CST BRANDS INC CST S
May 24, 2013 - 2:26pm EST by
COTB
2013 2014
Price: 33.35 EPS $1.94 $1.63
Shares Out. (in M): 76 P/E 17.2x 20.5x
Market Cap (in M): 2,535 P/FCF NA 46.3x
Net Debt (in M): 724 EBIT 263 228
TEV: 3,259 TEV/EBIT 12.4x 14.3x
Borrow Cost: NA

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  • Gas stations
  • Spin-Off
  • Secular decline
  • Poor management
 

Description

Short CST: Breaking Rose-Colored Glasses

CST is a gas station/convenient store business that was spun off from VLO on 5/1/13. CST has traded well and is at ~$33 now. Given the information vacuum and general excitement around spin-offs, CST is highly misunderstood. There’s nearly 40% downside to fair value of $21 once the market appreciates significant downside to earnings and CST’s poor business prospects. In particular, CST should generate 2013 EPS of ~$1.60 (vs Street’s ~$2.25) and deserves below-market multiple of 13x (vs Street’s target of 15-16x) reflecting its worst-in-class assets with negative same-store sales (SSS). CST’s weak FCF potential (44%-85% of EPS depending on growth assumptions) suggests further downside below $21.

Conversations with VLO and CST suggest both management teams are pleasantly surprised by how well CST has been trading. It’s also interesting that recent CST equity awards were not granted through options but through restricted stock.

Company Overview

  • CST operates 1,032 gas stations in the U.S. (mostly in the Southwestern states). CST captures profit both from fuel retailing and c-store businesses.
  • CST also has 848 locations in Eastern Canada. CST captures fuel retailing profit from all locations but participates in c-stores at 261 locations (the remaining locations are either operated by dealers/agents or are unattended truck fuel sites without a c-store).
  • In 2012, 47% of gross profit came from motor-vehicle fuel, 40% from c-store merchandise, and 13% from other (e.g. car wash, heating oil, ATM, lottery). This business mix is unique as CST has much greater exposure to fuel and less exposure to merchandise vs both publicly listed peers and industry average.

FY12 Gross Profit Mix

CST

Industry Avg

Public Peer Avg

CASY

Couche-Tard

PTRY

SUSS

Fuel

47%

33%

26%

23%

26%

26%

30%

Merchandise

40%

62%

71%

74%

74%

74%

60%

Other

13%

5%

3%

3%

0%

0%

9%

Total

100%

100%

100%

100%

100%

100%

100%

Note: SUSS result pro forma for distribution fee to SUSP. CST pro forma for commercial supply agreement.

         Industry data per NACS for most recently available year (2011).

 
  • In 2012, CST generated $378m of EBITDA, $263m of EBIT, and $1.94 of EPS. (These figures are pro forma per company disclosure to incorporate the impact of commercial supply agreement, incremental public company cost, and current capital structure). See CST P&L summary at the end of this report.

Street’s Perception vs Reality

CST EBITDA Bridge

Street Low

Street Mid

Street High

Realistic

2012 PF EBITDA

$378

$378

$378

$378

US fuel margin

0

10

19

(34)

US volume / new stores

16

19

22

5

C-store margin   improvement

10

13

15

0

2013 PF EBITDA

$404

$420

$434

$349

2013 PF EPS

$2.12

$2.26

$2.38

$1.63

  • There is currently no official consensus as only one sell-side firm has initiated on CST. However, buy-side investors appear to converge around a consensus of ~$420m EBITDA and ~$2.25 EPS in 2013. This represents ~$40m of increase in EBITDA from 2012.
  • Examples of Street’s general view can be seen in these articles (http://bit.ly/16xYdax and http://bit.ly/17Z3kRq).
  • Specific drivers behind the ~$40m yoy increase differ among investors but generally come from some combination of the factors summarized in the above table and discussed further below. In contrast, a more realistic fundamental view suggests EBITDA should fall by ~$30m yoy to $347m in 2013.

1. US fuel margins

  • Street assumes US fuel margins to be flat or rise by 1c/gal based on an apparent trend of rising margin in recent years. Note that every 1c/gal of fuel margin translates to $19m of EBITDA in the US.
         

Street

Realistic

Fuel margin (cents /   gal)

2009PF

2010PF

2011PF

2012PF

2013E

2013E

US - VLO reported

12.6

14.0

14.4

16.2

   

Spin adjustment

(0.2)

(0.4)

(0.4)

(0.4)

   

Commercial agreement

(1.5)

(1.1)

(1.0)

(1.1)

   

