The Pantry Has Some Juice

There are few industries as fragmented as the convenience store market. The National Association of Convenience Stores estimates that there are 140,655 such stores in the U.S., delivering total annual sales of just under $500 billion. Many of these are one-off locations and there are very few large multi-state chains. Of course, you have heard of 7-11, but unless you live in the Southeast, you are likely unaware of The Pantry (Nasdaq: PTRY).

The Pantry operates about 1,400 convenience stores across 11 states in the southeastern U.S. With $4.4 billion in revenues for 2005, the company has about 0.9% of the national convenience store market.

The Pantry's strategy is to act as a consolidator in the business. One-off convenience stores and small local chains have several major disadvantages when competing with The Pantry. For one thing, fuel accounts for about three-quarters or your average store's sales, and profit margins are razor-thin in that business. Small operators don't have enough market power to fight for and win volume discounts from the big oil companies.

The food business is extremely profitable for convenience stores. Consumers are willing to pay high, premium prices for snacks and drinks they grab after pumping gas into their cars -- the convenience warrants the higher cost. But smaller chains are also at a disadvantage in this business. Sourcing costs for food are higher for smaller stores, and modern scanning and inventory management equipment are often out of the budget range for such stores.

The Pantry's strategy is to buy up these smaller chains and one-off convenience stores. The company then integrates these stores into its existing centralized inventory management and distribution system and adds modern scanning equipment. Thanks to relationships with the likes of Subway, The Pantry can vastly expand a convenience store's offerings to include freshly made sandwiches, specialty coffees and chilled fountain drinks. These food items earn even higher margins, and consumers tend to enjoy the expanded selection of merchandise.

Moreover, The Pantry has existing relationships with several major oil companies. As a result, it's able to get good prices on gasoline and volume discounts. That serves to boost margins on the gas business.

The Pantry has plans to continue opening new locations and buying up small chains in the southeast U.S. to expand its market share. In the first six months of 2006, the firm bought 107 stores. And looking ahead, management has stated it has the intention of building 20 to 25 stores per year from the ground up. Thus, it's not hard to imagine The Pantry adding 250 to 300 stores per year to its current base, grabbing considerable additional market share in the process.

Disclosure: Author has no position in PTRY