Casey’s General Stores: Fueling Convenience - [Business Breakdowns, EP.125]

24:24So on the margin side, generally they can probably get an incremental one, two, three percent of added margin growth there. So EBITDA margins can grow 8 to 10 % if they can give that sales growth growing. Where is it today? You got an average margin around between 6 and 6 .5%, which from a retailing perspective is quite attractive. I think traditional retailers, or I'm talking like food retailers and so forth, if you're making margins anywhere between 2, 3 or 4%, it's great. So this is higher on this. And then that margin growth going forward, the idea is that as you sell more grocery and particularly prepared food, you should grow that margin up as well.

25:03Few margins have been actually pretty decent. The other bit that's played into few margins is you're seeing specializing You put it up at the gas station, you generally see there's three options available. People are driving larger SUVs, higher end premium cars. It's recommended that you buy the premium fuel. You added difference from 87x295. There is a lot then, you get the margin expands quite nicely. That's a very, very nice business. But the key for them is you're going to have to pull into gas up anyway. So why are you there? Why not go in and spend some nice money inside? Keep in mind that the average ticket size when you walk into these stores, if you don't by the prepared food is anywhere between six to seven eight nine ten dollars And then if you do pick up added food you're talking about another five to ten maybe the pizza twenty and that gives you an idea of the Average spend when you're going yet.

25:49So I think those margins generally can move up to higher single digit range over time combination of sales growth mid single digit some margin and enhancement you're looking at an EPS growth in the low single digits and And with the fuel business, I'm just curious about the dynamics there in terms of getting fuel supply and the suppliers of fuel and the ability to adjust pricing on the actual gasoline in unison with that. So do they ever have quarters where they're stuck basically in between where they've got extra supply of fuel and they're offloading that old inventory at cheaper prices and buying new fuel at higher prices, does that ever create any cyclical dynamics or is it simply a pass -through mechanism for them?

26:35With a lot of these guys, they don't actually store their own fuel, so they'll buy from the fuel wholesalers, where they do have their logistics more than half their fuel they provide on their own big trucks that they deliver. Again, that plays into cases versus some of the other peers, this is this big emphasis on controlling as much of the logistics chain as you can without actually owning the underlying commodity. That also has benefits in that they are more of a bulk buyer as well from scale, there would be some benefits from this. Generally with pricing, and this is the interesting bit as well, and this comes back to the technology investment as well.

27:05As you remember, if you think of the old -school forecourt, you pull in, and the guy every morning would be getting up on the ladder, changing the stickers for the price and so forth, and a lot of that's now changed to digital pricing. So if you pull into a lot of modern forecourt, now the pricing which is shown can actually become more dynamic during the day, and what they do is a combination using data technology to monitor what nearby pricing is doing and will adjust their pricing accordingly. Now again, they're not specifically driving the price of gas that they'll have to sell in their local corner or square or town where they're selling.

27:35That tends to be determined by the guy who has the highest cost and needs to cover those costs. Then which tends to be the smaller players. What they are doing is if you are really focused on gas price, they could be marginally less or they could be matching it. But then as you look at the two four courts, you're like, okay, that one's only got two gas areas, it looks a bit messy, doesn't look like it has a bar from, and I'm kind of feeling kind of hungry. And then across the street it is this beautiful, shiny, nice, clean lots of lights, lots of areas you can park. Oh, it looks like some people having coffee, and I know I can get some food there.

28:07That's the immediate sort of two -second decision you'll make and you'll pull it. And then once you've been in once, you know it. And so when you see the next cases, you're probably going to pull in again. And again, generally safety when you're pulling into a gas station, particularly late at night, or early in the morning is a key factor. So particularly women drivers feel more comfortable going into a larger chain. If you're with a kid, you feel more comfortable going to larger chains. Yep, if it's 1am and I need to use a bathroom, I'm going to have to use a key. It's going to be a no for me.

28:36And I'm willing to pay more than an extra penny or two for the gas as well. That's an easy way for me to make the decision. When you start thinking about the growth strategy, You mentioned a little bit in terms of the opportunity based on a little of the just -expresence. How do they go about that in terms of expansion and going into new territories? It sounds like it's still very geographical base where they feel like they haven't saturated the markets that they're in. Are there opportunities to expand into other states? Or is it mostly just focusing on their core markets and getting more penetrated there?