US - CST pro forma

10.9

12.6

13.1

14.7

15.7

12.9

  • This apparent trend obscures the underlying relationship between fuel margins and changes in wholesale fuel prices. In a period of rapidly falling crude oil and wholesale fuel cost (such as in 2Q12 when Brent fell from ~$125/bbl to ~$90/bbl, the sharpest fall in the history during Q2), CST would reduce retail fuel price more slowly and capture greater margins. Conversely, in a period of rapidly rising crude oil and wholesale fuel cost (such as in 2009), CST would experience some headwind and report lower margins.
  • Fortunately, a large historical dataset (quarterly since 2002) is available on VLO’s website (http://bit.ly/13zRx8R) to clearly demonstrate this relationship. Indeed, a regression between realized fuel margins against changes in wholesale gasoline cost (MOIGC87P Index on Bloomberg) from the beginning till the end of each quarter shows tight correlation and conclusively proves this underlying relationship (see regression charts here http://bit.ly/12PWcCF). For any math/stat major out there, the product of “p-values” indicates the odds that this relationship does not hold (and perhaps margins are secularly rising) is 1 in ~3 trillion (~16,000x longer odds than a PowerBall jackpot)!
  • Furthermore, CST and VLO have acknowledged the negative relationship between wholesale fuel cost and retail fuel margins in public filings (e.g. see page 45 of VLO 2Q12 10-Q). Other public comps have recognized this relationship as well and indicated that fuel margins in 2012 were abnormally high and should contract in 2013.
  • Assuming oil price remains stable for the rest of the year, 2013 margin should be 1.8c/gal lower than 2012, representing $34m in EBITDA headwind in the US. A large yoy decline should occur in 2Q13, when CST will be comping against an impossibly high bar in 2Q12 (VLO’s historical data shows US retail EBIT in 2Q12 was 2.7x the preceding 10-year average). Note that fuel margins in 3Q12 and 4Q12 were below and above average respectively, but together the 2H12 margin was approximately in-line with the normal range and should be flat into 2013 (absent wild swings in crude oil and fuel cost).
  • Why is the market missing this fundamental relationship? A constellation of factors align and cause this colossal misunderstanding:

a)     False trend - CST’s limited historical data by chance shows rising margins.

b)    Rose-colored glasses - Investors eager to chase spin-offs are ready to see the upside and management hasn’t proactively managed expectation.

c)     Irrelevant to VLO - Legacy VLO investors don’t focus on retail metrics since it’s more useful to analyze the much bigger and more volatile refining business. Most CST investors aren’t even aware of relevant historical disclosure provided by VLO.

d)    Irrelevant to peers - Perhaps most importantly, even veteran retail sell side analysts and investors aren’t well aware of this negative relationship because (i) the relationship is less important to other public comps with small exposure to fuel margins, (ii) the correlation is less pronounced for other c-stores as they typically cut retail fuel price quickly (and do not benefit as much from the lag) in order to drive more traffic towards the c-store business. (CST can’t afford to do the same since fuel is the main business).

2. US organic and new store growth

  • CST’s US business generated $162m out of the $263m in total EBIT in 2012. Most of its US locations are in the Southwestern states (especially Texas) which have strong economic growth. This fact was prominently highlighted in CST presentation and resonates with many investors. A 5% organic growth in the US (similar to Susser which operates in Texas) equates to $8m of EBIT. In addition, CST is investing $115m to open 23 new stores this year. Street assumes 25% EBITDA return on this capital. Assuming new stores open ratably through the year, CST should generate $14m of incremental EBITDA.
  • Actual results show that CST’s US fuel volume and merchandise sale (per store per day) have had zero growth over the past two years.
         

CAGR

Per store per day

2009

2010

2011

2012

'10-'12

US fuel volume

4,983

5,086

5,059

5,083

(0.0%)

US merchandise sales   ('000s)

$3,207

$3,333

$3,370

$3,341

0.1%

  • The same weakness can also be seen in EIA data, which shows flat gasoline demand in the Southwestern region (PADD 3) over the past two and five years. While PADD3 is doing “better” than the US overall (down 3% and 6% over the past 2 and 5 years), it is nothing to write home about.

Gasoline demand   (mmbbls/d)

2007

2008

2009

2010

2011

2012

US

9,284

8,988

8,995

8,990

8,752

8,703

PADD3

1,415

1,359

1,407

1,395

1,325

1,412

  • CST’s prospect is even worse than it looks because the flat per store metrics (different from SSS metrics which were not disclosed for 2009-12) include benefits from M&A. Since 2009, CST has (a) closed/divested 217 underperforming stores (which boosts per store metrics for remaining stores) and (b) opened/acquired 137 new stores that are larger (which also improves per store metrics). To benefit from significant M&A tailwind and still show no growth means SSS in recent years must be negative. Indeed, CST disclosed SSS metrics for the first time in 1Q13, showing 1.6% decline in fuel volume and 0.9% decline in merchandise sales. These figures benefit from higher growth rates from the ramp-up of new stores which should taper off as the stores mature. SSS figures are slightly worse (-1.1% fuel and -2.0% merchandise) excluding new stores. Because of negative SSS, new store investments are needed just to keep CST from sinking. The “Realistic” case above assumes $5m of net EBITDA increase from new stores, offset by negative SSS.
 

All

All

Legacy

Legacy

Same Store Info (per store per day)

1Q12

1Q13

1Q12

1Q13

Sites

991

991

969

969

Fuel volume

5,063

5,018

4,964

4,910

Growth

 

(0.9%)

 

(1.1%)

Merchandise sales

3,183

3,131

3,160

3,097

Growth

 

(1.6%)

 

(2.0%)

