Spectrum Brands: Hard Catalysts To Drive Significant Value Creation Amid Turbulent Markets

Spectrum Brands (NYSE: SPB $83.12) MV = $3.4bln; PF EV = $3.2bln; 3mo ADV = 0.29mm shares             

Trades @ 6.7x 2023E EBITDA; 15x 2023E FCF; Net Leverage Ratio (2021 EBITDA) = Net Cash

Blended Target Price: $119 or 43% Upside

Author: Philippe Kurzweil | pjsubstack@gmail.com                                                  

Date: 7/6/2022

Disclaimer: I own common shares in SPB. Please do your own work.

LINK TO 1-PAGER HERE

Intro:

Once a beleaguered platform company, Spectrum Brands (ticker: SPB) is trimming down to a lean, unlevered and recession-resilient home, garden and pet business. Pro-forma (PF) for the divestiture of SPB’s Hardware & Home Improvement (HHI) and separation of its Home & Personal Care (HPC) businesses, SPB will become a faster growing, higher margin, consumable-oriented (90%) and less cyclical consumer staples business with an enviable net cash position and a voracious appetite to buy back stock. Yet despite these transformational moves, PF for the HHI divestiture, SPB’s stock price implies a 6.7x ’23 EV/EBITDA multiple, grossly undervaluing the remaining businesses. Investors clearly have reservations: a) the HHI divestiture won’t go through, b) the business saw an unsustainable bump from COVID and c) management cannot execute. In our view, these concerns are more than priced in as we envision a) a solid ‘cover’ bid for HHI, b) positive secular trends in the remaining businesses, Global Pet Care (GPC) and Home & Garden (H&G) and c) a revamped and more disciplined management team. Our variant perception is that, in a non-recessionary scenario, SPB will exceed Street expectations on the top and bottom line, particularly on a per-share basis, as Consensus understates both growth and the potential for substantial share repurchases. Using a conservative sum of parts analysis, we believe that, on a probability weighted basis, SPB is worth $119/share (+43%) with a bull case yielding a $164/share price (+97%). Thus, with a series of hard catalysts and an improved business profile, we see SPB outperforming its higher-levered peers under both ‘blue sky’ and ‘stormy’ economic scenarios.

Business Overview:

“Look, these are very exciting times for Spectrum Brands. We have now begun our evolution into a faster growing, higher margin, pure play Global Pet Care and Home & Garden company. We believe we can create meaningful shareholder value with this transformation” – CEO David Maura Q1 ’22 Earnings Call

SPB Product Overview (Continuing Operations)

Source: Company Presentation

Founded as a small battery company in 1906, the company previously known as Rayovac IPO’ed in 1997, subsequently acquiring businesses in Home & Personal Care (HPC), Global Pet Care (GPC) and Home & Garden (H&G) spaces, before rebranding to Spectrum Brands in 2005. Since the early 2000s, the playbook for SPB has been to acquire consumer staple/durable brands where it can leverage its retail relations to boost point of sale (POS), expand into new channels/geographies and utilize centralized infrastructure to shrink fixed costs. SPB typically has a top 3 industry position in the niche markets it competes in and in many cases, offers the ‘value’ option. SPB’s platform strategy has delivered mixed results: on the one hand, it led to the growth of three strong franchises in Global Pet Care (GPC), Home & Garden (H&G) and the soon-to-be divested Hardware & Home Improvement (HHI). On the other hand, SPB’s high leverage resulted in a 2009 bankruptcy and has since weighted on its trading multiple while its occasional lack of operational focus has hurt execution. With the latter negative factors weighing on SPB’s share price (flat since 2015), starting in 2018, SPB took decisive action to simplify its portfolio: it divested its legacy battery and auto care businesses, upgraded management and recently announced the divestiture of its Hardware & Home Improvement (HHI) and anticipated separation of its Home & Personal Care (HPC) businesses. In our view, these portfolio changes along with a net cash balance sheet and tangible operational improvements are the culmination of 4 years of heavy lifting and finally set the stage for improved stock performance.                 