29:09Right now, the business originally are centered around Illinois, and then they expanded into sort of the ancillary states. What they like to do is look at their distribution centers because this is really what they're leveraging on the operating leverage side of the business. You draw a circle of 500 miles from which logistically makes sense to operate. So actually yesterday they announced an acquisition of some 60 stores is a telemetry Tennessee based operator. Because of the nature of its ancillary and geographically next door is people who had been maybe driving one part will see cases and they know it and so it becomes the network effect of oh another cases opened up in the area and then it becomes a word of mouth thing as well.

29:50So that's generally how they're expanding right now they seem very happy with this Midwestern area. It's an area where the competition is slightly less from the national chains. Why because I mentioned there's a lot more smaller towns but you do have significant traffic going through in terms of freeways and highways. Where most of their competition in these mid -sized area tends to be is from traditional QSRs like domino pizza chains, the other fast food chains as well. You do have supermarket chains which have started to offer their own version of convenience as well. And then you have the dollar stores which also cater to a significant part of this population.

30:23But again, the key leverage there is this idea of the fresh and the other stuff and then also the branded private label whether it's the drinks and other bits and pieces. For now, they're happy in their expansion areas. I think we'll see more and more of this move. If I'm looking at their scatter map right now, really adding it probably we will see more and more in the Southwestern area as well. And what you do have is you have these regional chains which tend to dominate this area. So for instance, Wawa will dominate the Jersey area. You go down to Pennsylvania, you'll see a lot of the sheets.

30:52Wawa has been expanding further south. I think you go to Florida, particularly there's a big falling of Wawa down there as well. These are regional players. And as I mentioned from a market share perspective, they're still relatively small. Do they go national at some sort of footprint? We'll see. There are certain states where it's not as attractive to do business. So if you speak to the larger players like Sok OK, California, because of particularly onerous regulations, is not an area where gas chains really want to expand in a big way. Since the pandemic, we've seen a change of where people are looking to live in terms of cost of living, and that tends to play into areas where they are.

31:25To give you an idea, they give the statut their recent investor meeting. They operate in 10 of the 20th cheapest cost of living states in the United States. The average salary of the customer is in 50 to 60 ,000 dollars a year range, which when you come from the big city, South, low, but the cost of living in these areas is very, very attractive. That's attracting more and more people to live, but also you're seeing more and more industry moving to areas where the cheaper costs are living. So they tend to be in growth markets in terms of states of demographics, because these are more rural, it's a place where you still need a car to get around.

31:59And then if you think about just the nature of there's a lot more driving, your car is needed to get around, and so you're driving more. So it's one of those stories where you have to go visit and see it, because when you're sitting in an office in New York and you think about your daily lifestyle, this is very, very different. My favorite type of business for sure. With the expansion and the decision to acquire in retrofit versus new build, how hard is it to build a new gas station? I imagine there's a lot when it comes to the environmental dynamics on top of not in my backyard. But is it even achievable to grow that the way they want to grow without acquiring existing stores?

32:37The growth profile there putting out is on average They're looking to grow their footprint anywhere between a hundred to 120 stores a year and that's of a base of 2500 on the acquisition side They're looking for about half of that to come from acquisition and half from new bill now again It's very hard to know when these portfolios become available So for instance the 60 stores in Tennessee was a larger smaller medium enterprise Most often when they're dealing with the smaller players, you're looking at between five and ten stores. And then occasionally you'll see some of the larger oil and gas companies decide to get rid of a portfolio in a certain area because it doesn't make any sense for them.

33:13Ideally, there are benefits from a new build because you can start fresh and do so forth. But then at the same time, coming back to your point about Nimby, factors the number of actual gas stations available hasn't really grown in recent years. because even if people need them, the facts is most people don't want it nearby. So generally newer bills tend to be when you find newer developments, they'll be one built. But mostly in existing areas and towns, it's about coming in and buying that footprint. Now, that's both a pro and a con. It's a pro and the sense that if you get that piece of real estate, it's very valuable.