3. Why CST is different from peers.

  • Many investors compare CST to other fuel/c-store retail peers and imply that CST will enjoy similar growth and deserves similar valuation. Figures above clearly shows poor prospects for CST which can be attributed to the following reasons.
  • Fuel vs merchandise. The table in the overview section shows that CST is primarily a fuel retailing business while peers are primarily a merchandise retail business. Fuel is in a secular decline while merchandise can generate moderate growth (with the right store format). The distinct fundamentals between fuel and merchandise make CST not comparable to peers.
  • Flexibility. CST’s outsized fuel exposure also limits its flexibility to use low fuel price as a “leader” to attract customer traffic to boost merchandise sales. While this strategy may be attractive to peers with a dominant merchandise business (2-3x of fuel gross profit), the tradeoff doesn’t work as well for CST. Effectively, CST is stuck with relatively large fuel exposure (this applies to CST as a whole and separately to US and Canada segments) and cannot easily diversify to merchandise. Over time, as industry fuel volume declines and the fuel-for-merchandise tradeoff becomes increasingly attractive, there will be more pressure on fuel margins which will disproportionately hurt CST. To use the supermarket analogy, CST is selling a lot more milk (a well-known loss leader) than peers.
  • Foodservice. The key growth category in merchandise is foodservice, offering not just hot dogs on rollers but actual QSR implants serving made-to-order items such as tacos with a nice sitting area a la Chipotle. CASY’s stores even offer pizza delivery! QSRs require bigger store boxes ranging from 3,200 sq.ft. at the low end to over 5,000 sq.ft. With an average box size of 2,300 sq.ft., CST simply doesn’t have enough space to install a kitchen. Growth from foodservice will have to come from new stores.
  • Size. CST already has a large base of 1,880 locations. Adding 23 stores this year (or even more next year) will hardly move the needle, especially considering the likely offset from store closures (an average of 45 per year during the past 3 years). CST’s large size also hinders its ability to increase mix shift towards foodservice. Even peers that started from a much smaller base and have prioritized growth in merchandise show little mix shift from fuel towards merchandise over the past 15 years.
  • Timing. CST is also disadvantaged as a late entrant into the large store format. Peers like Susser were picking the best locations for new stores, developing its food and merchandise brands, and winning customer loyalty since 2000. The competition has recently gotten fierce. As Susser noted in its 1Q13 call “The strong economy in our region also is attracting significant numbers of new retail competitors, including expansions by the dollar stores, drug stores, and large box retailers offering fuel. In addition, in certain markets, we're seeing an increase in the number of new convenient stores, being built by traditional operators.” It’s hard to imagine how new CST stores today will be able to match the ramp-up of Susser’s store vintages that opened a decade ago.

4. Merchandise gross margin improvement

  • CST has lower merchandise gross margins (29.6% in 2012) than peers (average of 35.2%). Street believes the company is undermanaged and margins can improve. Every 100bps increase equates to $15m of EBITDA.
  • Most of the 560bps difference can be explained by CST’s worse merchandise mix. In particular, CST’s lower exposure to foodservice alone explains 330bps of the difference (foodservice carries 30% higher gross margin than average). As discussed earlier, CST’s low foodservice exposure cannot be fixed easily. CST’s higher exposure to cigarettes accounts for another ~50bps of margin downside (cigarettes has ~15% lower margin than average). The remaining 180bps gap can be attributed to CST’s older store base, which is unlikely to command as much pricing power as peers.
  • Some have suggested an easy margin fix by replacing cigarette sales with food sales. That’s a good plan if we can put a kitchen on the small shelf behind the cash registers.
  • Even assuming some upside in gross margins from greater foodservice mix, this would be offset by increased operating expenses given the service-oriented nature of foodservice. The table below shows greater ratios of SG&A to gross profit for all peers relative to CST.
  • It’s more likely that increases in gross margins and lower mix of cigarettes will be driven by declines in cigarette sales (the pace of which have intensified over the past year) rather than by increases in sales of other merchandises (1Q13 result shows same-store merchandise sales ex cigarettes only grew 0.5% yoy). This means gross profit dollar per store is actually falling despite the increase in gross margin (gross profit per store per day in US fell from $939 in 1Q12 to $936 in 1Q13 despite margin rising from 29.5% to 29.9%).
 

Merchandise Sales Mix

CST

Peer Avg

CASY

Couche-Tard

PTRY

SUSS

Cigarettes

32%

29%

37%

NA

32%

19%

Foodservice

9%

20%

27%

NA

11%

21%

Other merchandise

59%

51%

36%

NA

58%

59%

Total

100%

100%

100%

 

100%

100%

Merchandise gross   margin

29.6%

35.2%

40.0%

33.1%

33.7%

33.9%

Cash SG&A / GP

65.7%

72.2%

68.6%

72.5%

74.4%

73.5%

5. Poor FCF prospects

  • CST “maintenance” CapEx guidance of $75m (below D&A of ~$120m) ostensibly suggests FCF should be higher than EPS.
  • However, negative SSS means meaningful new store CapEx is required to maintain flat EBITDA or generate any growth.
  • The table below shows that CapEx needs to be $140-190m to generate minimal 0-3% EBITDA growth, indicating FCF of $0.72-$1.38 or only 44%-85% of EPS.
 

