Central Garden & Pet Company

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Central Garden & Pet Company operates as a leading producer and distributor of branded and private label products for the lawn, garden, and pet supplies markets, primarily in the U.S. and the rest of North America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Central Garden & Pet (CENT) operates in two core segments: Pet and Garden. The company’s business model is quite diversified, with products available through multiple channels, including large and small retailers as well as online.

Business Overview:

  • Revenue Distribution: CENT operates under two main segments: Pet and Garden. The Pet segment is the larger of the two, accounting for approximately 66% of net sales in 2023, while Garden accounted for around 34%.
    • Pet Segment: This segment includes products like consumables (food, treats), health products (parasite preventatives), and other supplies (beds, toys, and training products) for pets. The segment has demonstrated strong growth over the last year due to its increasing popularity among pet parents.
    • Garden Segment: This segment comprises products such as fertilizers, weed control products, lawn care, and gardening accessories. While this segment is more seasonal, CENT has been focused on increasing its all year product offerings and brand-building in this area.
  • Industry Trends:
    • Pet Industry: The pet industry continues to grow due to an increasing number of pet households and humanization of pets. This includes a move towards premium products and more specialized pet care, which creates opportunities for higher margin goods.
    • Garden Industry: The garden industry faces some volatility due to weather patterns and economic cycles. The trend towards home gardening continues, and there are also more demands for more sustainable and eco-friendly products.
  • Margins: Central Garden & Pet’s profit margins vary significantly between their pet and garden segments. The pet segment generally experiences higher gross and operating margins, and is less vulnerable to seasonal sales variations.
  • Competitive Landscape: The industry is highly competitive, with major retailers (like Amazon, Walmart, and Chewy) and niche retailers, as well as brands with unique positions (like Spectrum Brands or Scotts Miracle-Gro). The pet supply industry is quite concentrated, with a few larger players. The garden segment is generally more fragmented with smaller local suppliers as well as large brands. To compete effectively, the company is focused on product innovation and building brand loyalty.

A key differentiator for Central Garden & Pet is its diversified portfolio. By serving both pet and garden markets, the company can leverage the different growth cycles between these two areas and balance their revenue streams.

Financial Analysis:

  • Growth: The company is focused on both organic growth as well as growth through acquisitions. In 2023 they reported revenue growth mainly driven by increases in Pet segments, while Garden’s growth slowed a bit. However, if acquisitions are included, both pet and garden would show significant revenue gains from the previous years.
  • Profitability: While gross margins are relatively stable at approximately 30%, operating margins can vary a bit because of operational expenses and timing of promotional activities. In general, Pet segment is the main driver of profit growth, while some sub-segments in Garden have seen increased costs due to raw materials and supply issues, affecting their profit margins.
  • Cash Flow: Cash flow is more volatile than earnings because it depends on inventory cycles, capital expenditure, and acquisitions. For 2023, cash flow from operating activities decreased due to the increase in inventories and trade receivables.
  • Capital Structure: Total debt is significant for the company. It was approximately $2 Billion as of September 30, 2023. It is important to monitor their debt to EBITDA ratio, and ability to service their debt obligations, especially when interest rates are rising.
    • Free Cash Flow In general, free cash flow is weak or even negative for the company. The business requires a lot of working capital and investment in acquisitions, so it struggles to generate free cash flows. In 2023, this weakness was especially noticeable.
    • Liquidity The company’s liquidity metrics are poor. The quick ratio is well below 1, while the current ratio was a bit over 1. This suggests a lot of short-term liabilities. Moreover, it is worth noting that some of their recent acquisitions are financed by borrowing from a credit line. They have shown the ability to meet payment obligations but have had difficulties in repaying existing debt.

