q4, management guided for a slight earnings loss in Q4 as they increase levels of spending towards e-commerce, digital marketing, and cost control measures. As a result, management expects full-year EPS to be at or above $1.90, implying negative EPS of minus $0.08 in the upcoming quarter. However, it’s important to keep in mind that Q4 is the smallest earnings quarter for the company. For example, in Q4 of 2018 and 2019, the company did $0.03 and $0.04, respectively in diluted EPS.
From a valuation point of view, the company is trading at a forward P/E multiple of 19x, approximately in-line with its 5-year average of 22.8x. We believe CENT is trading at fair value and the stock price is already pricing in the favorable outlook for CENT’s business segments (mainly Pet products and Garden Products). We also believe revenue growth through acquisitions might be hard to come by in a hot market. M&A has been the main growth driver for CENT, having completed 50 acquisitions since 1992. However, with strong tailwinds lifting the sector, management might have trouble finding a suitable deal at a reasonable valuation.
To sustain forward earnings of 18x, organic growth needs to remain resilient, which would depend in part on how the pandemic develops in the upcoming quarters. If a vaccine takes longer than expected, then it is reasonable to assume consumers would keep spending their discretionary incomes towards categories such as pets and gardens.
That said, with CENT trading at a fair value multiple, we would rather wait for a bigger margin of safety before initiating a position to account for the unpredictability of the current market. We are neutral on the company.
Tailwinds drove CENT’s best quarterly results
CENT reported third-quarter sales of $833M, up 18% on a year-over-year basis, and beating expectations by $110M. The company also reported a GAAP EPS of $1.27, beating the consensus by $0.43.
There was strong demand for both CENT’s product segments. The company experienced organic sales of 18% in Garden, and 15% in Pets compared to the prior-year period.