No Growth

3% Growth

 

2013 PF EBITDA

349

349

 

Growth target

0%

3%

 

Incremental EBITDA   target

0

10

A

       

2013 PF gross profit

1,085

1,085

 

SSS

(1.2%)

(1.2%)

 

EBITDA loss from   negative SSS

(13)

(13)

B

       

EBITDA required from new stores

13

23

C = A - B

Assumed EBITDA / CapEx   return

20%

20%

D

Required new store   CapEx

65

115

E = C / D

       

Maintenance CapEx

75

75

F

Total CapEx

140

190

G = E + F

       

2013 net income

124

124

 

D&A

121

121

 

CapEx

(140)

(190)

 

2013 FCF

105

55

 

FCF per share

$1.38

$0.72

 

Other items

  • Management: All of CST senior management came from the legacy Retail business or other parts of VLO. CEO was previously VLO’s general counsel. No new talent from the retail industry added.
  • Share count: CST has a total of 76m shares, including 61m shares of float and the remaining 20% retained by VLO. Some reports use an incorrect share count of 61m.
  • Incremental public company cost: CST has guided to $20m of cost (as noted in company presentation). Some reports (including Stephens’ initiation) fail to capture this cost.
  • MLP: Susser’s MLP was anchored around its wholesale fuel distribution business. CST doesn’t have a wholesale business and its fuel retail business is not MLP-able.
  • REIT: CST owns real estate in 61% of its total locations (1,152 out of 1,880). REIT conversion (ie opco/propco) is not doable because the distribution of propco to VLO (which owns 20% of CST) would trip up tax rules. Management also wants to retain control of real estate. In any case, on realistic estimates CST is already trading at a premium to CASY (which owns 99% of its stores) and to potential upside from forming a single-tenant propco.
  • 1Q13 result: Reported EBITDA of $59m reflects no impact from incremental public company cost ($5m per quarter) and only partial hit from fuel supply agreement ($5m vs full impact of $8m because the agreement was not fully implemented at the beginning of the quarter). PF EBITDA should be $51m. In addition, reported result doesn’t reflect interest expense on new debt ($11m per quarter). PF 1Q13 EPS should be 10c.

Conclusion / Valuation

  • Motor fuel demand is in a secular decline thanks to rising fuel economy. Despite being the best house in the neighborhood, the Southwestern states are showing no growth. An eventual decline seems inevitable.
  • CST is overexposed to fuel retailing and underexposed to the c-store business.
  • CST’s challenge is structural and difficult to be fixed. CST’s businesses are struggling to stay flat despite significant investment in new stores and the benefit from store closures.
  • Growth will come largely from new stores, but they are unlikely to be significant relative to CST’s large existing store base.
  • Given the above considerations, a 13x P/E seems appropriate for this no-growth, secularly and competitively challenged, and worst-in-class business. This results in fair value of $21 and implies an EBITDA multiple of 6.7x. CST’s poor FCF generation suggests further downside.
  • Note that peers CASY, PTRY, and SUSS are trading on average at 7.3x CY13 EBITDA with significantly greater growth than CST (SUSS multiple is adjusted for its ownership in SUSP, which brings the headline multiple down from 8.7x per Bloomberg to 7.4x). Couche-Tard’s multiple of 10x CY13 EBITDA benefits from its significantly lower tax rate of ~15% (vs peers in the mid 30’s) which converts 31% more pretax income to the bottom line (85c vs 65c for every dollar of pretax income). Adjusting for this unique tax advantage, Couche-Tard would be trading in-line with other peers.
 

Valuation Summary

Current

 

Target

 

Price

33.35

 

21.20

 

S/O

76.0

 

76.0

 

Market cap

2,535

 

1,611

 

Cash

(330)

 

(330)

 

Debt

1,054

 

1,054

 

EV

3,259

 

2,335

 

 

Street

Realistic

Street

Realistic

EV / EBITDA

7.8x

9.3x

5.6x

6.7x

P / E

14.8x

20.4x

9.4x

13.0x

2013 PF EBITDA

$420

$349

$420

$349

2013 PF EPS

$2.26

$1.63

$2.26

$1.63

P&L Summary

         

Street

Realistic

P&L Summary

2009PF

2010PF

2011PF

2012PF

2013E

2013E

             

Motor fuel

402

468

517

521

   

Merchandise

388

412

430

443

   

Other

128

137

142

139

   

Gross profit

918

1,017

1,089

1,103

   

OpEx

581

605

636

644

   

G&A

72

77

79

81

   

EBITDA

265

335

374

378

420

349

D&A

101

105

113

115

121

121

EBIT

164

230

261

263

299

228

             

Other income (expense)

1

2

1

1

1

1

Interest expense

(43)

(43)

(43)

(43)

(43)

(43)

Pretax income

122

189

219

221

257

186

             

Income taxes

41

63

73

74

86

62

Tax rate

33.3%

33.3%

33.3%

33.3%

33.3%

33.3%

Net income

82

126

146

148

171

124

             

EPS

$1.07

$1.66

$1.93

$1.94

$2.26

$1.63

Shares out

76

76

76

76

76

76

 
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

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    Description

    Short CST: Breaking Rose-Colored Glasses

    CST is a gas station/convenient store business that was spun off from VLO on 5/1/13. CST has traded well and is at ~$33 now. Given the information vacuum and general excitement around spin-offs, CST is highly misunderstood. There’s nearly 40% downside to fair value of $21 once the market appreciates significant downside to earnings and CST’s poor business prospects. In particular, CST should generate 2013 EPS of ~$1.60 (vs Street’s ~$2.25) and deserves below-market multiple of 13x (vs Street’s target of 15-16x) reflecting its worst-in-class assets with negative same-store sales (SSS). CST’s weak FCF potential (44%-85% of EPS depending on growth assumptions) suggests further downside below $21.

    Conversations with VLO and CST suggest both management teams are pleasantly surprised by how well CST has been trading. It’s also interesting that recent CST equity awards were not granted through options but through restricted stock.

