Rating Update: Stock Rating B-Positive (11/25/19)-Central Garden & Pet Co (CENTA).

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BUSINESS

Central Garden & Pet Company, together with its subsidiaries, produces and distributes products for the lawn and garden, and pet supplies markets in the United States. It operates through two segments, Pet and Garden. The Pet segment supplies products for dogs and cats comprising edible bones, edible and non-edible chews, rawhide, dog and cat food and treats, toys, pet carriers, grooming supplies, and other accessories; and food, cages and habitats, toys, chews, and related accessories for birds, small animals, and specialty pets. It also offers animal and household health, and insect control products; aquariums, furniture and lighting fixtures, pumps, filters, water conditioners, food and supplements, and information and knowledge resources for fish, reptiles, and other aquarium-based pets; and products for horses and livestock.
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INVESTMENT RATING

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Reflecting future returns on capital that are forecasted to be above the cost of capital, CENTA is expected to continue to be a modest Value Builder.

Central Garden & Pet has a current Value Trend Rating of B (Positive).
The Value Trend Rating reflects inconsistent signals from PTR’s two proprietary measures of a stock’s attractiveness. Central Garden & Pet has a neutral Appreciation Score of 48 but a good Power Rating of 78, and the Positive Value Trend Rating results.

Central Garden & Pet’s stock is selling below targeted value. The current stock price of $29.95 compares to targeted value 12 months forward of $33.
This neutral appreciation potential results in an appreciation score of 48 (52% of the universe has greater appreciation potential.)
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Central Garden & Pet has a Power Rating of 78. (CENTA’s good Power Rating indicates that it has a higher likelihood of achieving favorable investment performance over the near to intermediate term than all but 22% of companies in the universe.)
Factors contributing to this good Power Rating include: is in a strong phase current; recent price action has been favorable; and earnings estimate behavior for CENTA has been slightly favorable recently.

INVESTMENT PROFILE

CENTA’s financial strength is average. Financial strength rating is 56.
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Relative to the S&P 500 Composite, Central Garden & Pet Co has moderate Value characteristics; its appeal is likely to be to Capital Gain-oriented investors; the perception is that CENTA is normal risk. Relative weaknesses include: low forecasted profitability, low historical profitability, and low financial strength. CENTA’s valuation is moderate: low dividend yield, moderate P/E ratio, and low price/book ratio. CENTA has unusually low market capitalization.

CURRENT SIGNALS

Central Garden & Pet’s current operations are eroding. Return on equity is falling, reflecting: falling asset utilization; declining pretax margin; and falling leverage.

Central Garden & Pet’s current technical position is very strong. The stock price is in a 3.0 month up move. The stock has appreciated 41.1% from its prior low. The stock price is above its 200 day moving average which is in an uptrend. The 200 day moving average has just turned up.

ALERTS

Central Garden & Pet Co (NASDAQ: CENTA). Important positive changes in investment behavior have recently occurred: its longer term price trend turned up.
Recent minimal positive changes in fundamentals have benefitted Central Garden & Pet Co (NASDAQ: CENTA): the stock’s power rating rose above 70.
The stock is currently rated B.
On 11/25/19, Central Garden & Pet Co (NASDAQ: CENTA) stock suffered a major decline of -24.3%, closing at $0.28. This decline was accompanied by normal trading volume. Relative to the market the stock has been strong over the last nine months and is unchanged during the last week.

CASH FLOW

In 2018, Central Garden & Pet generated a very significant increase in cash of +$448.0 million (+995%). Sources of cash were much larger than uses. Cash generated from 2018 EBITDA totalled +$214.5 million. Non-operating uses consumed -$1.2 million (-1% of EBITDA). Cash taxes consumed -$3.3 million (-2% of EBITDA). Re-investment in the business amounted to -$212.5 million (-99% of EBITDA). On a net basis, debt investors contributed +$257.3 million (+120% of EBITDA) while equity investors contributed +$193.2 million (+90% of EBITDA).
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CENTA’s Non-operating Income, %EBITDA has exhibited little to no overall change over the period. This stability was accompanied by an uptrend for the Central Garden & Pet Co Peer Group. (Since 2016 Non-operating Income, %EBITDA has experienced very sharp improvement.) In most years, Central Garden & Pet was in the top quartile and third quartile. Currently, Central Garden & Pet is upper quartile at -1% of EBITDA (-$1.2 million).

