Shareholders in convenience store operator The Pantry (NASDAQ: PTRY) have likely not been the happiest lot over the past five years, due to stock price appreciation that has significantly trailed the market averages. The company has found profit growth hard to come by during that time period, partially as a result of rising competition from the deep discount retail chains, like Dollar General (NYSE: DG) and Dollar Tree (NASDAQ: DLTR), that share a similar focus on the food consumables merchandise category and anecdotally have a convenience advantage due to their larger store bases.
However, The Pantry's share price has received a lift in 2014, thanks in large part to better than expected profitability in its latest fiscal quarter, evidenced by a 9.0% gain in adjusted operating income, which led to a subsequent double-digit pop in its share price. So, after a nice year-to-date stock price run, is The Pantry a good bet?
What's the value?
The Pantry is a major operator of convenience stores, with a network of more than 1,500 locations around the country, mostly in popular tourist areas, like Orlando, Florida and Biloxi, Mississippi. The company uses fuel sales to generate high customer volumes, despite the notoriously low margins, hoping it will bring people into the stores for higher-margin purchases of prepared foods and an assortment of impulse merchandise, including tobacco and packaged grocery items. Unfortunately, The Pantry's strategy hasn't worked that well over the past few years, as lower per-store sales of fuel have more than offset higher per-store sales of merchandise, leading to an overall downward trajectory in profit and cash flow.
In its latest fiscal year, it was a continuation of the negative trend for The Pantry, highlighted by declines in revenues and adjusted operating income of 5.2% and 3.7%, respectively. Despite slightly higher operating income in its merchandise segment, the company was negatively impacted by a 5.7% decline in fuel volumes sold, as well as marginally lower average fuel prices. The net result for The Pantry was a drop in operating cash flow, hurting its ability to fund its capital expenditures and pay down its relatively sizable long-term funded obligations, which tip the scales at roughly 4.6 times annual adjusted operating income.
Struggling to grow
Of course, the question for investors is whether The Pantry can deliver profit growth in the foreseeable future, thereby providing a solid foundation for a higher market valuation. On that score, the evidence seems a little murky at best. While the company reported adjusted operating income growth in its latest fiscal quarter, as previously mentioned, it posted a negative performance in the FY2014 year-to-date period, down 2.3%. In addition, The Pantry continues to struggle with declining customer traffic volumes, evidenced by a 2.3% decline in fuel sales volumes during its latest fiscal quarter.
Part of The Pantry's problem is the growing store footprints and merchandise assortments available at the deep discount retail giants, like Dollar General. With roughly 11,000 locations in 40 states, Dollar General has outgrown its dollar store roots and now offers a broad assortment of merchandise, including packaged food, personal care, and houseware items. More disconcerting for The Pantry, though, is Dollar General's major inventory investments in the low-margin food consumables area, which accounts for roughly 76% of Dollar General's total sales. While the calculated move has led to a lower gross margin for Dollar General in FY2014, down 60 basis points, it has allowed the company to continue generating increases in customer traffic volumes, providing opportunities for sales of higher-margin products.
Likewise, Dollar Tree seems to be operating from the same playbook as Dollar General, aggressively investing in freezers, which covered a majority of its overall store base at the end of its latest fiscal year. The strategy has undoubtedly been partly responsible for a continued increase in the company's customer volumes in FY2014, which has helped to power a 3.2% increase in comparable store sales. More importantly, the greater per-store sales have led to higher adjusted operating income for Dollar Tree, up 6.4%, despite a roughly 60 basis point hit to its gross margin from the push into the low-margin food consumables product area. The net result for Dollar Tree has been a solid pickup in operating cash flow, fueling additional investments in greater inventory assortment, a move that will likely put further pressure on smaller competitors, like The Pantry.
The bottom line
The Pantry is an interesting bet, given the potential for future operating margin expansion, as well as due to the recent addition of activist shareholders to the company's boardroom, which holds the potential for a greater corporate focus on shareholder value. That being said, at current levels, The Pantry's share price trades at a pricey 75 times expected EPS for FY2014, as illustrated in the below table.
|Estimated FY2014 Net Income||$6.6 M|
|Outstanding Shares @ 3Q2014||23.4 M|
Source: The Pantry 3Q2014 Press Release, my estimates
In addition, the company still needs to find a way to increase its customer traffic, in the face of continuing encroachment from the deep discount retailers. As such, The Pantry seems to have more downside risk than upside potential and prudent investors should probably avoid the shares at current levels.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.