    Company Overview

    FY12 Gross Profit Mix

    CST

    Industry Avg

    Public Peer Avg

    CASY

    Couche-Tard

    PTRY

    SUSS

    Fuel

    47%

    33%

    26%

    23%

    26%

    26%

    30%

    Merchandise

    40%

    62%

    71%

    74%

    74%

    74%

    60%

    Other

    13%

    5%

    3%

    3%

    0%

    0%

    9%

    Total

    100%

    100%

    100%

    100%

    100%

    100%

    100%

    Note: SUSS result pro forma for distribution fee to SUSP. CST pro forma for commercial supply agreement.

             Industry data per NACS for most recently available year (2011).

     
    • In 2012, CST generated $378m of EBITDA, $263m of EBIT, and $1.94 of EPS. (These figures are pro forma per company disclosure to incorporate the impact of commercial supply agreement, incremental public company cost, and current capital structure). See CST P&L summary at the end of this report.

    Street’s Perception vs Reality

    CST EBITDA Bridge

    Street Low

    Street Mid

    Street High

    Realistic

    2012 PF EBITDA

    $378

    $378

    $378

    $378

    US fuel margin

    0

    10

    19

    (34)

    US volume / new stores

    16

    19

    22

    5

    C-store margin   improvement

    10

    13

    15

    0

    2013 PF EBITDA

    $404

    $420

    $434

    $349

    2013 PF EPS

    $2.12

    $2.26

    $2.38

    $1.63

    1. US fuel margins

             

    Street

    Realistic

    Fuel margin (cents /   gal)

    2009PF

    2010PF

    2011PF

    2012PF

    2013E

    2013E

    US - VLO reported

    12.6

    14.0

    14.4

    16.2

       

    Spin adjustment

    (0.2)

    (0.4)

    (0.4)

    (0.4)

       

    Commercial agreement

    (1.5)

    (1.1)

    (1.0)

    (1.1)

       

    US - CST pro forma

    10.9

    12.6

    13.1

    14.7

    15.7

    12.9

    a)     False trend - CST’s limited historical data by chance shows rising margins.

    b)    Rose-colored glasses - Investors eager to chase spin-offs are ready to see the upside and management hasn’t proactively managed expectation.

    c)     Irrelevant to VLO - Legacy VLO investors don’t focus on retail metrics since it’s more useful to analyze the much bigger and more volatile refining business. Most CST investors aren’t even aware of relevant historical disclosure provided by VLO.

    d)    Irrelevant to peers - Perhaps most importantly, even veteran retail sell side analysts and investors aren’t well aware of this negative relationship because (i) the relationship is less important to other public comps with small exposure to fuel margins, (ii) the correlation is less pronounced for other c-stores as they typically cut retail fuel price quickly (and do not benefit as much from the lag) in order to drive more traffic towards the c-store business. (CST can’t afford to do the same since fuel is the main business).

    2. US organic and new store growth

             

    CAGR

    Per store per day

    2009

    2010

    2011

    2012

    '10-'12

    US fuel volume

    4,983

    5,086

    5,059

    5,083

    (0.0%)

    US merchandise sales   ('000s)

    $3,207

    $3,333

    $3,370

    $3,341

    0.1%

    Gasoline demand   (mmbbls/d)

    2007

    2008

    2009

    2010

    2011

    2012

    US

    9,284

    8,988

    8,995

    8,990

    8,752

    8,703

    PADD3

    1,415

    1,359

    1,407

    1,395

    1,325

    1,412

     

    All

    All

    Legacy

    Legacy

    Same Store Info (per store per day)

    1Q12

    1Q13

    1Q12

    1Q13

    Sites

    991

    991

    969

    969

    Fuel volume

    5,063

    5,018

    4,964

    4,910

    Growth

     

    (0.9%)

     

    (1.1%)

    Merchandise sales

    3,183

    3,131

    3,160

    3,097

    Growth

     

    (1.6%)

     

    (2.0%)

    3. Why CST is different from peers.

    4. Merchandise gross margin improvement

     

    Merchandise Sales Mix

    CST

    Peer Avg

    CASY

    Couche-Tard

    PTRY

    SUSS

    Cigarettes

    32%

    29%

    37%

    NA

    32%

    19%

    Foodservice

    9%

    20%

    27%

    NA

    11%

    21%

    Other merchandise

    59%

    51%

    36%

    NA

    58%

    59%

    Total

    100%

    100%

    100%

     

    100%

    100%

    Merchandise gross   margin

    29.6%

    35.2%

    40.0%

    33.1%

    33.7%

    33.9%

    Cash SG&A / GP

    65.7%

    72.2%

    68.6%

    72.5%

    74.4%

    73.5%

    5. Poor FCF prospects

     

    No Growth

    3% Growth

     

    2013 PF EBITDA

    349

    349

     

    Growth target

    0%

    3%

     

    Incremental EBITDA   target

    0

    10

    A

           

    2013 PF gross profit

    1,085

    1,085

     

    SSS

    (1.2%)

    (1.2%)

     

    EBITDA loss from   negative SSS

    (13)

    (13)

    B

           

    EBITDA required from new stores

    13

    23

    C = A - B

    Assumed EBITDA / CapEx   return

    20%

    20%

    D

    Required new store   CapEx

    65

    115

    E = C / D

           