Moat Assessment (2/5):

Central Garden & Pet has some characteristics of a moat, but they are not strong enough to provide a wide economic moat and a strong long-term advantage:

  • Brand Recognition and Loyalty: In the pet segment, well-established brands such as Adams Flea and Tick, Nylabone, and Kaytee give the company an advantage with consumers. They can create a loyal customer base.
  • Distribution and Shelf Space: By holding various brands across the Pet & Garden sector, the company can negotiate with various retailers and occupy more shelf space than competitors which are limited to smaller product offerings, leading to some pricing power.
  • Scale: The size of Central Garden & Pet compared to smaller brands allows them some economies of scale, but not enough to prevent large retailers from leveraging their own scale to keep prices low, specially for their non-branded products.

Weaknesses:

  • Switching Costs: The products they sell are usually easily substitutable. Consumer loyalty is not that high, especially in a commoditized sector like lawn and garden, so consumers can quickly swap brands if they don’t see value for the price.
  • Commodity Business: Many of their products lack differentiation from other manufacturers and competitors, especially in the garden sector. The pet segment has better differentiation, which allows them to increase prices without an immediate drop in volume, but still there is a limit of what they can charge.
  • Competition: There are many large, well-funded players that can compete effectively. The scale of Walmart, Amazon and Chewy allows them to offer low prices that smaller distributors or suppliers can’t, while other brands can create well-defined brands with pricing power.

Risks to the Moat and Business Resilience:

  • Industry Consolidation: Increasing consolidation can increase the bargaining power of retailers and larger competitors, eroding existing competitive advantages.
  • Shifting Consumer Preferences: The market is heavily subject to changes in trends. Trends like changing demands for eco-friendly products or specific kinds of pet food can shift market share towards other brands if CENT is unable to adapt.
  • Supply Chain Disruptions: Significant disruptions to supply chain, due to issues in raw materials or other problems, can have a negative effect on profitability and availability of their products, leading customers to leave for other brands.
  • Economic Downturns: Since a significant portion of the revenues are discretionary goods (garden and pet supplies), an economic downturn can lead to less customer spending and thus a reduction in growth and revenues.

Given the significant debt position and the sensitivity to changes in demand and preferences, the company has a decent level of risks involved.

Understandability (2/5):

  • The business model is relatively simple and it is easy to understand what they do but there are nuances that aren’t immediately clear. It serves both pet and garden supplies, each with its own set of market dynamics and industry trends, which require careful segmentation to fully grasp the business. Moreover, you also need to be aware of how accounting policies affect cash flow to calculate and understand the true profitability of the business.

Balance Sheet Health (3/5):

  • The balance sheet has a moderate level of health. Their debt levels are high (approx 2B), and the company’s cash position is not great. As of their last quarter, they barely generated positive free cash flow, meaning that the company is relying on credit and debt to finance most of its activities. This limits their flexibility to invest and innovate, and might lead to higher risk in the future.

Recent Concerns, Controversies, and Management’s Perspective:

  • Increased Inflation & Consumer Spending Slowdown: During their recent earning calls and reports, management has acknowledged that the current economic climate includes a slowdown in consumer spending and they expect lower organic growth for the coming periods. They believe that pet spending will remain more resilient than garden, but the growth will still be lower than before. The ongoing inflation has led them to increase prices, which they’re unsure if will be enough to maintain revenues and margins.
  • Supply Chain Issues: Some supply chain issues and raw material inflation have impacted margins in the past and these issues still persist. The company is focusing on controlling their operating costs and improving efficiency to minimize costs in supply, transportation and labor.
  • Acquisitions: They have recently completed a few acquisitions that management believe will provide growth for the future. They have not outlined their specific strategy on future acquisitions and how they will affect their balance sheet. There is a lot of uncertainty related to the effect of recent acquisitions.

In Summary: Central Garden & Pet is a diversified player in the pet and garden supply market. They have some sustainable competitive advantages mostly in the pet segment through brands and distribution, but overall have a weak economic moat due to high substitutability and tough competition. Their financial position is also somewhat risky due to significant debt and cash flow fluctuations. Recent growth has been driven by acquisitions, and organic growth in their existing business has slowed somewhat due to the economic headwinds. The company must balance between cost and volume, and have to make important decisions about their capital allocation and acquisitions to maximize their overall value. Overall, Central Garden & Pet is an average-quality business, but it’s important for investors to pay attention to debt, supply chain, and competition.