Casey's General Stores: Multiple Business Lines Create A Market Mispricing

| About: Casey's General (CASY)


Mr. Market thinks of Casey's as a grocer that sells fuel, but Mr. Market is missing the value of Casey's real estate and its fast-growing prepared foods business.

Shares of Casey's are undervalued by about 20% currently.

Casey's move into the pizza delivery business and having all stores operating 24-hours will drive revenue, same-store sales, and EPS growth.

When the Nation's Restaurant News named Casey's General Stores (NASDAQ:CASY) the fifth fastest-growing chain in the country, I knew it was worth looking into. After all, the chain came in just behind Chipotle Mexican Grill (NYSE:CMG), which was ranked fourth. What I found was a chain of convenience stores operating in 14 Midwestern states, with the majority of its stores in Iowa, Missouri and Illinois. The first store opened in 1959 and has grown to over 1,800 today.

The big difference between Casey's and other convenience stores is that each location is its own restaurant. At a Casey's General Store, you can get fresh pizza, doughnuts, cookies, subs, wraps, pasta, burgers, and sandwiches. So, in effect, Casey's becomes a one-stop shop for its customers to get gas and eat. To me, this is a very attractive business model. Casey's sells more than 15 million pizzas per year. Casey's also sees to it that it controls distribution, as well as owning the real estate its stores sit on. Casey's in-house distribution center delivers about 75% of the gasoline to its stores and 90% of the store's other products.

Another big difference is that Casey's focuses on small towns and rural communities. About 59% of its stores are in towns of 5,000 or less. It's a similar strategy that Sam Walton used when he started Wal-Mart Stores (NYSE:WMT). Today, Wal-Mart is the world's largest retailer and has evolved beyond serving small towns. The closest company that I can think of with a similar strategy is Hibbett Sports (NASDAQ:HIBB). Hibbett Sports focuses on smaller towns where it is most likely the only game in town and is not competing with the likes of Dick's Sporting Goods (NYSE:DKS).

Latest quarterly earnings report

Q4 EPS came in at $0.59, which was $0.01 lower than last year, but beat estimates by $0.06. Revenues missed expectations though by $10 million. However, they were still 5.5% higher on a y/y basis.

The reason for the earnings shortfall was due to lower fuel margins. This lead to a $0.22 impact on earnings. Same-store gallons rose 1.8% with an average margin of 13.8 cents. This is much lower than the 17 cents per gallon Casey's earned last year. The Fuel Saver program helped boost same-store gallons at participating locations by 2.9%. A further rollout of the Fuel Saver program should help Casey's other stores. The good news is that even with the lower fuel margins, EBITDA improved slightly to $76.5 million for the quarter. Casey's also sold 12.1 million renewable fuel credits for $5.7 million in Q4.

Outside of fuel, grocery same-store sales rose an impressive 7.2% in Q4 with an average margin of 32.1%. The average margin was 40 basis points higher than last year. The most competitive aspect of this category is the cigarette business. Here, Casey's is growing market share after reducing its prices last year. Year-to-date cigarette sales are up 7.7% because of the price cuts.

In the prepared food segment, same-store sales were even better at 12.1%. Total sales increased 17.6% to $163 million. The average margin was 60.1%.

It is this segment that I am most impressed with. Casey's has implemented a number of new initiatives to grow this part of the business. Most notably, Casey's is now serving food 24-hours a day at 725 of its locations and the company introduced pizza delivery at certain locations. How many convenience stores are out there that not only make pizza, but also deliver? It's these types of initiatives that make Casey's a serious competitor to other fast-casual dining chains like Papa John's International (NASDAQ:PZZA) and Domino's Pizza (NYSE:DPZ).

Casey's was also able to successfully increase its prices due to rising meat and cheese prices. The average cost of cheese was $2.58 per pound in the quarter compared to $1.89 a year ago. With the price increases already in effect, a drop in cheese and meat prices would further boost margins. We're already seeing cheese prices come down. Last month, the price of cheese was down to $2.25 a pound. Very few restaurant chains are able to pass along rising input prices to their customers without staging a revolt. In the restaurant space, the only two that I know of that have been able to do so are Chipotle Mexican Grill and Starbucks (NASDAQ:SBUX).

Full year results were even better

Earnings per share for the full fiscal year increased to $3.46 compared to $2.86 in the previous fiscal year. EBITDA increased 17.1% to $377 million. Same-store gallons sold increased 3.1% and the margin for the full year was 16.8 cents. Total gallons sold increased 8.5% to 1.7 billion gallons. Gross profit from fuel sales increased 20% to $280.1 million.

Grocery and other merchandise saw same-store sales increase 7.4% in the fiscal year and the average margin was 32.1%. This segment looks to be very consistent as Q4 results were similar to the full year results. In this category, total sales increased 11.6% to $1.6 billion and gross profits rose 9.8% to $507.9 million.

In the prepared food category, same-store sales rose 11.8% and the average margin was 61.1%. To illustrate how impressive Casey's same-store sales growth is, consider that Chipotle's same-store sales rose 5.6% in FY13. Total sales in this category increased 16.7% to $659.2 million and gross profits increased 15.5% to $403 million.