    Maintenance CapEx

    75

    75

    F

    Total CapEx

    140

    190

    G = E + F

           

    2013 net income

    124

    124

     

    D&A

    121

    121

     

    CapEx

    (140)

    (190)

     

    2013 FCF

    105

    55

     

    FCF per share

    $1.38

    $0.72

     

    Other items

    Conclusion / Valuation

     

    Valuation Summary

    Current

     

    Target

     

    Price

    33.35

     

    21.20

     

    S/O

    76.0

     

    76.0

     

    Market cap

    2,535

     

    1,611

     

    Cash

    (330)

     

    (330)

     

    Debt

    1,054

     

    1,054

     

    EV

    3,259

     

    2,335

     

     

    Street

    Realistic

    Street

    Realistic

    EV / EBITDA

    7.8x

    9.3x

    5.6x

    6.7x

    P / E

    14.8x

    20.4x

    9.4x

    13.0x

    2013 PF EBITDA

    $420

    $349

    $420

    $349

    2013 PF EPS

    $2.26

    $1.63

    $2.26

    $1.63

    P&L Summary

             

    Street

    Realistic

    P&L Summary

    2009PF

    2010PF

    2011PF

    2012PF

    2013E

    2013E

                 

    Motor fuel

    402

    468

    517

    521

       

    Merchandise

    388

    412

    430

    443

       

    Other

    128

    137

    142

    139

       

    Gross profit

    918

    1,017

    1,089

    1,103

       

    OpEx

    581

    605

    636

    644

       

    G&A

    72

    77

    79

    81

       

    EBITDA

    265

    335

    374

    378

    420

    349

    D&A

    101

    105

    113

    115

    121

    121

    EBIT

    164

    230

    261

    263

    299

    228

                 

    Other income (expense)

    1

    2

    1

    1

    1

    1

    Interest expense

    (43)

    (43)

    (43)

    (43)

    (43)

    (43)

    Pretax income

    122

    189

    219

    221

    257

    186

                 

    Income taxes

    41

    63

    73

    74

    86

    62

    Tax rate

    33.3%

    33.3%

    33.3%

    33.3%

    33.3%

    33.3%

    Net income

    82

    126

    146

    148

    171

    124

                 

    EPS

    $1.07

    $1.66

    $1.93

    $1.94

    $2.26

    $1.63

    Shares out

    76

    76

    76

    76

    76

    76

     
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Messages


    SubjectRE: question
    Entry05/24/2013 04:11 PM
    MemberCOTB
    Good question. There's a deferred tax asset of $119m related to step up of tax basis of assets and liabs in Canada. This will allow CST to book higher D&A and report lower income in Canada for tax purposes than GAAP. We don't know for sure how quickly this benefit can be fully realized, but using average PP&E life as a proxy (gross PP&E ex land /  depreciation) suggests the duration is about 13 yrs. This suggest NPV of this deferred tax asset (at 10% discount rate) is $65m or 86c per share.
     
    We can incorporate this benefit into a FCF-based valuation framework, but this will likely yield a lower fair value than $21 which is anchored around a P/E multiple. Also note that I'm not hitting FCF for working cap which will likely offset this tax benefit in the likely event that CST is managed to deliver at least some growth (e.g. the 3% growth case).

    SubjectDebt
    Entry05/24/2013 06:13 PM
    Membernathanj
    I think your Net Debt of $724m is too low.  They actually took out $1.05B in new debt after Q1 to give to Valero as part of the spin-off.  So net of $70m in cash at end of Q1, net debt is closer to $980m.

    SubjectRE: Debt
    Entry05/24/2013 07:52 PM
    MemberCOTB
    Net debt is pro forma for one-time working cap benefit of $260m (see 8-k released on Wednesday). The figure also includes capital lease obligation of $4m to be consistent with industry practice.

    SubjectCornerstore-4-Me
    Entry05/25/2013 04:03 PM
    MemberMencken

    Nice work COTB. I’ll repost the comment that I left on the SUSS board, correcting for my complete flub of the WASO (I had been working off the Form 10 drafts which had no sharecount, then forgot to update my placeholder when the final # was determined). 

    Too many people have read Joel’s work and just plunged headfirst into spin-offs with little to no thought. I’ve seen it with OSH and LPR most recently, and CST definitely falls into the same camp. I’m not short yet because I prefer a harder catalyst (nothing against your idea – I just prefer to short against an impending covenant violation, dividend cut, failed M&A, etc. and my small AUM allows me to short <$5/sh stocks in worthwhile size relative to my assets).

    2 other random quips:

    (a) Pretty interesting how they got cagey on the exact dividend $ number outlined in one of the earlier drafts of the Form 10 – I was hoping for them committing to a “too high” # (approximating trailing FCF) which would spell a dividend cut in the future. I’ll keep my eyes on that prospect though.

    (b) Did you see that the original corporate website name was cornerstore4u.com? Rolls right off the tongue, eh?

    --------------------

    I've spent a bunch of time looking into CST so here are my notes:

    1) Company's April 2013 Investor Presentation is a complete work of fiction:

    - Maintenance CapEx of $40k per store (~$80m / 1,900 stores) appears significantly understated based on comps and the Company's own historical capital intensity

    - Mgmt plans to spend ~$220m CapEx next year, with $30m of that for IT spending as part of the spin-off. The $190m does *not* include "Strategic Activity" (i.e. M&A), so what's the other 60% of that capex if it's not maintenance?