Acquisitions Since Emerging From Bankruptcy

Source: Company Filings, Wells Fargo Research

Divestitures Since Exiting Bankruptcy

Source: Company Filings, Wells Fargo Research

Pro-forma for the announced divestiture of HHI and separation of HPC, SPB is a more focused business with higher growth, higher margins, reduced cyclicality and leverage. Historically, SPB’s organic growth has been muddled by seasonality and operational missteps – we believe the category growth rates for its remaining core businesses, GPC and H&G, will be in the L-MSD digits with SPB expecting to outperform by 100-200bps. From an EBITDA perspective, GPC and H&G have sustained high-teens and low 20% margins respectively, both significantly above SPB’s primary comp, Central Garden & Pet (ticker: CENT). With limited capex needs, these two businesses should also be highly FCF generative, a fact that has been obscured by persistent cash restructuring. As a bonus, with the divestiture of HHI and separation of HPC, SPB will have reduced supply chain exposure to SE Asia. In our view, the remaining two core businesses of H&G and GPC are well-positioned to anchor the ‘new’ SPB.

Global Pet Care (GPC) – Becoming An Investor’s Best Good Friend

“We've seen an influx of new pet parents into companion animal categories and new hobbyists into the aquatics and reptile categories. This bodes well for all the repeatedly purchased items in our portfolio like dog and cat chews and treats, grooming tools and aids, bird and small animal foods, pet stain and odor removers and aquatic food filtration and water care products. These products typically carry strong margins and represent a significant portion of our overall portfolio. This is just another reason why we remain bullish about the continued growth of this business.” – COO Randy Lewis Q4 21 Earnings Call

Historical GPC Financials

Source: Company Filings

Entering the pet industry over 20 years ago, SPB has meaningfully improved its portfolio mix, diversifying away from low growth/lumpy aquatics food and equipment to faster growth companion pet (dogs and cat) consumables. Today’s GPC is better aligned with trends in pet ownership with 70% of its business now exposed to companion pets (versus 45% in 2014) and 80% of its products being consumables. From a pet exposure perspective, the shift away from aquatics is crucial for growth: from 2000-2018, the number of dogs and cats grew at a 1.6% and 1.4% CAGR respectively while the number of fish remained flat. From a product perspective, GPC concentrates in areas where it is a market leader: GPC is #1 in aquatics (Tetra), dog chews (Dingo, SmartBones, DreamBone), pet grooming (FURminator) and pet stain & odor (Nature’s Miracle). Despite uneven growth over the last decade (to be discussed), GPC is finally reaping the benefits of its business repositioning, growing organically at a 7.5% CAGR over the last 3 years. At SPB, GPC-specific growth drivers include boosting distribution in underpenetrated channels such as Food and Drug stores and continued product innovation.

Source: Statista

Looking forward, GPC is well positioned to grow given the positive secular trends in pet ownership and the COVID-bump in new pet owners. On a secular basis, the household penetration rate of pets has increased from 56% in 1988 to 62% in 2008 to 70% in 2020. This growth in household penetration results in an upward spiral of pet ownership as current and past pet owners are more likely to adopt in the future. Meanwhile, though US pet expenditure grew at an 11% CAGR from 2018 – 2021, it still grew at a robust 5% CAGR from 2010 to 2019. The upshot is that with pet expenditure outstripping pet ownership growth, increases in spend per pet household has grown MSD, anchoring our organic growth expectation for GPC.

Source: Statista

While COVID may have resulted in a ‘pull forward’ of pet adoption, we note that the larger cohort of pets adopted creates a larger ‘install base’ to which GPC can sell its consumables. Interestingly, the COVID bump in pet adoption was disproportionately attributable to Millennials and Gen Z – per Central Garden & Pet’s (ticker: CENT) recent investor day, those two cohorts comprise 57% of new pet owners. This increase in young pet owners underscores that the secular increase in pet ownership will have a long tail; recent survey data suggests that Millennials and Gen Z both spend more per month on their pets than other cohorts. In addition, the growth in Millennial homeownership is a net positive for pet ownership as homeowners are far more likely to own pets when compared to renters. Finally, from a cyclicality perspective, US pet expenditure grew at a 5.5% CAGR from 2007-2010, suggesting that pet owners are less likely to pull back on pet spend in a downturn. The bottom line is that GPC, with its positive secular tailwinds combined with limited seasonality and low cyclicality, should be SPB’s most consistent grower.

