Murphy USA (MUSA) first caught my attention after Southeastern Asset Management acquired a massive stake ($668mm) in its former parent company Murphy Oil Corporation (MUR) in Q1 2013. One thing about Murphy Oil Corporation I noticed after an initial glance through their 10-K and annual report was its ownership of a valuable fuel and convenience retailer segment with high ROIC, valuable real estate, low CAPEX requirements, and relatively decent growth prospects that was under-followed and whose underlying value was concealed by the parent company's core production and exploration business.
Fast forward several months and Murphy USA now trades independently after being spun-off Murphy Oil on August 30, 2013. It is my opinion that Murphy Oil's primary reason for spinning off its retail division was to create disparity in valuation between itself and Murphy USA. Since its independence, the stock has witnessed heavy insider buying and no insider selling, which provided me with a legitimate warrant to look further into the Company's SEC filings and presentation.
Currently, Murphy USA only trades at 6.6x TTM adjusted EBITDA. Normally, a company trading at a low EV/EBITDA ratio either a) are very overleveraged, or b) have unsustainable EBITDA levels. Murphy USA exhibits neither characteristic. I believe not only that Murphy USA's current EBITDA level is sustainable, but that the Company has tremendous opportunities for organic growth in the next 3 years following potentially stagnate EBITDA levels from 2013 to 2014.
The reasons for a low valuation:
1. Indiscriminate selling partially offset by insiders purchasing: Institutions owned parent company Murphy Oil Corporation for its production and exploration business, not its fuel retailer, subsequently causing institutional investors to flood the market with "undesired" shares of Murphy USA.
2. Lack of complete analyst coverage/information: My personal broker, Fidelity, only had one incomplete research report available on Murphy USA as of 9/9/13. The limited supply of available information coupled with the Company's small market capitalization ($1.86bn) are most likely the prime culprits.
Headquartered in El Dorado, Arkansas, Murphy USA's core business segment is a motor fuel and convenience merchandise retailer, operating 1,179 locations as of June 30, 2013 (~90% locations owned) in 23 states throughout the South and Midwest areas of the United States.
A valuable and unreproducible intangible asset the Company possesses is their partnership with Wal-Mart, whom Murphy USA has had a working relationship with since its inception in 1997. The majority of the Company's retail locations are strategically placed adjacent to a Wal-Mart. Murphy USA's retail stations participate in the Wal-Mart discount program, offering cents-off per gallon purchased for fuel when using specific payment methods. The Company's product offerings (cheaper fuel on a price per gallon basis relative to its peers and low-priced convenience goods) primarily target the Wal-Mart shopper demographic of low-to-mid income individuals and families; thus, the pair create an effective synergy structured around convenience and low prices. The Company will continue to grow organically with Wal-Mart, as the vast majority of new locations will be situated adjacent to a Wal-Mart store.
Retail Units: Murphy USA's retail gasoline stations operate at lower CAPEX and maintenance levels and operating costs relative to its peers.
CAPEX (avg. per site)
Operating Expense (avg. per store)
This is driven by the fact that Murphy USA locations are 208 and 1200 sq. Ft. kiosks, which requires only one or two on-site employees, no rent expense (as the vast majority of locations are owned), and have a smaller store footprint than its competitors. These attributes give the Company a valuable scalability advantage over its peers. With its "Kiosk model," it cost Murphy USA $2.15mm to open a new site, selling 278K gallons of fuel per month and $4,744 of merchandise per square foot annually vs. the industry average of $3.22mm to open a new site, selling 124K gallons per month and $547 merchandise sales per square foot annually.
Supply Chain: Murphy USA has a broad supply-chain of proprietary and third-party fuel terminals. Its "Best Buy" method of dispatching third-party tanker trucks to the most favorably priced terminal to load products for each Murphy USA site reduces fuel product costs. The Company's supply-chain allows it to price its fuel at a lower price than its competitors while still maintaining fuel margins.