33:45It's unlikely, if you're particularly in a more denser area, that someone's going to be able to rock up across the street and build a new one just doesn't happen. So that's the value of the real estate over time as these towns grow and develop becomes even more valuable. And remember the NIMBY factory is not just gas, but also two of the key products they sell in their stores are cigarettes or anything related to smoking and then liquor. Some would argue these are sin products, but a lot of not in my backyard products become available and that also creates a captive audience where you know it's one of the few places you can go and where you can get it.

34:18I think I already know the answer as to why they don't franchise their stores and many of the benefits that they're getting from operating themselves having this larger and larger ecosystem. But when you look at them versus the competitors that do franchise, is this something that ever comes up in terms of investor conversations with the management team? What's the thought process behind that and the pros and cons to it? Right now, no, who knows down the road? Maybe franchising allows you to expand a lot quicker. generally though from a quality control perspective it can be harder to manage because their own is is driving the growth of the business particularly on the margin side from the kitchen and the fresh controlling that I think is important to ensure that pizza they're selling where there's a store in Iowa to the one in Tennessee has the same level of quality and product and because they've decided to take this approach of having their own distribution center as a driver of operating leverage of the business and controlling the business over time, but who's them to keep that control?

35:17And I think they would argue the flexibility gives them in terms of how they can decide on the fresh product they offer and the changes they need to do is beneficial versus that attraction or just ramping revenue through franchising. So I don't see it happening. Generally, I've also found that if I look at companies like cases like Huawei, like sheets, people do like 7 .11, don't get me wrong, there's the slushy there that everyone likes and so forth. But for the product in terms of all the food, that brand awareness, that brand loyalty, tends to be these companies that own their real estate, which is exactly what those other two do as well.

35:53And it's something which we're seeing, for instance, the other big player, which is Circle K, Kushtard, one of their policies which changed has been towards trying to own more and more of the real estate as well. And that also gives you other options. One thing which is new and growing is this idea of the automatic car wash. to go to Europe, it's very, very popular. When I was a kid, I used to make some extra money going washing cars on the street, right? You take your bucket. You can't do that in certain places now. Why? Because as EPA rules about what water goes into the drains, chemicals and so forth.

36:21So one of the replacements of that is you pull up and there's an automatic car wash. And these things are fully run. There used to be lots of people, lots of labor, now it's automatic. And you'll see this as some gas station that you pull in and they'll say, by the way, you're filling out, would you like a discount on doing the car wash? Which takes you another five minutes. it's you get it done and dust it. And so owning your land and the ability to say I'm going to invest that money in your solid there is very different to where you're leasing. So it's a long winded answer to get your point, but I think specific to cases, the emphasis on the kitchen side of things, the freshness and leveraging their distribution centers probably means the franchising side is not there today.

36:56No, it's really interesting. I thought they had one stop shop covered with food and gas, but then you had something like the car wash in there as well and it just keeps giving you more options. There's other things in there. Think about the Amazon pickup lockers. You're not just pulling up to get your gas to pick up the pizza. I'll just go pick up my e -commerce order and by the way I got the car wash all done within 20 minutes by the way. Something which if you add it all together would be maybe a two -hour event gives you time to do a lot of other things. Do they ever have storage clothes? Is there a much churn on the actual store base?

37:25With these guys less so, they're still in expansion mode. What they'll often do sometimes is if they have two smaller stores and they get the space to do a bigger one, they'll maybe close to to move to another one for the most part of these incremental growth. And then sometimes in acquisitions, and it does happen as you get benzer in certain areas, say you buy a portfolio of 60, five or six of those you may dispose because it doesn't make any sense. But for the most part, this is an additive growth. We're not seeing a significant amount of disposal. And I think we've talked a little bit about their own acquisition potential.

37:57But in terms of their attractiveness to another buyer, is that anything that comes up because I could see a case for owning several regional players and getting some of the benefits from the cost perspective. Is that something that gets brought up much? Absolutely. The reason I love talking about this company is since we've been invested in it, I've seen it grow very, very nicely both in terms of the revenues, the earnings power, the offer, the management has come through very nicely. We can talk about that later, but the change of management really drove added growth potential for the group as well, which I think was a very smart decision.