Home & Garden (H&G) – Praying For Good Weather

“This business is highly profitable, with high barriers to entry, and we see opportunity to shift from a value player to a category leader as we continue to invest in innovation and consumer engagement. We compete in outdoor controls, indoor insecticides and personal repellents are all areas that we think are [less] cyclical, more resistant to the macro cycles. We have the #1 position in the combined market, at an estimated 27% share, which has steadily grown over the last 6 years, led by Spectracide, which was the only brand in the top 7 that grew last year in the U.S.” – CFO Jeremy Smeltser Ray James ’20 Conf.

Historical H&G Financials

Source: Company Filings

Sporting SPB’s highest margins, H&G is a well-protected business thanks to the lengthy EPA registration process for new products (~2 yrs) and its vertical integration. The business is highly seasonal and very exposed to fluctuations in weather, which can obfuscate or exaggerate underlying trends and cause high volatility from quarter to quarter. Like GPC, H&G is focused on consumable product areas where it has strong competitive position (often #2): H&G’s business is split 39% ‘Controls’ or outdoor weed/pest protection (Spectracide), 30% ‘Household’ or indoor pest control (Black Flag/Hot Shot), 27% ‘Repellents’ (Cutter) and 4% ‘Cleaning’ for indoor use (Rejuvenate). H&G has been a good example of where SPB’s playbook has worked out – per MRI-Simmons data, its increase in channel distribution and continued product innovation have led to sustained market share gains (see Black Flag and Hot Shot). At SPB, H&G-specific growth drivers include additional tuck-ins in the indoor cleaning space, continued distribution expansion (under-indexed in mass merchants, Grocery/Drug stores) and product innovation.   

SPB Brands Have Taken Share In Insecticides

Source: Statista/MRI-Simmons

Looking forward, while H&G has historically been a low-growth business, several COVID related developments will likely push growth higher. First, the migration of households from urban centers to suburbs has created incremental demand for lawn care and pest control. Second, with work from home being more common, households are looking to expand and beautify their outdoor living spaces. Interestingly, as was the case with pet adoption, a higher percentage of younger cohorts are getting active in gardening with 70% of Millennials being active, compared to 57% of Gen X and 51% of Baby Boomers. The Scotts Miracle Gro Co (ticker: SMG) notes in its investor presentation that Millennials are much more likely to purchase ‘Controls’ products (H&G’s main vertical) when compared to Boomers. Given the stickiness of these trends and the consumable nature of these products, the COVID bump in demand for H&G products should have some legs. Competitors are noting these same positive secular trends: at a recent investor day, SMG bumped up their LT growth expectations for their ‘Consumer’ business from 0-2% to 2-4%.

Millennials More Likely To Purchase ‘Controls’ Products When Compared To Boomers

Source: The Scott’s Miracle Gro Co Investor Presentation

Longer-term, global warming will create more favorable trends that should improve demand over time. Higher temperatures can extend prime lawn season in the North and promote insect population growth while increased rainfall can promote additional weed growth. Finally, the secular household migration trend from the blue to red states ultimately means a greater number of households will seek out H&G’s products given the longer growing season. From a recession perspective, while H&G products may appear more discretionary, during the Great Recession, CENT’s ‘Garden chemicals and control products’ business grew, indicating that revenue fluctuations are more tied to weather than economic backdrop. Therefore, weather aside, broader trends in migration, consumer engagement and weather support a LSD top-line growth rate. With its high barriers to entry, vertical integration, low cyclicality and strong brands, H&G is SPB’s most defensible business.

Hardware and Home Improvement (HHI) – The Key To A Better Balance Sheet

“The announced definitive agreement is for us to sell our HHI business for $4.3 billion in cash . . .  The net proceeds create significant opportunity to drive total shareholder return and unlock value for Spectrum Brands shareholders. . . . The transaction today represents a significant premium . . . With approximately $1 billion in net cash . . . we're going to significantly reduce our debt and be a very delevered company.

