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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 hand 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 growth of 7% to $302.1 million in the first quarter of 2012, reflecting increased sales in the garden and pet products segments. Moreover, reported net sales surpassed the Zacks Consensus Revenue Estimate of $290 million.

Garden Products segment sales increased 8% year over year to $102.8 million, whereas Pet Products segment sales increased 7% to $199.3 million.

Bottom Line Struggling, Margins Under Pressure

However, despite witnessing a growth in the top line, Central Garden & Pet’s posted disappointing bottom-line results, battered by higher input costs, change in product mix and seasonality of business.

The company’s quarterly loss of 27 cents a share widened from a loss of 16 cents in the prior-year quarter. The analysts covered by Zacks had expected the company to incur a loss of 26 cents per share in the reported quarter.

During the quarter under review, gross profit shrunk 2.8% to $80.7 million, whereas gross margin contracted 280 basis points to 26.7%. The decline reflected a rise in raw material costs and sales of lower margin products. Total operating loss for the quarter was $11.3 million, indicating a significant widening of loss from $6.5 million in the year-ago quarter.

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

For 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 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 to $70 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 $9.50. However, Central Garden & Pet holds a Zacks #2 Rank that translates into a short-term Buy rating and well defines the initiatives undertaken to salvage the company from waning margins and dismal bottom-line performance.

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