Central Garden Kept at Neutral

Central Garden & Pet Company ( CENT - Analyst Report ) is a leading producer and marketer of premium and value-oriented products focused on the lawn and garden as well as pet supplies markets in the U.S. On the one hand, the company is witnessing increased sales, but on the other it is reporting dismal bottom-line results due to rising costs of raw materials that are weighing upon margins.

Top-Line Sustaining Momentum

The company’s diversified portfolio of brands has helped it to develop a healthy commercial relationship with giant retailers, such as Wal-Mart Stores Inc. ( WMT - Analyst Report ) , The Home Depot Inc. ( HD - Analyst Report ) and Lowe’s Companies Inc. ( LOW - Analyst Report ) . This provides a significant upside potential for the company.

This was quite evident from the company’s top line that registered a growth of 8.6% to $376.9 million in the fourth quarter of 2011, reflecting increased sales in the garden products segment. Moreover, the reported net sales surpassed the Zacks Consensus Revenue Estimate of $360 million.

Garden Products segment sales jumped 24% to $165.1 million; however, Pet Products segment sales inched down 1% to $211.8 million.

Bottom-Line Struggling, Margins Under Pressure

Despite witnessing a growth in the top line, Central Garden & Pet posted disappointing bottom-line results, battered by higher input costs and increased sales products carrying lower margins.

The company’s quarterly loss of 21 cents a share widened from a loss of 2 cents in the prior-year quarter. The analyst covered by Zacks had expected the company to incur a loss 6 cents.

During the quarter under review, gross profit dropped 5.1% to $98.2 million, whereas gross margin contracted 370 basis points to 26.1%. The fall reflected a 14.4% rise in the cost of goods sold. Total operating loss for the quarter was $4.6 million, indicating a significant decline from an operating income of $7.4 million in the year-ago quarter.

Gross margin has portrayed improvement from fiscal 2004 through fiscal 2010 but shriveled in fiscal 2011. We believe that the sale of innovative products carrying higher margins, a reasonable price increase and cost containment efforts may improve gross and operating margins.

Strategies to Step Up

As Central Garden & Pet enters into fiscal 2012, the company’s primary focus is on streamlining its cost structure and increasing operating efficiencies in order to improve its margins. Management hinted of gross margin improvement and bottom-line performance to improve in the second half of calendar 2012.

The company’s long-term target is to attain a growth of at least 10% in the top line, and achieve operating margins in the range of 10% to 15%. The company also targets a $30 million yearly savings in cost as it exits 2012.

The company intends to transform into an integrated, multi-brand company from a portfolio of stand-alone businesses, by restructuring and reorganizing operating units and consolidating manufacturing facilities and logistics centers.

Central Garden & Pet has lowered the count of sales and logistics warehouses to 27 in fiscal 2011 from 34 in fiscal 2008 and expects to further consolidate about 6 facilities during the first half of fiscal 2012, and intends to decrease its inventory level by approximately $60 million by the end of fiscal year in order to manage working capital effectively. Another significant area of savings is the SKU rationalization, and the company aims to lower its total SKU count by at least 30% to 35%.

Let’s Conclude

Given the pros and cons, we prefer to maintain our Neutral rating on the stock with a price target of $8.25. However, Central Garden & Pet holds a Zacks #4 Rank that translates into a short-term Sell rating and well defines the depressed third-quarter 2011 results.