While we're proud of the success from HHI . . . it became clear HHI's business differs from our other businesses in a few important ways . . . HHI sales are closely tied to the industrial sector and the new housing market. HHI's products are a little bit more durable than our other product offerings, and they're purchased a little less often compared to our other business units. HHI's customer include more industrial commercial segments than the rest of our businesses” – CEO David Maura HHI M&A Call

Historical HHI Financials

Source: Company Filings

Acquired for 7.4x LTM EBITDA in 2012 from Stanley Black and Decker (ticker: SWK), HHI has proven to be one of SPB’s steadiest performing businesses over the last decade. Within the markets it serves, HHI is well-positioned with its lockset business being the crown jewel: the lockset business, which comprises 67% of HHI’s revenue, is #1 in the North American residential security market with 40%+ market share (Kwikset, Baldwin and Weiser) and has a substantial install base. Growth drivers for this business include Repair & Remodel spend (75% of lockset’s revenue) and the shift from mechanical to electromechanical/smart locks. With this combination of growth drivers and strong market/channel positioning, there has been notably strong inbound strategic/sponsor interest over the years. From SPB’s perspective, its inability to further scale HHI via M&A and the end markets served/durable nature of the products make this division less strategic. Thus, the announced divestiture of HHI to Assa Abloy (ticker: ASSAB SS) at 14x EBITDA is a home-run, selling the business at a premium multiple on peak earnings while enabling SPB to pivot from net ~3.5x leverage to a net cash position.

HHI Product Overview

Source: Assa Abloy HHI Merger Presentation

Yet despite the positive implications of the sale, SPB’s share price has largely been rangebound, implying some skepticism as to whether the deal can close. On a high level, the acquisition of HHI lockset business is complementary to ASSAB’s commercially focused security business in the US. To the extent there is overlap in the US residential digital door lock space, HHI makes a more competitively priced product sold through different channels than ASSAB’s higher-end August/Yale brands. Per the merger agreement, should a divestiture be required to satisfy regulators, ASSAB would be required to take ‘any and all actions’ to remedy the situation subject to certain undisclosed carveouts. From a motivation perspective, ASSAB has been very keen on entering the US residential security market but was unable to do so given its lack of market leading position and challenges making inroads with the DIY retail and homebuilder channels. As a vote of confidence, ASSAB agreed to a $350mm break fee (8% of the purchase price), well above the usual 4-6%, that would be paid to SPB should the deal not receive regulatory approval. Finally, in our timeline, we believe ASSAB has already responded to a second request from US regulators (March/April timeframe) and that with a timing agreement (for regulatory review) likely in place totaling 90-120 days, we expect a material update in July/August, well before the merger agreement end date of December 8th 2022.

Global Consumer Smart Lock Market Share By Brand

Source: ASSAB Press Release

To the extent ASSAB/HHI is unable to close, SPB will have other options to create value. As discussed on ASSAB’s M&A call, the sale of HHI was done in an auction process with two rounds and multiple interested parties. Given HHI’s favorable business profile and scarcity value, other strategics or PE sponsors do/would have interest, albeit at a lower price, reflecting both the decline in market multiples and peak earnings in 2021. While we haven’t found any good precedent transactions, we note that competitor Allegion plc (ticker: ALLE) trades at ~13x 2023 EBITDA. Admittedly, with more consistent MSD organic growth, greater diversity in end markets and a superior platform for M&A, ALLE deserves to trade at a premium to a stand-alone HHI. Assuming a discount to ALLE but some control premium, we believe HHI could fetch 10.5x EBITDA, a 25% discount to what ASSAB is willing to pay. With a 10.5x takeout multiple and the ASSAB break fee, SPB would net ~$3.1bln, still putting it in a net cash position and giving it substantial capital allocation optionality.

Home & Personal Care (HPC) – Ready To Be Shipped Out

“I think in an ideal world, we would find a different home, frankly, strategic home for HPC, where that business can participate in industry consolidation, which I think is important. It's a very different type of market than the other two businesses in the Continuing Operations, and that we would be more focused. Again, I said it earlier, consumer staples, consumables versus durable good type company.” – CFO Jeremy Smeltser 2022 CJS Conf.

