CSP Daily News Special Report

Published in CSP Daily News

Sluggish stock prices put chain in the acquisition crosshairs, analysts say

By  Mitch Morrison, Vice President & Group Editor

MONTREAL -- Weak fuel margins among other factors have placed a takeover bull's eye on the back of one of the nation's largest convenience store chains, according to an analyst with Newcrest, the equity division of TD Securities.

In a statement to clients, Michael Van Aelst, an analyst with the Montreal-based firm, said poor performance by Sanford, N.C.-based The Pantry and resulting diminished stock prices have made it a target for purchase by Montreal-based Alimentation Couche-Tard Inc.

Last week, The Pantry reduced guidance [image-nocss] again for its fourth quarter, fiscal 2007 EPS [earnings per share] due to weak fuel margins, pushing its share price down 42% since early July, Van Aelst said in an investor note. Pantry's shares are now trading at only 9.9x forward EPS and 6.0x forward EBITDA [earnings before interest, taxes, depreciation and amortization], implying that the market doesn't have much confidence in guidance. This could make it vulnerable to a takeover by Couche-Tard.

Van Aelst added that The Pantry also appears to have overpaid for some acquisitions and, with high debt levels, rising interest rates are also believed to be hurting results. At these levels, [Couche-Tard] could pay a material premium to acquire [The Pantry's] 1,645 stores and still make the acquisition accretiveassuming consensus estimates/guidance for Pantry are reasonable.

Van Aelst's assessment is based on financial speculation and logic. Financially, The Pantry is more vulnerable than it has in years to an unsolicited offer. If consensus estimates are reasonable, then a deal could be reasonably accretive, he told CSP Daily News in an e-mail interview. But, he added, it depends on whether it meets Couche-Tard's stringent return requirements.

Outside Interest in Industry Growing

Such speculation seems further buoyed by an increased flow of foreign investors and venture capital groups looking increasingly into the c-store arena, as well as the growing number of initial public offerings [IPOs] in recent years in a channel that historical prided itself on privately held, family-based operations. [Read more about outside investment in the c-store channel in the November issue of CSP magazine.]

Pantry CEO Peter Sodini had no comment for this story. What is clear, however, is the retailer, which rolled up its store count through a flurry of acquisitions in the Southeast starting at the end of the 1990s, has struggled in the past year, with its stock hovering around $27 a share, down dramatically from a 52-week high of $62.35.

Adding to the burden is a mixed portfolio, beset with older sites heavily reliant on fuel, acquired during the late 1990s to build up the company's store count and overall equity.

The Pantry's Demise Premature

If anything, however, The Pantry has demonstrated resilience. Earlier this decade, the company's stock value fell below $1 on NASDAQ and widespread speculation persisted that The Pantry would fall the way of its Southeastern compatriots Swifty Serve and Convenience USA, both of which went out of business after years of aggressive acquisitions.

Avi Cohen, an analyst of Veritas Investment Research, Toronto, told CSP Daily News that although he had not heard of any actual movement by Couche-Tard to acquire The Pantry, he felt such an acquisitionof one established c-store chain by another similarly established chainwould be complicated because of divergent corporate cultures.

What tends to happen in this industry, Cohen said, is that investors get excited when chains make big acquisitions. Expectations get built into the stock price based upon continuing acquisitions and increased synergies, Cohen said. Well, that's not always the case. Sometimes integration takes longer than expected. I think the growth through acquisition model' does make sense for c-stores, but sometimes the stock market gets a little ahead of itself.

So, while the recent deal of Susser Holdings acquiring Town & Country was applauded as an acquisition of complementary markets and cultures, such a union between The Pantry and Couche-Tard is less certain.

Still, rumors of a Couche-Tard/The Pantry deal is not new. Just last year, analyst Anthony Zicha of Scotia Capital said The Pantry would be a comfortable fit for Couche-Tard.

Strategically, it makes sense for Couche-Tard to look hard at The Pantry as a valid target for acquisitions, Zicha said in the June 2006 issue of CSP magazine. One of the advantages would be very little overlap between the two. It would basically fill in the area where they're not presently in and provide a critical mass for the company.

More recently, Zicha said that a growing c-store count and subsequent increases in real-estate prices are making near-term consolidations less likely. However in a newsletter to clients released in early October, he said the weakening U.S. dollar may in the long term make purchases here more attractive.

In that October newsletter, Zicha boldly said any number of prominent U.S. chains are targets, naming The Pantry; Ankeny, Iowa-based Casey's; and the c-store assets of Hutchinson, Kan.-based supermarket chain Kroger. He suggested such a purchase would occur within the next two years.

Agreeing with other analysts in some ways and disagreeing with others, Zicha said, We believe [Couche-Tard's] potential acquisitions are less likely to be affiliated with large oil companies and more likely to include chains in which the bulk are company operated."

Attempts to contact Zicha for comment for this story were unsuccessful because he was traveling.

Other Avenues for Couche-Tard

As for Van Aelst, his opinions in some ways concur with Zicha's, but in other ways conflict. Van Aelst saw additional buying opportunities for Couche-Tard, predicting it could open its wallet for more Shell-branded sites. Since 2005, Houston-based Shell has transitioned retail sites to wholesalers in many markets and has now said that it will sell its remaining 2,000 corporate-owned sites before 2010.

In our opinion, [Couche-Tard] would at the least be interested in the remaining Illinois, Florida and California sites, he noted. If there are enough sites in markets new to Couche-Tard to give it scale, we believe they would be of interest as well. Couche-Tard has already acquired about a third of the Shell stores divested to date, so we would have to believe that it is well positioned for the next round. This is particularly true for some of the stores in Chicago where [Couche-Tard] has been managing 31 of them as a test since August of 2006.

Moreover, Couche-Tard has an advantage in that it still has many unbranded sites that it could sign long-term supply contracts with Shell as part of a transaction, Van Aelst said. He added that it is unclear how many of the remaining 2,000 stores are company-operated vs. third-party operated. Company-operated stores are typically integrated into [Couche-Tard's] network quicker than third-party-operated stores, as was evident from its December 2006 acquisition of 236 stores from Shell.

By Mitch Morrison, Vice President & Group Editor
View More Articles By Mitch Morrison