    - Historical Average "ROA" (I presume this is Mgmt's term for ROIC) appears designed to specifically mislead investors -- the number doesn't deduct CapEx from the numerator (not even Mgmt's ~$80m "maintenance" CapEx figures); doing so would lower "ROA" to 14% ($240/$1,482), and that's using the fantasy ~$80m maintenance capex figure.

    - Using $190m as Maintenance CapEx drops "ROA" to 8.8% ($130/$1,482). Let's see... 8.8% is a crummy pre-tax ROA... gas stations are a crummy business... so, yeah, that's probably about right for this Company.

    2) CST paid $61m for 29 gas stations in Arkansas immediately prior to the spin-off. Let's see...

    $2.1m per store

    1,900 stores

       $4,000m Implied EV for CornerStore

    Where am I going with this? Hmm, let's go to the next module...

    3) Current CST Valuation

    ~$34/sh

    76m WASO

       $2,600m Equity Value

    $724m Net Debt

       $3,300m Enterprise Value

    $130m Normalized Unlevered FCF

    25x EV / Unlevered FCF

    4% Implied Cap Rate

    Funny how the implied value from CST's most recent M&A (just 9-months prior to the spin) provides a supportive valuation for the current market price.

    File this one under, "Things that make you go 'Hmmm....'"

    4) Valero clinging to a 20% stake, the Fuel Agreement w/ unspecified price ratchets in future years, the hiring of Valero's General Counsel as CEO (how many lawyers do you know run gas stations?), the rented space at Valero's headquarters, the token annual dividend to satisfy investors living in a ZIRP world [cited number from an earlier draft of the Form 10]... everything about this screams, "Dupe Event-Driven Hedge Funds into paying up for a crummy business on the premise that it's an undervalued spin-off."

    5) This is a crummy business. I will buy crummy businesses, but the catch is I will only pay crummy prices.

    I'd be interested at about 30% of the current market price, or $10/sh.


    SubjectRE: Cornerstore-4-Me
    Entry05/26/2013 07:14 AM
    Memberffer
    I don't disagree that this is overvalued, but I would note a couple things. The delta in the capex numbers is remodels/new stores...organic capex. I also think their new store economics will be solid...not because they are good operators etc, but because they are opening stores in the EagleFord. It seems pretty hard to screw that up. 
     
    COTB, have you done much work on their new store prospects?

    SubjectRE: RE: Cornerstore-4-Me
    Entry05/27/2013 10:44 AM
    MemberCOTB
    Thanks for the comments Mencken and ffer.
     
    Mencken - Regarding catalyst, I would point out that the likely miss in 2q13 could be a wake up call for market to realize that eps for the year is tracking closer to $1.60 than $2.25. Note that q2 and q3 are seasonally the strongest quarters of the year (followed by q4, and q1). To hit $2.25, CST needs to do around 85-90c in 2q13 which is unlikely. (There might be some noise from a pro forma standpoint when they report 2q13 which will include one month of data pre spin and two months post spin. So make sure you make appropriate adjustments for public company cost and interest expense on new debt for the full quarters). Some sell side analysts may also initiate on CST and offer a more realistic view of the company, similar to what I have laid out here.
     
    ffer - My post explains why CST will have to spend a significant "organic CapEx" just to keep EBITDA flat or deliver any small growth. The "maintenance" CapEx of $75m is a misnomer. The opportunity in Eagleford isn't as big as generally thought for the following reasons:
    1. CST is adding 23 stores which will hardly move the needle vs a baseline of 1,880 stores (many of which are legacy stores with declining SSS).
    2. Importantly, for the first time since the recent shale boom the number of oil rigs and the amount of CapEx targeting US shales are no longer growing. E&Ps have become more efficient - producing more output with the same number of rigs and rig crews by reducing drilling time for each well and employing strategies such as "pad drilling".
    3. The E&P boom in Eagleford and Texas over the past few years have failed to grow fuel consumption. Texas is doing better than the US overall but still there's no growth. With lower future growth in CapEx (and related employment of rig crews), Texas may soon join the rest of the country in seeing declines in fuel demand.
    4. In any case, I have assumed a 20% EBITDA return on new store CapEx. Susser (100% Texas with a proven QSR concept and more mature stores) is getting 23-25%. So I think 20% for CST is likely generous.

    SubjectRE: RE: Some questions
    Entry05/27/2013 11:10 PM
    MemberCOTB
    Hi JetsFan and everdeen - thanks comments and questions. I was approaching this from a long side originally, so I do appreicate where you're coming from. Below are my responses.
     