Historical HPC Financials

Source: Company Filings

Built through SPB’s 2010 merger with Russell Hobbs, HPC represents the largest share of SPB’s revenue yet is viewed as its least desirable business. Revenue is broken down into 59% home appliances (kitchen) and 41% personal care (hair/personal grooming) with 61% of sales coming from outside North America, making it SPB’s most internationally exposed business. While its products have strong market positions in various market niches (#1 brand of indoor grills – George Foreman; #1 brand toaster oven -- Toastmasters), they operate in low ‘barrier to entry’ markets with many well-capitalized competitors. Secularly, HPC’s EBITDA margins have been under substantial pressure, dropping from 15.8% in 2017 to 8.1% in 2021, the lowest among SPB’s segments. By outsourcing manufacturing to China and historically underinvesting in the business, HPC has been hit hard by tariffs, inflation and inconsistent organic growth. Perhaps most telling, SPB failed to make a single meaningful acquisition to further scale its platform and instead, focused on divesting it in 2018.  

Small HH Appliance Unit Sales Expected To Grow Very Slowly

Source: Statista

In our view, the commitment to separate HPC by ‘hell or high water,’ be it through a spin, JV, carveout or outright sale, will be critical in improving SPB’s multiple. Optically, its low underlying organic growth and HSD margins weigh on SPB’s overall financial profile. Secularly, the small appliance end markets are challenged with the US market expected to be flat on a unit basis for the next 5 years. While COVID did provide a nice bump in sales, given these products are durable, this lift has less staying power. From a recession perspective, the durable and discretionary nature of these products will make them less resilient than GPC or H&G. That all said, while proposed multiples were below management’s expectations, there was inbound strategic interest in HPC back in 2018. In early 2021, there were rumors that SPB was in advanced conversations with CVC to form a JV that would combine HPC and privately-held Conair. Separately, SPB’s recent acquisition of Tristar’s home appliance and cookware business further scales HPC (PF ~$1.7bln in revenue and ~$140mm in EBITDA), providing a new channel for distribution (TV) and enabling it to stand alone as a public company. In our view, the best path forward would be an outright sale or spin versus JV/carveout given a) the need to remove HPC from SPB’s consolidated financials and b) the significant weakness in the IPO market. In either scenario, we believe there will be some addition by subtraction by getting HPC off the books.

Operational Transformation – Cleaning Up The Dog Poop

“We talk about GPIP [Global Productivity Improvement Plan], and a lot of times . . . we lead with the savings. But the program is much more important than the savings. But really what GPIP is . . . about partnering with A.T. Kearney . . . to essentially help us on a journey to move from a decentralized acquisitive, what I'll call, portfolio management type company to a true operating company model, where many -- we would call them enabling function . . . supply chain, IT, finance, HR, legal, et cetera, commercial operations. Those functions are all led from the center with the best of talent from inside the businesses as well as a lot of external new talent to support the businesses so that the business can spend their time focused solely on consumer product and customer.” – CFO Jeremy Smeltser CJS Conf. 22

To understand investor perception of SPB as an operating company, it is important to revisit its uneven execution and poor investor communication over the latter half of the past decade. Operationally, from 2017-2018, SPB bit off more than it could chew when it attempted sell multiple businesses and rationalize/consolidate multiple facilities: missteps included a botched manufacturing consolidation in their legacy auto car business, product recalls in GPC, disastrous distribution center transitions in HHI and the undermanagement of HPC prior to/during its failed sales process. On the M&A side, SPB whiffed on a few GPC deals (P&G and Salix), resulting in revenue headwinds as SPB exited their low/no margin revenue streams and facility issues resulting in a major product recall and poor fixed cost absorption. Management did themselves no favors in downplaying the severity of some of these issues and overpromising on the expected timing/proceeds from the failed 2018 HPC sales process. The net result is that SPB had too many ‘one-time’ issues, requiring perpetual restructurings, and lacked credibility and operational focus.