CENTA’s Cash Taxes, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Central Garden & Pet Co Peer Group. In most years, Central Garden & Pet was in the lower quartile and second quartile. Currently, Central Garden & Pet is substantially above median at -2% of EBITDA (-$3.3 million).

CENTA’s Business Re-investment, %EBITDA has suffered a very strong overall downtrend over the period. This downtrend was accompanied by a similar trend for the Central Garden & Pet Co Peer Group. (Since 2016 Business Re-investment, %EBITDA has accelerated very sharply.) In most years, Central Garden & Pet was in the top quartile and second quartile. Currently, Central Garden & Pet is slightly below median at -99% of EBITDA (-$212.5 million).

CENTA’s Debt Investors, %EBITDA has experienced a very strong overall uptrend over the period. This improvement was accompanied by a similar trend for the Central Garden & Pet Co Peer Group. (Since 2014 Debt Investors, %EBITDA has accelerated very sharply.) In most years, Central Garden & Pet was in the third quartile and lower quartile. Currently, Central Garden & Pet is upper quartile at +120% of EBITDA (+$257.3 million).

CENTA’s Equity Investors, %EBITDA has enjoyed a very strong overall uptrend over the period. This improvement was accompanied by stability for the Central Garden & Pet Co Peer Group. (Since 2015 Equity Investors, %EBITDA has accelerated very sharply.) In most years, Central Garden & Pet was in the top quartile and second quartile. Currently, Central Garden & Pet is upper quartile at +90% of EBITDA (+$193.2 million).

CENTA’s Change in Cash, %EBITDA has experienced a volatile overall uptrend over the period. This improvement was accompanied by stability for the Central Garden & Pet Co Peer Group. In most years, Central Garden & Pet was in the top quartile and lower quartile. Currently, Central Garden & Pet is upper quartile at +209% of EBITDA (+$448.0 million).
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CENTA’s Cash, %Revenue has exhibited a volatile overall uptrend over the period. This improvement was accompanied by stability for the Central Garden & Pet Co Peer Group. In most years, Central Garden & Pet was in the second quartile and top quartile. Currently, Central Garden & Pet is upper quartile at +22%.

PROFITABILITY

CENTA’s return on equity has improved very significantly since 2009 although it experienced a very sharp decline after the 2017 high.
This very significant improvement was due to very strong positive trend in pretax operating return and small positive trend in non-operating factors.
The productivity of CENTA’s assets declined over the full period 2009-2019: asset turnover has experienced a downtrend that accelerated very sharply after the 2017 level.
More than offsetting this trend, however, pretax margin enjoyed a volatile overall uptrend that accelerated very sharply from the 2013 level.
Non-operating factors (income taxes and financial leverage) had a minor positive influence on return on equity.
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CENTA’s return on equity is slightly above median (9.8%) for the four quarters ended June, 2019.
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Operating performance (pretax return on assets) is at the upper quartile (5.9%) reflecting asset turnover that is at median (1.14X) and above median pretax margin (5.2%).
Tax “keep” rate (income tax management) is at the upper quartile (83.0%) resulting in after tax return on assets that is at the upper quartile.
Financial leverage (leverage) is below median (2.00X).

GROWTH RATES

There are no significant differences between Central Garden & Pet’s longer term growth and growth in recent years.
Central Garden & Pet’s historical income statement growth has been in line with balance sheet growth. Revenue growth has paralleled asset growth; earnings growth has paralleled equity growth.

Annual revenue growth has been 4.7% per year.

Total asset growth has been 6.1% per year.

Annual E.P.S. growth has been 12.2% per year.

Equity growth has been 7.4% per year.

Central Garden & Pet’s consensus growth rate forecast (average of Wall Street analysts) is 7.8% — in line with the average of the historical growth measures.
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Relative to the Central Garden & Pet Co Peer Group, Central Garden & Pet’s historical growth measures are consistently third quartile. Revenue growth (4.7%) has been below median. Total asset growth (6.1%) has been below median. E.P.S. growth (12.2%) has been below median. Equity growth (7.4%) has been slightly below median.

