No Margin for Error

Faced with high debt and mounting competition, The Pantry forges a new strategy‐again.

By
Mitch Morrison, Vice President & Group Editor

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Hedging Nightmare

While The Pantry continues to feel out new growth opportunities inside the store, on the forecourt it is finally, it hopes, gaining traction after a rough stretch. Only five years ago, The Pantry broke from the shackles of terms and fixed contracts, embracing an aggressive hedging strategy that sought to capitalize on volatility and deliver to the company extra pennies of pure profit for every gallon sold. And for a company pumping millions of gallons monthly, pennies quickly translated into thousands of dollars and, over time, into seven-digit profits.

But in 2008, The Pantry reported a net loss of $5.1 million for its second quarter. It blamed the flood of red ink on gasoline hedging positions. In somber tones, the company said it would halt acquisitions and close out its gasoline hedges.

“Sodini had such an unpleasant experience in hedging that they’ve never overcome it,” an oil expert says of then-CEO Pete Sodini, who took a modest local chain and turned it into the largest independent convenience retailer in the Southeast.“They’ve been much more traditional ever since, buying rack, entering contracts.”

This conservative approach, he says, has its drawbacks. “What’s challenging for them today is that companies like QuikTrip and RaceTrac have traders on their staffs,” said the expert, who spoke on condition of anonymity. “Those companies are aggressive and trying to gain every cent of profit they can. The Pantry isn’t doing that; they’re not leveraging the buying power they have to take advantage of volatility in the market.”

Another oil expert familiar with The Pantry agrees: “I’ve watched the Pantry since they really started sprouting and growing. For a while I thought they were cutting their teeth and trying to figure out fuels. But the last few years have been a real struggle for them.”This source estimates that 98% of The Pantry’s business is on a fixed contract.“They may have upper and lower ceilings with Marathon and Valero, but in this day and age you cannot commit 98% to contract,” the source says. “It would have to be one flippin’ sweet deal.”

Why are such contracts undercutting The Pantry? What’s wrong with predictability?“If they got a chunk of stores and this chunk of volume is tied to one index, they’re stuck,” the source says. “Their competition, like QuikTrip and Sheetz, are very aggressive and very flexible. It leaves The Pantry with no margin for error.”

Hatchell confirms that hedging is not in The Pantry’s future—“Not as long as I’m breathing,” he quips—but says there are opportunities in streamlining supply logistics. “If we sell from in-ground out to the tank, what do we do about in-ground back to supply? It’s more than just pick it up and deliver it all of the time. There airtimes to pick up more and times to pick up less. There are things to be done there that don’t have anything to do with hedging.”

For the past few years, The Pantry has-been gathering data from its KSS fuel price optimization software, which has helped it begin to understand how the markets are flexing and where it’s moving, and to get cents per gallon stabilized. The company is just beginning to realize the potential of that technology.

“Now we’ve got to track over what we got in prior years,” says Hatchell. “We have good weeks and bad weeks, depending on what happened in prior years, and we’re just holding our nose and getting past that.”

On the brand side, The Pantry now sells Marathon, Valero, BP and its own private label, which puts fuel in sync with the localization push inside the stores, he says. The next step will be encouraging customers drawn to the pump to also walk inside.

“We’ve got to grow the inside of outbox and reduce our reliance on fuel margins, so we can just enjoy them as they are, and manage those as best we can with price optimization,” says Hatchell. “We don’t want the pendulum swinging really wide back and forth on prices, so we want to move it a little bit and make fuel be attractive ... and get customers in here.”

Seeking Leverage

Back in late 2010, then-senior vice president Fisher told CSP, “Quite frankly, we’re not sure what the Kangaroo is yet.”That is, what did the brand mean?

Two and a half years later, a new team seems to have a better idea.

“I think they know who they want to be,” says Hunt of Wells Fargo. “There’s definitely the opportunity to raise the bar in terms of foodservice and margin capabilities throughout the chain because of initiatives that will be rolled out overtime. … We think that there’s a lot of upside to the business, and you’re just starting to see the initiatives in some of the stores play out.”