Stock Chart Performance Showing Relative Weakness Beginning 2017

Source: RBC Research

That said, the past two years have demonstrated both improved operational execution and better communication. Since David Maura took over as CEO in early 2018, SPB has upgraded management, promoting industry veteran Randy Lewis to COO and naming former SPX Corp exec Jeremy Smeltser as CFO. Operationally, SPB has been overdelivering on its Global Productivity Improvement Plan or GPIP, which was originally set for $100mm in gross savings and has been iteratively raised to $200mm ($150mm ex. HHI). Devised with the help of consulting firm A.T. Kearney, the plan improves procurement, supply chain, information management and other commercial operations resulting in savings that have been redeployed for growth initiatives. These cost saves have funded additional advertising spend, more than doubling SPB’s prior spend from sub 1% to roughly 1.8% of revenues as well as innovation spend, which has resulted in improved product launches and vitality. With SPB narrowing its focus to GPC and H&G, both of which were previously run by Randy Lewis, we believe management is well-positioned to execute, improving its credibility and ultimately reducing the ‘Spectrum discount.’

GPIP Overview

Source: Company Presentation

Why Are We Getting This Opportunity?

With SPB divesting HHI at a premium multiple, resulting in a net cash balance sheet, the question is why do the remaining businesses trade at a paltry 6.7x ‘23 EBITDA? We’ve already covered a few concerns, namely: a) whether the HHI sale to ASSAB gets antitrust approval, b) whether HPC gets separated, c) is the COVID bump sustainable, and d) management’s credibility and ability to execute. On top of these, we believe there are several additional factors including: a) ‘cross-over’ coverage nature of business (consumer staples + building products), b) lack of PF financials for SPB ex. HPC (HPC still reported in continuing operations), c) the chronic adjustments to EBITDA, EPS and FCF given persistent restructuring charges and d) potential downward pressure on 2022 guidance given the late spring season start.

Summarizing our thoughts relative to the previously discussed concerns:

a) HHI Divestiture – while we believe ASSAB is very motivated and incentivized to close the deal, we believe there are multiple ‘cover bids’ that will bring SPB to a net cash position;

b) HPC Separation – we believe HPC has the appropriate scale and growth opportunities to pursue any number of separation paths, including those that SPB can execute on its own;

c) COVID Bump – while the benefits to HHI and HPC will be shorter-lived given the durable nature of their products, we see sustainable improvements in demand for GPC and H&G’s consumable products; and

d) Management Credibility/Execution – we’ve seen marked improvements in SPB’s ability to ‘under-promise’ and ‘over-deliver’ even in a very challenging macro environment.

As it relates to the additional considerations:

a) Cross Over Coverage – with SPB simplifying into a pure-play consumer staples company, it should garner the attention of additional buy and sell-side analysts;

b) Lack of PF Financials for SPB ex. HPC – updated financials ex. HPC, which would project to higher growth and better margins, likely to come after HPC carveout financials are produced;

c) Persistent Accounting Adjustments – we believe SPB bit the bullet to cover all of its bases with its productivity program. With the program set to finish next year and with fewer businesses in its portfolio, we believe SPB will be better positioned to report cleaner financials; and

d) Potential Downward Pressure on 2022 Guide – management incorporated the ‘short term weather challenges’ when it provided updated guidance on its most recent earnings call. Should the challenging weather persist, we believe buy and sell-side analysts will look past this transitory issue and instead focus on updates for HHI and HPC.

Capital Allocation – Backing Up The Truck

“I'm starting to sound like a broken record on these calls, but I view our currency as kind of the cheapest thing to acquire. And obviously, we know the risks in our business better than I know the risk of a platform that we would acquire. And so again, I think our priorities would be -- the day we close is a big debt paydown and it's -- I've mentioned in the comments numerous times that we would accelerate our share repurchase activity, particularly if the stock stays at current levels and it has the valuation that it currently does.” – CEO David Maura Q2 22 Earnings Call