38:27This company was approached for acquisition by both 7 -11 and Circle K, Baron Kuchtard, back in 2010, for the specific reason that they have this very strong presence in some of these key growth states, it was rejected by the management of the time, could us to them. This is when the company was only at about a thousand stores. Since then, they've two and a half, they'll be on the track to more than trouble the size of that business over the next few years, and done very well in terms of valuation of the company. There are benefits of acquisition in this space, it's heavily fragmented. Also, the nature of the synergies once you put smaller chains into larger chains can be quite attractive.

39:04So deals in the space generally are done for anywhere between 14, 15, 16, 17 times EBITDA. But the synergies from larger deals and we've seen this elsewhere can generally take maybe three to four points off that very quickly. The nice thing about this business is this is an nature of the product you're selling. The cash conversion rate is very fast and high. So the ability to deliver quickly and free cash flow perspectives is also very, very attractive. So very often you see deals happen, the average bumps up comes down very, very quickly. Because you're not sitting on a lot of long term working capital product.

39:34Everything is consumed within a very short period of time. There's no serial sitting on the shelf for several weeks. And just the ability to lever back office technology and so forth makes this very, very attractive. Some of the other larger payers, they would have to pay up for it. Though this is a very good business. And the one thing they do, which others are copying, is this idea of the emphasis on fresh. And I think this is something we'll see others wanting to learn from the casey side, the story on the pizza thing is pretty phenomenal. You referenced the multiple range, that you said 12 to 14 times EBITDA, is that 10 to 12 or 12 to 14, is that the multiple range that cases and some of the peers are trading at?

40:13In the case of cases there are about a sort of nine to 10 times, that's on forward numbers. I think paying up to anywhere between 12, 13 times is pretty fair given the growth potential they have. Generally when you get above the 14 times, you start to price in a bit of the acquisition option. This is also a company by the way, as I mentioned, as they're gaining scale, it's also still small right now. I mean, I think the different yield is less than 1%. But they have put in place, and particularly under this new management since 2019, the idea of actually growing and I stated dividend as well. So they wanna become a bit of a dividend story play going forward, they're very under -levered, generally, or recashed.

40:51So they've been doing some buy -backs racing as well, but most of the focus here is this idea of becoming a dividend story over time as well. It sounds like they're still investing in the store growth, which I'm sure e -tap a lot of the capital budget and free cash flow. Is there an inflection point where that starts to transition more towards returning that capital to shareholders? Right now it's a good balance between the both. They found themselves in a situation where they're very under -level relative. I mean, it's the type of business that can easily carry two to two and a half times leverage.

41:18If they have to do a large yield, maybe three times. Right now they're running it about one -ish. And part of that is the scale of the company. Like I said, they've added 1 ,500 stores in the last 10 plus years, really grown the business. And I think they will see them adding maybe 1 ,000 stores in the next few years as well. And there's significant free cash flow generation because of the nature of the model. But I think the fact that they've talked about this different policy, that different and probably grows fast of the earnings over time. I think they can balance both. I just want to come back to the manager because in 2018 -19 there was a change of management.

41:49This tradition was run by very much the same management that had been there. And remember, the company had changed. It had been really a six seven state business, which was now in 16 states, gone from one these distribution centers, three distribution centers, much larger footprint. They took the decision to look outside the business for senior management. And the CEO himself actually was originally 7 .11. He also operated International House of Pancakes, I hope. And so was good pedigree. Yeah, good pedigree. You knew one of the bigger competitors. But also remember this emphasis on food and almost restaurant grocery style offering and he really also brought a lot of the emphasis on spending on the technology side Why because he'd seen this at larger chains and how that could drive productivity But also give management a better understanding of what's really selling well and become faster to responding to demands He came in and brought a bunch of other people from other various industry Experience including FinTech and technology side of things.

42:43There's other other added avenues which I think they're considering down the road, the idea of a loyalty card, but also maybe some sort of digital wallet. And then also with the loyalty card, it can start sending you bundle offers. So every time you buy five pizzas, get the six one for free, or if you fill up a certain amount of gas, you'll get the pizza thrown in for free and so forth. That's something which is still early stage right now. And I think they will look to grow and add. I think that plays on the experience of the new management they're bringing in. from an ESG perspective, which become more important.