    US fuel margins (JetsFan questions 3 and 4)
    - I'm not sure if I should explain the concept of statistical significance and p-value. Please skip if you know this. Basically it's an objective way to measure whether there's likely an underlying relationship between multiple datasets. Imagine a world with two types of basketball players - the good type which always make a free throw, and the bad which makes it only 50% of the time. If a basketball player makes two free throws in a row, you may not readily conclude he's a good shooter (a "bad" shooter still has 25% chance of such a fluke correspondig to a p-value of 0.25). But if he makes say 6 in a row, you would probably conclude he's a good shooter (because such a fluke has only 1.56% probability or a p-value of 0.0156). A lower p-value indicates greater statistical significance and a universally accepted threshold is 0.05. This is the same threshold the FDA uses to evaluate drugs in clinical trials. You ofen see pharma/biotech brags when they have a very low p-value. Conversely, high p-values suggest the seeming relationship may just be fluke. A p-value of 0.5 would be equivanlent to seeing just one successful free throw and conclude that the person is a good player.
    - If fuel margins were indeed a percentage of fuel price like you suggest, we should see low p-values from regressions between fuel prices and margins. A regression based on the data in the past 10 years yield a p-value of 0.31214, 0.42622, 0.65361, and 0.62408 respectively for Q1 to Q4. The results are  abysmal.
    - If fuel margins were indeed a percentage of fuel price like you suggest, we should see low p-values from regressions between fuel prices and margins. A regression based on the data in the past 10 years yield a p-value of 0.31214, 0.42622, 0.65361, and 0.62408 respectively for Q1 to Q4. The results are  abysmal.
    - In contrast, the relationship I indicated produces p-values of 0.04293, 0.00069, 0.00135, 0.000009. All highly statistically significant.
    - My thesis wasn't based on just one data point in 2Q12 like you suggested. It's based on 10 years and 40 quarterly data points of data. Hopefully the sports analogy above resonates with a Jets fan, but If you still don't understand, ask VLO, SUSS, ATD for their views.

    Secular decline (JetsFan questions 5 and 7)

    - My post shows that despite significant economic rebound from 2009 to 2012, fuel demand fell in the US and was flat in PADD3. This contradicts with your view that higher GDP would result in greater fuel demand. The answer lies in the CAFE.
    - The fuel economy standard for passenger vehicles has had NO change from 1990 to 2010 at 27.5 mpg (per NHTSA). GW Bush initiated an increase (effective after his term) and Obama followed through such that the mandated standard rose to 33.3 in 2012 and is set to rise further to 34.2 in 2013 and further to 38.5 in 2016 and 46.5 in 2021. Note that these are final rules which would improve average fuel economy for the entire new car fleet in 2021 similar to a current Prius (50 mpg). Prososed rules contemplate a futher increase to 56.0mpg in 2025. The rising CAFE standards explain why the rear view mirror may not provide an accurate picture of the road ahead.
    - With fewer trips to the gas stations, merchandise sales should be impacted as well. As one would expect, historical data shows some correlation between fuel volume and merchandise sales.
     
    C-store ownership (JetsFan question 6)
    - Not sure if I understand your comment. Conventional retail wisdom would suggets a dollar of earnings from a royalty income from franchisees deserve a higher multiple than the same dollar generated from owned stores.
     
    Acquisition risk (JetsFan question 8).
    - I'm not worried at all especially at valuation anywhere near here. ATD bought SFR NO at below 6x EBITDA and its failed bid for CASY was also under 6x. ATD has been very disclined and will only do deals under 7x. CST is trading at 9.3x on my '13 EBITDA (which I believe is right as opposed to "Street" EBITDA). On the last call ATD also said it will only deals up to $1.5b, less than half of currrent CST EV.
    - Again, you should ask ATD for their views of CST current valuation and asset quality.
     
    Asset quality / valuation (JetsFan questions 1, 2)
    - Not only does CST have worse gross profit mix than public peers, its mix is also worse than industry average per NACS (which includes a large share of single mom-and-pop stores).
    - Please re-read my post on why ATD uniquely trades a premium EBITDA multiple.
    - CST's after-tax unlevered return of 11.3% (pretax EBIT return of 17%) may be interesting if we can buy it near book value. I don't see how buying it when EV is 2.3x of IC is attractive. Basic corporate finance woud suggest EV/IC = ROIC/WACC. Assuming an 8% WACC suggests a fair EV of ~$2.0b, well below current value of over $3b. 
     
    Canada (JetsFan question 1)
    - My thesis does NOT embed any volatility discount for the Canadian fuel business. Nor does it assume that Canadian margins in 2012 were inflated. But I do believe Canada is not growing and is inferior to the merchandise business of public peers which show some growth.
     
    Store size (JetsFan question 9)
    - The stores obviously vary in sizes. I pointed out the opportunity to roll out foodservice in larger/NTI stores, but these represent only 4% of total c-stores. The average does matter and it's hard to make the math work when the average is well below peers.
     

    SubjectRE: RE: RE: Some questions
    Entry05/27/2013 11:16 PM
    MemberCOTB
    Sorry for a few minor typos below...

    SubjectRE: RE: RE: RE: RE: Some questions
    Entry05/28/2013 08:46 AM
    MemberCOTB
    I hate to go over Stats more than I already have, but find a book on regression with dummy variables to capture the impact of seasonality. To put it mildly overlooking the obvious seasonality in the business wouldn't make a lot of sense.
     
    I gather that you're not convinced despite seeing very low p-values but somehow convinced seeing very high p-values. Short of an actual future result, I'm not sure what is needed to convince you one way or another.

    SubjectRE: RE: RE: RE: RE: Some questions
    Entry05/28/2013 09:00 AM
    MemberCOTB
    CST comps have shown small positive growth in fuel volume. The PADD3 pie is not growing (should soon shrink) but within the mix there are share gainers and share losers. US overall is declining but again if you're a good operator and can afford to use low fuel price as a leader then you can comp positiive.

    SubjectUpdated thoughts?
    Entry08/13/2013 11:06 AM
    Memberarcher610
    Any updated thoughts here?
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