With the HHI deal still yet to close, we believe both the buy and sell-sides are underrating SPB’s ability to allocate significant capital to share repurchases. With HHI deal proceeds of $3.5bln and adjusting for the seasonality of cash flow, we see SPB utilizing ~$2.1bln of cash to pay off its loans and call its ’25 and ’26 bonds. The net result is that the PF balance sheet has $1.9bln of cash and $1.2bln of gross debt. With a new leverage target of 2.5x and an estimated $300mln of cash needed to run the business, SPB will be able to redeploy $1.6bln of capital. When SPB was presented with a somewhat similar situation with the sale of its battery and auto care businesses, it leaned heavily into its $1bln authorization, repurchasing ~$600mm in shares over a 1.5yr period from 2019 to 2020. Currently, Maura has made it clear he doesn’t want to add another leg to the stool, and with his 1.5% beneficial ownership in SPB, we believe he will act to maximize value. With management’s belief that the stock is unbelievably cheap and that the M&A market for GPC and H&G is still overheated, we see management deploying $700mm to $1.2bln in buybacks over 2023/2024. If we assume SPB front loads the buybacks 70/30 in 2023/2024, we see a path to $6.14 (base case) and $7.45 (bull case) of 2024 EPS, well above consensus at $5.27. Critically, we see 2024 FCF/share ramping to $8.10 (base case) and $9.79 (bull case), giving SPB more dry powder for additional shareholder returns.  

What’s It Worth?

“Look, we're really focused on creating value for our stakeholders, right? And we've got 2 phenomenal businesses in our holding company, our Global Pet Care business and our Home & Garden business. And these tend to be much faster growing, much higher-margin businesses. And when I look at the valuations being paid in the private sector of recently 14, 15, 16x EBITDA for assets similar to this, I think it's behooven upon me as a fiduciary to think about how to create value for our stockholders. . . I think if people really look at our business today, the holding company today is trading at about 7x EBITDA pro forma the HHI business. And that's why I've been aggressive in buying back our shares because I do believe once appliances is spun off, our multiple can be re-rated much more in line with where I believe a home and garden and a pet business of our caliber should trade. So that's what I'm trying to do to create wealth for our stockholders.” – CEO David Maura Q1 22 Earnings Call

Laying Out The Scenarios

Given the various permutations of sales proceeds, financial performance and multiples, we will break out our bull, base and bear/recession scenarios separately (see above for scenario inputs). As an important note, in our model, we follow the company’s current reporting of including HPC in continuing ops – this makes our forecasts comparable to Street estimates. However, in our valuation, we assume that HPC is sold, using different EBITDA forecasts and multiples in each scenario.

Focusing on GPC, while there are no great pure-play comps that match SPB’s category exposure, CENT and, to a lesser extent, J.M. Smucker Co (ticker: SJM) have some good overlap. While we don’t have CENT’s product sales breakdown, we note that a fair amount of their pet business includes less consumable items, such as dog toys and dog beds. On the flip side, CENT has had more consistent organic growth in part due to a mix shift towards private label business. SJM focuses on consumables including dog/cat food and treats. Though SJM has other significant businesses, pet has largely been the focus for M&A, suggesting a favorable bias towards that category. Thus, for our base case, we take a blended average of CENT/SJM’s 2023 EV/EBITDA multiples or roughly 10.4x. For our bull case, we note that SJM did acquire Big Heart Pet in 2015 and Ainsworth Pet Nutrition in 2018 for 13x and 12x EBITDA respectively. Taking a 1-turn discount for the control premium yields a bull case multiple of 11.5x. For our bear/recession scenario, we assume GPC is worth 6x EBITDA or roughly 0.75x below the current implied multiple for SPB (GPC, H&G and HPC combined) post the HHI divestiture.

As was the case for GPC, H&G has no great pure-play comps, particularly given SPB’s narrow product focus, but CENT and, to a lesser extent, SMG have overlapping/competing business lines. Looking at CENT, we find it hard to rank order the quality of businesses within this segment, particularly given that both pesticides and fertilizer require some form of registration (barrier to entry). Regarding SMG, with its Hawthorne business (hydroponics) struggling, we believe that valuation for SMG is likely better anchored to its Consumer business, whose ‘Controls’ business competes with SPB. That said, given the noise with SMG, for our base case, we give 66%/33% weight to CENT’s and SMG’s 2023 EBITDA multiples, yielding a ~10.8x multiple. For a bull case, we will assume a half-turn premium to our base case and for our bear/recession scenario, we will again use a 6x multiple.