43:14I think this will be their third year of reporting in ESG report. They're really working on everything on that side of things. They have a lot of senior management who are women in their area. And keep in mind that background of cases was most of their store staff were women and these women have grown through the management sites. We always think small, mid -American company, this must be a very male dominated. It's actually a very diverse group of managers. What do you see as the key risks for this business and ask another way when do convenience stores have hiccups when they do operationally?

43:44On an area which is going to be interesting is the shift to electric vehicles. This is government policy, this is just consumer habit is moving this way, will become a bigger pie of the overall transportation fleet. It's not going to happen overnight. I know there are ambitious targets set by the White House, but the fact is go to the car companies and so forth between logistics of actually building them, getting the stuff, but also charging stations is it going to be a problem, but if we look 10 years from now, it's something they have, and they are preparing for this. So the evidence we've seen in terms of convenience stores and electric vehicles, probably the best market from a developed market perspective is Norway.

44:19So if you go to Norway, I think more than half car sales are now EVs, it's very heavily subsidized by the government and there's a lot of things that go into it, but there's a market where EV penetration of vehicle sales is pretty high. The company that has the most data on this has been and Kush -Tard who owns Circle K. What they've seen is actually, you do have this issue about, yeah, people can power up their eaves at home, but a lot of people forget to do it overnight. It takes a lot of time. If you wanna go for the supercharger, again, you do get an imbi effect. It's very hard for most people to put a supercharger in their house because of transmission and wires on there.

44:53Most gas stations tend to find themselves at the intersection of areas in town, where there's also power cables coming over and so forth. So the area where no one wants to be happens to have most of the resources you need. Well, they found as people pull in generally most EVs today just charge correctly. The supercharge will be a 15 20 mini event. They're finding these people are going in having a couple of cappuccinos buying a few products. You're there anyway. You know you're not going to sit in the car. You go in the average ticket spend is a bit higher. Now, the data is a bit incorrect in that most people who have the EVs today, I would argue, are probably of a higher income cohort.

45:30So it probably isn't fully reflective of mainstream spending, but the early evidence is fairly positive. And specifically to cases, they gave data at their last investor day where they talked about less than 1 % of the customer base AC traffic coming into their stores, they believe are EV related. And that's mostly in their Chicago area stores. It's a threat to be aware of. It's still early though, because you and I have this podcast 10 years from now the bulk of the fleet out there will still be internal combustion engine. And if you go out to the Midwest area, they operate, it's trucks, it's big SUVs.

46:05You're not seeing a lot of tezzas driving around. As far as the sea storm format, any further regulation on cigarettes and liquor, they are two areas where they do sell. Generally, they don't count on cigarettes being a growth area, but you are seeing this shift to vaping systems and so forth. Then the factors there are still a lot of people out there who smoke. So unless that is banned and we go to prohibition, America's had I've never seen that in my profession before, so never rule anything out. That would impact sales, but right now I don't see any of that coming down the horizon. This has been an excellent conversation and I've learned way more than I expected to in terms of all the different dynamics on this business.

46:40What do you think the main lessons are that you can pull away from cases and maybe apply elsewhere when you're thinking about investing framework? So something we look for very much in all our calls, your growth investments is the ability to develop a product which has branding power because branding brings loyalty and trust. That generally means there's something there that can be priced different to a commodity product and the ability to play into a structural growth theme. So in this case, convenience and also the fact is bundling a lot of convenience factors together. Finally, the ability to generate decent cash flow so you can reinvest in the business.

47:14So in this case, in distribution centers, technology and improving the product range to have a growth runway, which is very, very attractive. In the case of cases, you speak to anyone you enjoy from the USA, say cases, and they're like, oh, cases, love cases. And that plays very nicely, just like you mentioned about your wallow experience. Excellent. Thank you very much, Marcus. This has been an excellent conversation. I've enjoyed it very much. I appreciate you joining us. Yeah, thank you for your time. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna or to sign up for our weekly summary, check out joinkolasis .com.

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