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By Randy Durig CEO of Durig Capital

Travel Centers of America LLC (TA)
Per share values on 2-14-2011:
Market value $ 7.02
Cash $ 1.44
Real Estate $ 4.80
Equity value $5.58


TravelCenters of America (AMEX: TA) is the one of the nation's largest full-service travel centers serving professional drivers and everyday motorists alike. Its mission is to take care of all highway travelers in the finest full-service facilities while on the road, and the company has been doing this for over 30 years.

We selected TravelCenters of America because it is one of the select few that fits our model. Our goal is to select, purchase and continually monitor companies in an effort to obtain outstanding performing investments while minimizing risk by finding stocks with low valuations for our clients. We will cover part of our review and selection process as well as explain why TravelCenters of America has recently been included in our High Cash Stock Review portfolio.

Introduction

TravelCenters of America is one of two major fuel service firms in America. In June 2010, two major competitors, Pilot Travel Centers and Flying J merged, becoming the Pilot Flying J. The Flying J was Valued at $1.8 billion in bankruptcy. When Pilot took over the Flying J and merged the two companies, they repaid $1.4 billion of outstanding debt and kept the 224 server centers. This merger greatly reduces the overall competition, and according to the FTC, the merger will “likely result in higher diesel fuel prices for long-haul trucking fleets.” The reduction of competition within the industry may also help increase the margins at TravelCenters of America.

TravelCenters of America has a strong balance sheet and has outstanding operation leverage which may possibly be even greater than Adam’s Resources, whose equity has performed well since it was included in our Investment with Income portfolio. We have been following TravelCenters of America for a while, knowing the lease from its parent was financially prohibitive, thus penalizing its market valuation. A new leasing agreement was recently reached with the owners of the property, Hospitality Property Trust (NYSE:HPT), after some drawn out negotiations. With the new contract which saves $42 million dollars and finally appears to be agreed upon at arms length, this should allow for better execution of the business profit-wise. TravelCenter of America’s operational business moving forward should be the barometer of its value. It was valued below and now near liquidation values due to the stranglehold the former long-term lease had on the income statement.

With the cash flow from operations generated over the quarters and the renewed savings from the new lease agreement, based on benchmarking against its peers, we believe TravelCenters of America still is currently valued at very distressed valuation.

Step 1 – We first search for companies with pristine balance sheets.

TravelCenters of America has $125 million in cash and $100 million in debt on the books, which means each share has a cash value, after paying off debt, of $1.44. They have $5.9 billion or $330 per share in sales per year with a meager $102 million ($ 5.58 per share) enterprise value. This is stronger than most company’s balance sheets, but sets a new low for our review. TravelCenter has tremendous operational leverage, and one example is its price to gross profit, which is better than many competitors' price to sales.

Step 2 – We like extremely low valuation

After reviewing hundreds, if not thousands, of companies for value, TravelCenters of America, even after a very large move, is still one of the lower valued companies that we could identify. The enterprise value per share is only $5.58. During the last year, sales increased to $5.9 billion from $4.7 billion or 27% compared to the year prior.

The operational business could be categorized for simplicity's sake into two segments---petrol sales and in store sales. Profit margins of each category are drastically different, as petrol or fuel is very low and in-store sales are quite large.

    1. TravelCenters of America's in-store sales increased 5.5% to $1.15 billion with cost of goods sold at $488 million, thus generating a profit margin of 58% and or operational profits from in store sales of $662 million on sales four times larger than in-store sales.
    2. Petrol sales were about $4.75 billion with cost of goods sold about $4.42 billion. The operating profits from petrol sales were half, $328 million.
2010 Sales Cost of goods soldGross profitGross margin% of sales
Petrol$4.75 billion$4.42 billion$328 million7%80.5%
In Store$1.15 billion$488 million$662 million58%19.5%
Total$5.90 billion$4.908 billion$990 million16.7%100%


Since the in-stores sales have higher margins compared to the petrol sales margins as seen above, we felt the best benchmark for TravelCenters of America may be gross income which was $990 million last year. If you value them at 2.1 times gross income, a level that many retail companies achieve, TravelCenters of America could be worth about $120 per share on an operational level. This does not include cash on hand, rental income, or real estate. It appears that the oversized lease payments of the past have hidden the value derived from their incredible size and leverage.

If you compare just TravelCenters of America (no fuel or rental income) in-store sales to other stores with similar merchandise, most stores have a 40% gross profit margin. In-store sales peers average $0.85 in equity value for every $1 of sales. If TravelCenters of America were valued based solely on its in-store sales benchmarked against its peers, the store’s equity value could achieve around a $56 value.

Hidden value

TravelCenter of America has real estate on the books of around $3.50 per share. Even though the combined real estate book values might be on the high side, since it was acquired in 2007, it should have some real value. It owns a 40% equity minority investment in a joint venture in Petro Travel Plaza with a book value of $17.5 million. That works out be about $1.01 per share of hidden value. TravelCenter of America invested $5.2 million in Affiliates Insurance Company or about $0.29 per share. In total, the real estate and the joint venture should represent a value of about $4.80 per share.

ItemValue per share
Property on Books$ 3.50
40% Minority Interest $1.01
Affiliates Insurance $0.29
Total$ 4.80

TravelCenter of America currently has about $105 million worth of unrestricted federal loss carry forward. This could allow them to run a profitable operation without paying federal taxes for at least a couple of years. This could boost after tax earning per share going forward. Simply put, the next $6.00 of profit per share should have very little if any tax drag.