Andrew Clyde, a former managing partner at Booz & Company's global energy practice, was appointed President and CEO of the new company. Mr. Clyde has over 20+ years of consulting experience focusing on the downstream value chain, gasoline, and convenience retailing. Despite not being an organically grown executive, Mr. Clyde has been intimately involved with Murphy USA's operations for several years according to Steven Cossé, President and CEO of Murphy Oil Corporation. Mr. Clyde has been providing advice to Murphy's U.S. retail business and leading the development of the unit's future business strategy. Mr. Clyde recently purchased 4,000 shares of Murphy USA, aligning his interests with shareholders.
Murphy USA's executives performance compensation equates to around 40-50% of their respective base salary. The Company's Chairman of the Board, Robert Madison Murphy, owns $47.5mm worth of Murphy USA stock.
In addition to its fuel retail segment, the Company also owns and operates two ethanol production facilities in Hankinson, North Dakota and Hereford, Texas. Management has indicated a likelihood of a potential divestiture of the Company's ethanol production business in order to shift their focus primarily towards its core retail business. A divestiture would benefit Murphy USA by stabilizing earnings and margins, as well as allowing management to better focus on its core retail business. The segment recorded an $84mm impairment expense in 2012 as a result of ethanol sales prices falling and corn prices rising. A divestiture would result in earnings and margins less subject to fluctuating commodity prices (Both ethanol and corn prices affect this segment).
Any given stock's value is generally governed by 4 variables: Return on invested capital ("ROIC"), revenue growth, capital structure, and expectations. On an EV/EBITDA basis, Murphy USA trades below the industry average of 8.5x despite higher ROIC (~13.4% vs.~8% industry average), better growth prospects, and a more attractive capital structure.
EV = $1,860mm Market Cap + $650mm Debt - $100mm Cash = $2,410mm
TTM EBITDA = $359
ROIC = TTM NOPLAT/Invested Capital = 171/1,274 =13.4% (Relatively low when compared to historical rates of ROIC)
Murphy USA should conservatively trade at 8.0x EBITDA given its growth prospects, higher ROIC, and capital structure relative to its peers. The reason why I decided not to assign Murphy USA the industry average multiple is due to the fact I believe current EBITDA levels are slightly elevated by a temporary source of revenue which I will go into further details later. Trading at 8.0x EBITDA implies a valuation of $49.64 per share (~27% upside).
The Company's business model (low cost operator, small store format, low cost provider of goods, strategic placement adjacent to Wal-Mart stores, supply-chain optionality) and robust balance sheet (~90% of retail locations are owned, providing substantial collateral if debt financing is necessary for growth) will allow them to scale effectively. As Murphy USA only operates in 23 states, with there being roughly one Murphy USA retailer per every four Wal-Mart stores, the Company has ample room to expand its geographical presence.
Over the past five years under Murphy Oil Corporation, Murphy USA has organically grown its store fleet at a rate of approximately 30 new locations per annum. As an independent company, Murphy expects to accelerate growth by expanding its store fleet to 1,408 locations in the next 3 years (roughly 66 new locations annually). The Company's expected 2013 and 2014 CAPEX allocated towards growth are $168mm and $135mm, respectively. The 2 figures are materially higher than its 2012 portion of CAPEX allocated towards growth (~$72mm). A little less than 50% of new locations will follow the 1,200 sq. Ft. kiosk format while the remainder will be 200-800 sq. Ft. It is my belief that the 200 new locations will result in an 8.7% EBITDA compounded average growth rate from now to mid-year 2016.
My arrival at 8.7% EBITDA CAGR figure:
Petroleum product sales = 200*278,000 (Avg. fuel gallons per Store Month)*12 months = 667,200,000 gallons per year*$3.37-3.46 (Avg. price of unleaded in South/Mid-West regions) =
$2,248,464mm - $2,308,512mm
Assuming 45% of new locations will be 1,200 sq. Ft. kiosks, and the remainder being 208 sq. Ft. kiosks, the result would be 90 1,200 sq. Ft. kiosks and 110 of the latter. The Company reports $4,744 annual sales per square foot.
