Latest from H&Q:
Company: Central Garden & Pet Co.
Price: 8.88
Recommendation: Market Perform
Notes: a, b, f
Date: 7/12/99
Central and Scotts End Exclusive Agreement -- Move to Market Perform
CENT and Scotts have ended the exclusive Solaris distribution agreement -
representing approximately $300 million in sales in FY99 with approximately
$200-250 million to be taken over by Scotts next year. Based on management's
ability to reduce costs relatively quickly, the loss of Scotts revenue may
cost roughly $0.25 per share. We are reducing our FY00 EPS target to $1.00
from $1.65. With significant uncertainty heading into seasonally slow
quarters, we move to the sidelines until we get better visibility on expense
cuts.
1998 A 1999 E 2000 E
Q1 EPS $(0.02) $(0.01) $--
Q2 EPS 0.42 0.51 --
Q3 EPS 0.59 0.50 --
Q4 EPS 0.22 0.14 --
FY EPS 1.35 1.15 1.00
FY REVS (M) 1,295 1,485 1,341
CY EPS 1.25 1.11 1.07
CY P/E 9 8 8
FY Ends Sep Current Price $8.88
52-Week Range $8-34 Market Cap(M) $265
Shares Out(M) 30.0 Book Value $10.42
Net Cash/Share $0.10 3-Year EPS Growth 15%
CY99 P/E-to-Growth 0.6
Central and Scotts end exclusive distribution agreement: Today, Central
Garden & Pet and Scotts announced changes in the distribution agreement
effective until the end of September 1999 for Solaris products which include
Ortho and Miracle-Gro. Currently, CENT is the exclusive distributor of
Solaris products - representing approximately $300 million in sales in FY99.
Scotts will continue to use Central as a lawn & garden distributor but will
also use a combination of other distributors and sell directly to larger big
box retailers such as Home Depot and Lowes. Importantly, Central will
continue to provide services to key accounts such as Wal Mart, Orchard and
Target.
Significant impact to CENT's EPS in FY00: Central's management indicated
that sales volume of approximately $200-250 million will be taken over by
Scotts next year - leaving CENT will roughly $50-100 million in Solaris
distribution revenue. The gross margin associated with these sales is in the
$15-25 million range. Importantly, management believes it can cut roughly $12
million in expenses heading into FY00 with a plan based on lower sales volume.
Nearly 80% of Central's cost structure is salary and related items which can
be reduced by the next Spring season. Moreover, facility expenses (which
represent ~2% of sales) are semi-variable as CENT will look to lease extra
space and cancel some "seasonal" warehouse space. Based on management's
ability to reduce costs relatively quickly, the loss of Scotts revenue may
cost roughly $0.25 per share. Lastly, we expect CENT will take one-time
charges of $10-20 million in Q4 to realign its lawn & garden distribution
business including lease write-offs, severance costs and the reduction in
capitalized Solaris inventory.
The new CENT will look and act differently: Clearly a loss of 20% of
Central's top line revenue is a "shock" to the system. However, Central will
continue to work with Scotts and will continue to look to additional agency
partners to beef up its distribution business. Moreover, we believe Central
may now be able spend more time on marketing its own branded products
including Pennington with its key retail partners. Additionally, we expect
Central will renew its focus on its acquisition program and growing its own
portfolio of branded products (which represent roughly 35% of sales on a pro
forma basis with reduced Solaris sales).
Reducing forward targets including Q4 FY99 adjustment: On June 8th, we
reduced CENT's Q3 estimates as a "longer" garden season had not materialized
with higher expense levels in the quarter. We believe the higher expense
levels are continuing in Q4 - a seasonally slower quarter - which will likely
push EPS below our previous $0.35 estimate. As such, we are reducing Q4 to
$0.14 - moving FY99 to $1.15 from $1.33. Most importantly, with a large
portion Scotts sales going away, we are taking $0.25 out of our model in FY00
while growing core earnings by 10% - moving our EPS target to $1.00 from
$1.65. Our target may prove conservative as we are taking a wait and see
approach ahead of the Spring 2000 selling season.
CENT continuing to repurchase stock: After the close, Central announced
that it increased its share repurchase program by an additionally $25 million
to $130 million. To date, CENT had repurchased 8.3 million shares for $99.7
million or $12 per share. Our new model does not account for any incremental
shares repurchased which could lead to significant EPS leverage going forward.
Lower to MARKET PERFORM with uncertainty and weaker quarters ahead: CENT
dropped roughly 15% to $8.88 on the Scotts news. At this price level there
may be significant appreciation potential if Central can get expenses under
control, focus on growing its branded portfolio (including future
acquisitions) and efficiently execute its distribution business. However,
with significant uncertainty heading into seasonally slow quarters, we move to
the sidelines until we get better visibility on expense cuts. We move to a
MARKET PERFORM from BUY.
1999 Copyright Hambrecht & Quist LLC. All rights reserved
Note Legend:
(a) Hambrecht & Quist LLC maintains a market in these stocks.
(b) Hambrecht & Quist LLC has been an underwriting manager, or co-manager, or
has privately placed securities of these companies within the last three years.
(f) Options are available on these issues. |