Plenty of growth ahead

Last year, Casey's built 44 new stores, acquired 28 stores, and also completed 20 replacements as well as 25 major remodels. For FY15, Casey's has already acquired 24 stores with its Shop-n-Go acquisition in May. There are also 27 new stores and 23 replacement stores under construction. Casey's also has 38 new sites, 28 replacement sites and 5 acquisition stores under contract. A second distribution center is being built in Indiana to handle future growth improve the current supply chain.

Here's the problem

The biggest issue that I see for Casey's General Stores is that the market doesn't know how to properly value the company. Casey's is a fundamentally misunderstood story. Morningstar has it being in the Grocery Store industry. Yes, Casey's does sell grocery store items, but it does not take into account its fuel operations and prepared foods business. Meanwhile, its major peers, CST Brands (NYSE:CST), Murphy USA (NYSE:MUSA), and The Pantry (NASDAQ:PTRY) are all classified as specialty retailers.

The key difference between Casey's and these other store operators is that it has a prepared food business, which also happens to be higher margin than the fuel/merchandise businesses. Casey's gets around 70% of its revenues from fuel, 20% from grocery/merchandise and 10% from prepared foods. Meanwhile, CST Brands collects 83% from fuel, The Pantry 77% and Murphy 87%. For Casey's, the sale of non-fuel items accounts for 78% of its gross profits.

As a result, Casey's valuation is a bit skewed.

Notice that Casey's trades at a discount to its peer average on a forward P/E basis, and only a slight premium on an EV/EBITDA basis. However, its earnings growth is well above all its peers. Comparable store sales are on the rise, and should continue, as Casey's keeps more stores open 24 hours and increases its pizza delivery rollout. Casey's stores that have pizza delivery witnessed an immediate 25% to 30% increase in prepared food sales. There are still about 1,100 stores that need to be converted to Casey's 24-hour format. This year, about 100 stores will be converted to the 24-hour format and 80 stores will get pizza delivery. So we'll see an incremental sales boost at about 5% of Casey's stores.

What's more is that it has higher margins, but its margins should continue rising, where the margins on prepared foods are higher than grocery items. As a result, valuing Casey's fuel/merchandise business in line with peers is fine, but its prepared foods business deserves a higher multiple. In the last 13 months, Casey's had only one month where same-store sales dipped below 10%. These are numbers any restaurant would love to have. In the latest quarter, Domino's managed to grow its U.S. same-store sales by only 5.4%.

So to determine the proper multiple for Casey's, we need to use a blended P/E valuation. For example, its top peer in the prepared foods segment, Domino's, trades at a forward P/E of 23.1. Using a 19.6 forward P/E (peer average) and a 23.1 (Domino's), a justified P/E is closer to 20.

An MLP is unlikely

There has been some speculation that Casey's could spin-off some assets into an MLP. This comes mainly because Casey's owns its real estate and because of its fuel volume growth. However, Casey's does not have a wholesale fuel distribution business like what Susser Holdings (NYSE:SUSS) was able to do with Susser Petroleum Partners (SUSP). There would also be tax implications for Casey's regarding its older stores if it went the MLP route. CFO Bill Walljasper addressed this issue on the last earnings call.

We have looked at this and don't believe it currently is the value, the same type of value that Susser has experienced with theirs. So we will continue to look at that in addition to other strategic alternatives as we normally do.

We would have to put specific amount of real estate into that. And doing so there is some of our older stores which potentially might create a tax leakage. So best assured, we have looked at it in great detail. We had third-party look at that as well outside of the internal structure. So we will continue to evaluate and see that makes sense going forward.

Bottom line

Casey's is proving to be one of the best operators in the business. Its margins and expected earnings growth is top in the industry. This alone justifies a premium multiple for Casey's. Using earnings expectations of $4.02 a share for fiscal 2016 and a 20 P/E suggests that Casey's price target is over $80.

What's more is that it has upped its dividend payment for 11 straight years. That's a trend that will likely continue. Assuming the store operator pays an $0.82 dividend over the next year, and then $0.66 over the next three quarters after that, for $1.48 in total dividends. That's in addition to the $13 plus in stock appreciation. Coupling the dividends and stock price movement, and Casey's looks to offer a total return opportunity of 21.5% in just over 20 months. That's an annualized 11.8%.

In terms of downside protection. Casey's owns the land for 1,787 stores and the buildings for 1,792 locations. Last year, Casey's acquired 28 locations at an average price of $1.128 million. If we use the same multiple, Casey's real estate alone is worth $2 billion. With an enterprise value of $3.26 billion and a market cap of just $2.53 billion, shares look cheap when you consider that the business generated $379 million in EBITDA last year.

Taking into account the value of Casey's real estate and a blended P/E multiple, fair value is north of $80. Overall and in today's market environment, I see Casey's General Stores as being a solid bet for investors.

Disclosure: The author is long CASY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.