Step 3 – Is the operation or enterprise driving value to their shareholders?

TravelCenter of America has been generating a high level of free cash flow for the last year due largely to the fact that it was not paying for complete lease that were recently adjusted downward. This represents a free cash flow return from enterprise of $1.63 share for the 2010 year. The last 12 months of free cash is rough equal to 29 % of the entire enterprise. It is impressive when the free cash also covers some of the cost of raw property, which even though has value, might reduce cash flow for items like taxes. The cash flow from the enterprise minus the book value of the real estate shows that there is over an 100% return on the enterprise which is about the same as our article titled “Has the market Miss-price UVE”.

The red line - Since the beginning of 2nd quarter 2009 sales (revenues) have increased.
The dark blue field- The value of the underlying stock

No wonder once the leasing issues were cleared up that TravelCenters of America attained a much higher value and the stock appreciated dramatically. TravelCenters of America still has one of the best values we could identify, based on almost $6 billion in sales and about $100 million in enterprise value. The $100 million in enterprise value carry on the books almost $ 80 million in hidden value. If you subtract that the hidden value the $6 billion operation could have only a $13 million enterprise valuation. Having a $13 million equity (minus hidden value) that produces a gross income of $990 million is greatly distressed.

If one takes into account the $42 million annualized in lease saving, this should translate into about $0.60 per share each quarter, or $2.42 annually. Since there should be no additional costs, and taxes should be at worst minor, the lease reduction should flow directly to the bottom line increasing earning per share by about $2.42 annually.

That combined $42 million in lease expense savings with real and measurable operation sales and improvements, the 2011 bottom line, over the prior year’s bottom line, may be robust.

Step 4 – Is this a good business?

This is a very good business. There are few national competitors servicing professional drivers. With many barriers to entry, few new companies will appear as major competition. If TravelCenters of America utilizes its economy of scale, it may actually gain market share by eroding competition from smaller firm. Fuel and in store sales are a very repeatable business and almost annuitized. The combination of very high barriers to entry and repeatable business should help drive the value higher. The largest negative to the business is the very narrow margins on petrol sales and with the consolidation in the industry, these may start to widen.

Step 5 – Is the Train Wreck and then the fog from the Wreck clearing?


With a negative or in this case low enterprise, often a “Train Wreck” is needed to drive value close to cash. We’ve identified three major issues and risk that has kept the value so low:

1. High Rent

2. Third Party control

3. Law suits


High Rent

TravelCenter of America recently changed their lease terms with the owners, Hospitality Properties Trust (HPT), reducing annual payments by $42 million per year. Even though this still might not be market value, it should be enough to increase profits by about $2.42 per year per share. Knowing that the retail convenient store peer group receives about 18x PE valuation, the $2.42 improvement per share means the equity may increase by $43 per share. Since TravelCenters of America has negative profits, the calculation isn’t material but helps explain why on the lease news it moved from $4 to $7 dollars per share immediately.

Third Party Control


TravelCenters of America’s board of directors and top management have come from and are still related to Hospitality Properties Trust. The successful lease reduction was driven by outside shareholder lawsuits. A properly run board of directors should act as fiduciaries. The board should have spotted this and thus not had it brought to light by outside share holder. The board of directors must be able to make decisions that are best for TravelCenters of America shareholders and not for their related firms, friends and family. Even though the negotiations were successfully for shareholders, the company may be seen as having a higher risk due to the board of directors conflicting interests.

We believe TravelCenters of America and also Hospitality Properties are subject to additional lawsuits until both boards can truly fulfill their mandated fiduciary duties. Since these are significantly related industries due to the property leases, stock ownership, and shared top management, both the cronyism and the associated liability from failing to provide the required corporate governments such as

1. Mitigating conflicts of interest between manager and shareholders and directors and share holders.

2. Insure assets are used to the benefit of investors and stake holders.


This truly invites substantial additional ongoing litigation risk until they can provide fiduciary corporate governance with proper structures that without question put their share holders and investors first. .

Lawsuits (environmental)

TravelCenters of America has several environmental lawsuits dealing with regulations relating to management of underground storage tanks. In today’s world, this appears to be an industry wide ongoing event.

In Summary

If TravelCenter of America could increase their margins by just 2% with similar revenues, this would translate into an increase in net income of almost $7 dollars per share and knowing currently convince stores in the industry are price at 18x PE this could equal to a hypothetical improvement of $126 per share. This huge operational leverage and the hidden value as described above has put TravelCenters of America in our sweet spot of greatly distress value with possibly large profitability improvements. We enjoy owning highly distressed valued companies that can provide outstanding profit growth that are deeply distressed and that are why TravelCenter of America fit our model.

We believe that TravelCenter of America is trading over a 90% discount to many of their peers and well below most companies in the in the convenient store industry. We find TravelCenters of America is looking forward to a greatly improve year, combined with their discounted value and huge leverage, we are including them into Durig Capital’s High Cash Stock Review portfolio.

Disclosure: I am long TA.

Additional disclosure: Durig Capital owns TravelCenters of America for itself, clients and related client accounts.

Source: Travel Center of America Fills the Value Tank