Merchandise sales =
1,200 sq. Ft Kiosks = (90*4,744*1,200 sq. Ft.) = $512,352mm
208 sq. Ft. Kiosks (110*4,744*200) = $104,368
If we assume "other" revenues will normalize to $10mm, total 2015 revenue attributed to new stores will equal $2,865,194mm to 2,925,242mm
Gross Profit = (gross margin*respective sales)
Petroleum = 3.57%*$2,248,464mm - $2,308,512mm = $80,270mm to 82,434mm
1,200 sq. Ft. Kiosks = 15.5%*512,352 = $79,414
208 sq. Ft. Kiosks = 12.8%*104,368 = $13,359
Total Gross Profit = $173,043 to 175,207
Operating + SGA Expenses (2.85% of total sales) = $81,658mm to 83,369mm
EBITDA = $91,385mm to 91,838mm
Add on $320-$330mm adjusted TTM EBITDA from existing locations (adjusted for RIN sales) and 2016 EBITDA will equal $411 to 422. We must assume current locations can sustain their EBITDA. Many variables could either adversely or positively impact this figure such as fluctuating fuel prices, closure of locations, better cost control, and improved/worsening midstream supply chain. Another key assumption is the "sales per square foot" figure. As only 4% of all Murphy USA retail locations use the 1,200 sq. Ft. format, there is a high likelihood that the 1,200 sq. Ft. kiosks sell less merchandise on a per square foot basis than the Company's 208 sq. Ft. kiosks.
In the Short-Term
Selling Renewable Identification Numbers ("RINs") generated by ethanol and biodiesel blending has temporarily inflated Murphy USA's revenue and earnings. Because the Company has the capability to source its fuel directly at the terminals and then blend the fuel themselves, RINs are generated in the process. These RINs may be sold in the market to companies who fail to meet their annual RIN quota as set by the EPA. Revenue from RINs contributed to $44mm in sales for 6-months ended June 30, 2013 vs $3mm in sales for 6-months ended June 30, 2012. The primary cause for the increase in RINs revenue is connected to RINs prices reaching obscene levels during the first half of 2013 (Ethanol RINs were about $0.05/gallon throughout 2012 vs. $1.50/gallon peak in July) resulting from the shortage of corn due to last summer's drought, which suppressed ethanol production and caused blenders to turn to buying RINs to meet their RFS requirements. Because Murphy USA's reported statements cover operating results ending June 30, 2013 before the price peak, RINs sales throughout Q3 FY13 may result in a revenue and earnings surprise. This is temporary as I don't expect RINs sales to be a driver of revenue growth in the future. Once RINs prices return to normal levels, so will the portion of the Company's revenue and EBITDA attributed to them (~$10mm annually). When RINs prices return to normal levels, this will likely cause EBITDA stagnation from YE13 to YE14, assuming EBITDA from the new store openings will offset substantially lower RINs sales.
Potential acquisition target. The low valuation combined with Murphy USA's scalability advantage, partnership with Wal-Mart, 1,000+ locations including the land underneath, and attractive ROIC makes Murphy USA a likely acquisition target. Likely acquirers would include other fuel retailers looking to synergize their own supply-chain with Murphy USA's optionality supply-chain to lower costs, fuel retailers looking to eliminate a competition (Murphy USA had ~3% market share in US in 2011), and fuel retailers with distribution networks in other regions who will provide Murphy USA with access to fuel pipelines and streams the Company currently does not have access to and utilize the Company's scalability to accelerate growth.
Earnings surprise. It is highly probable that revenue and earnings from new store openings, high Q3 sale of RINs, and normalized earnings from the ethanol production segment will result in a revenue and earnings surprise for Q3 FY13. This may lead to additional public recognition, attention, and analyst coverage of the Company.
Divestiture. Management divesting ethanol production segment resulting in more directional focus towards the Company's core retail business. Management will allocate more time and energy towards strengthening its supply-chain, cutting costs, and strategically opening new locations.
Continuation of insider purchasing. Since the spin-off, 3 insiders have all purchased Murphy USA shares including board members Thomas Gattle and Jack Taylor, and Murphy USA board member), and Murphy USA's President and CEO Andrew Clyde.
I am recommending investors to take a long position in Murphy USA as it trades at a multiple below its peers on an EV/EBITDA basis despite higher ROIC, better capital structure, as well as growth prospects. I ultimately believe a natural reversion to mean is likely to occur within the next few months or years following more time and public recognition of the Company.