For HHI and HPC, we assume that SPB sells both divisions given SPB’s motivations to both deleverage and exit HPC. Focusing on HHI, in our bull scenario, we assume that the HHI deal closes as is for net proceeds of $3.5bln. Frankly, this scenario is more of a base case, but to the extent we want to be conservative, we assume that under our base scenario, another bidder pays 10.5x EBITDA implying a 25% haircut to the current deal, with SPB getting the $350mm break-fee. In our bear case, we assume that SPB sells HHI using the 5yr trailing average EBITDA ($263mm) with the same 10.5x multiple, again getting the $350mm breakup fee. Incidentally, this calculation is equivalent to taking 9x multiple using ASSAB’s EBITDA calculation. Finally, for HPC, we utilize the 10% guidance for normalized EBITDA margins as what a buyer would underwrite (ex. synergies). In our bull scenario, we assume a buyer is willing to pay a 8.5x buyer’s multiple or 10.5x seller’s multiple on 2023 EBITDA. In our base and bear/recession scenarios, we assume a buyer would be willing to pay a 7.5x and 6.5x buyer’s multiple, implying a seller’s multiple of 9.4x and 9x respectively. We note that our base/bear buyer’s multiples are still at a discount to Newell Brands (ticker: NWL) while our base/bear seller’s multiples are in-line with comps.

Tying it all together, we obtain a base case target price of $134/share or 61% upside, a bull case target price of $164/share of 97% upside and a bear/recession case target price of $67/share or -20% downside. Using probability weights of 20%/40%/40% for base/bull/bear scenarios, we get a blended price target of $119/share or 43% upside. Alternatively, given our view that the HHI deal goes through, if we assume that every other assumption remains constant, we get a base/bull/bear price target of $148/$164/$90 per share, implying a blended target price of $131/share or 58% upside. Finally, if one wanted to greatly simplify the analysis and assume that the HHI and HPC deals go according to our base case and that the remaining businesses trade at CENT’s multiple (conservative given its high leverage and controlling shareholder), we get a $127/share stock price or 53% upside.

Valuation By Scenario

Catalysts

One of the strengths of SPB’s story is the series of upcoming hard catalysts that should re-rate the stock. First, with our estimated timeline of the US antitrust process, investors should get a material update on the HHI deal within the next two months. The closure of this deal would then trigger a series of capital allocation moves including debt paydown and a larger share repurchase authorization. With the announcement of deal closure and repo authorization, we also believe that the Street will revisit estimates that are too low on a per-share basis. Separately, we see the release of carveout financials for HPC (this summer) and decision to move it into discontinued operations as providing investors additional confidence that the business will be separated. In our view, the complete separation of HPC from SPB’s financials (sale, spin or minority JV ownership) will be critical to unlocking a higher trading multiple.

Longer-term, once both the HHI divestiture and HPC separation are complete, we envision a potential merger between SPB and CENT. We note that in 2014, HRG (the majority owner of SPB at the time) attempted to acquire CENT but was rebuffed by its board given the perceived low-ball offer (Chairman Bill Brown has voting control). As a point of reference, the offer of $10/share with the assumption of debt valued CENT at 12x ’14 EBITDA and 8x ’15 EBITDA. From both sides, the industrial logic of a deal makes good sense: On the H&G and GPC sides, SPB and CENT have both competing and highly complementary product lines. Aside from the ability to consolidate sales, marketing, innovation and corporate spend, the combination would have better positioning vis-à-vis the concentrated H&G distributors (SPB/CENT have 65-70% exposure to Walmart, Home Depot and Lowe’s). On the GPC side, with distribution being more fragmented, the combined entity would have better scale to broaden its reach. In our view, given the red hot private market and CENT’s Chairman’s age (81), we believe a merger is not a matter of ‘if’ but rather ‘when.’

CENT/SPB Business/Product Exposure

Source: Central Garden & Pet 2020 Investor Day

Appendix: Base Case Model

Appendix: Bull Case Model

Appendix: Bear/Recession Case Model

Appendix: SOTP Analysis By Scenario

Appendix: Comps