Despite the new competition, Hatchell and his team seem confident that if they trust in the customer, everything else will fall into place. “If we put well trained people who are energized in those stores, and give them products that pertain to their local neighborhoods, because the stores are there, I think that’s a really big competitive advantage for us,” Hatchell says. “We’re not sourcing sites. We’re deploying a lot of capital in remodeling these stores, replacing them or building new stores within the network we have, up to and including acquiring stores if they’re there. So the whole thing is laid out.”

The Pantry has a goal of remodeling 10% of its stores annually over the next five years, boasting the upgrading of 200 sites since Hatchell took the reins. What many consider a major impediment—The Pantry’s diverse portfolio—Hatchel sees as a strength.

But analysts and observers, from within the convenience channel and on Wall Street, aren’t certain. An industry respected financial expert cites The Pantry’s skewed debt-to-equity ratio, which is substantially higher than other publicly traded convenience chains, such as Casey’s and Alimentation Couche-Tard. The Pantry’s portfolio girth is undercut by its lack of capital ownership, he says.

“They only own about 300 of the sites, and the rest is leased. So there really isn’t much to leverage,” he says. “This company is crying to be taken out of public. There is no dominant shareholder to help right their course, and there is too much debt and not enough hard assets to support a takeover or [acquisition].”The veteran c-store expert quoted earlier wants to see more from The Pantry’s executive leadership before he’s convinced of a successful turnaround: “To say you’re going to remodel 10% of your stores a year? That’s what any respectable business does. How is that going to put them in a position to compete against better models like QuikTrip and Sheetz in the Carolinas, and Wawa and Thornton’s in Florida?”Hunt of Wells Fargo is less concerned. From his view, debt to cash flow or debt to EBITDA are the more critical numbers. And, as others point out, the company’s units are cash positive.

“If you look at their leverage ratio, while it is high relative to management’s desires, they still are in the position even with a heightened cap-ex number for remodels and other initiatives to generate fairly substantial free cash flow,” he says. He estimates the chain will generate free cash flow of $35 million in 2013, which is about 3.5% of debt—a good number, although “not extraordinarily healthy.”

That, added to what is already slated, would give the company the capability to build 10 to 15 new stores. Hunt expects The Pantry to accelerate its new store opening program after 2014, adding, “Going from zero, anything’s an acceleration.”

Hatchell accepts the hand he’s been dealt. He waxes philosophical when asked about the long-term debt and the company’s assets, citing that as property leases expire The Pantry is assessing whether to divest the site, remodel or raze and rebuild.

“I think the healthiest thing you can do is focus on what you’ve got,” he says. Any consideration of taking the company private—which experts suggest would be cost-prohibitive—is simply not part of the board’s plan, he says.

Rather, as observers debate and predict the future of the chain, Hatchell sees only one direction: forward.

“The Pantry is what The Pantry is, and let’s just run the fire out of it,” he says.“Private companies have their own issues, and public companies have their own issues. The Pantry is The Pantry: We’re just doing the best job we can.”


At a Glance: The Pantry

Headquarters: Cary, N.C.

Store Count: 1,571 (as of Feb. 5, 2013)in 13 states

Employees: About 6,000

Key Profi t Drivers: QSRs/Foodservice in more than 200 sites, car washes in more than 200 sites, fuel at all locations

Top Three Categories: Cigarettes packaged beverages, alcohol beverages

Hot Growth Categories: E-cigarettes, energy drinks, cold/frozen dispensed beverages,publications

Capital Investments: Remodeled more than 200 stores, investments in fresh foodservice and Lifestyles Initiative


The Pantry’s Key Financials

Total annual revenue (2012): $8.3 billion

Net loss: $3.1 million

Fuel gross profit: $48.9 million, up $5.1 million from a year ago

Cents-per-gallon margin: 11 CPG after credit-card fees

Comparable store merchandise revenue (including cigarettes):+2.2%

Comparable store merchandise revenue (excluding cigarettes):+4.6%

Long-term debt: Approximately $500 million (down $200 million since December 2011)

Cash on hand: $24.4 million, with nearly $130 million available via revolving credit facility

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