Consistent with this pattern, consensus growth forecast (7.8%) is also at the lower quartile.
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PRICE HISTORY

Over the full time period, Central Garden & Pet’s stock price performance has been volatile and quite good. Between January, 2009 and November, 2019, Central Garden & Pet’s stock price rose +399%; relative to the market, this was a +32% gain. Significant price moves during the period: 1) February, 2016 – April, 2017: +160%; and 2) January, 2014 – October, 2015: +171%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of -4.6% is lower quartile relative to the S&P 500 Composite.
In addition to being lower quartile relative to S&P 500 Composite, current annual total return performance through October, 2019 of -4.6% is substantially below median relative to Central Garden & Pet Co Peer Group.

Current 5-year total return performance of 26.9% is upper quartile relative to the S&P 500 Composite.
Through October, 2019, with upper quartile current 5-year total return of 26.9% relative to S&P 500 Composite, Central Garden & Pet’s total return performance is upper quartile relative to Central Garden & Pet Co Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, CENTA’s overall valuation is exceptionally low. All five factors are upper quartile. The highest factor is the price/earnings ratio, followed by the ratio of enterprise value/earnings before interest and taxes, then by the ratio of enterprise value/assets, then by the price/equity ratio. The lowest factor is the ratio of enterprise value/revenue.
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Central Garden & Pet has a major value gap compared to the median valuation. For CENTA to rise to median valuation, its current ratio of enterprise value/revenue would have to rise from the current level of 0.66X to 1.12X. If CENTA’s ratio of enterprise value/revenue were to rise to 1.12X, its stock price would be lower by $24 to $54.
For CENTA to hit lower quartile valuation relative to the Central Garden & Pet Co Peer Group, its current ratio of enterprise value/revenue would have to fall from the current level of 0.66X to 0.66X. If CENTA’s ratio of enterprise value/revenue were to fall to 0.66X, its stock price would decline by $-0 from the current level of $30.

VALUE TARGETS

Reflecting future returns on capital that are forecasted to be above the cost of capital, CENTA is expected to continue to be a modest Value Builder.
Central Garden & Pet’s current Price Target of $32 represents a +8% change from the current price of $29.95.
This neutral appreciation potential results in an appreciation score of 48 (52% of the universe has greater appreciation potential.)
With this neutral Appreciation Score of 48, the high Power Rating of 78 results in an Value Trend Rating of B.
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Central Garden & Pet’s current Price Target is $32 (-8% from the 2018 Target of $35 but +8% from the 11/25/19 price of $29.95). This slight fall in the Target is the result of a +23% increase in the equity base and a -25% decrease in the price/equity multiple. The forecasted decline in return on equity has a very large negative impact on the price/equity multiple and the forecasted increase in cost of equity has a large negative impact as well. Partially offsetting these Drivers, the forecasted increase in growth has a very large positive impact.
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PTR’s return on equity forecast is 9.8% — slightly below our recent forecasts. Forecasted return on equity enjoyed a dramatic, erratic increase between 2010 and 2018. The current forecast is well above the 2014 low of 5%.

PTR’s growth forecast is 17.0% — above our recent forecasts. Forecasted growth enjoyed a dramatic, erratic increase between 2010 and 2018. The current forecast is significantly above the 2016 low of 3%.

PTR’s cost of equity forecast is 8.7% — in line with recent levels. Forecasted cost of equity suffered a dramatic, erratic increase between 2010 and 2018. The current forecast is above the 2013 low of 5.5%.
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At Central Garden & Pet’s current price of $29.95, investors are placing a positive value of $5 on its future investments. This view is consistent with the company’s most recent performance that reflected a growth rate of 8.0% per year, and a return on equity of 11.2% versus a cost of equity of 7.8%.
PTR’s 2020 Price Target of $32 is based on these forecasts and reflects an estimated value of existing assets of $25 and a value of future investments of $8.

About John Lafferty 58018 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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