Casey's General Stores: Heads I Win, Tails I Don't Lose Much

| About: Casey's General (CASY)

Summary

A low-risk business with attractive risk/reward.

Casey's continues to outperform its peer group, yet trades at a lower multiple.

Remains an attractive takeover target if performance stumbles.

One of the few retailers still immune to Amazon's threat.

Mohnish Pabrai's book The Dhandho Investor explores the idea of low-risk, high-return investing. Using the analogy of the Patels - a group from a small region in India which now owns more than half of the motels in the United States - he illustrates how the goal of high-returns doesn't have to come with high risks. In simple, predictable and low-change industries, investors can do quite well without incurring a significant amount of risk, especially if the price paid is attractive. The idea is summarized nicely in "Heads I Win, Tails I Don't Lose Much".

While the EBITDA multiple of Casey's (NASDAQ:CASY) is no longer screamingly cheap, it is still lower than the peer group despite having the best sales performance of any North American convenience store chain. Perplexing. The grocery and prepared food offering continues to benefit from a store remodel plan and the tailwind of lower fuel prices. With a backlog of stores to remodel, outperformance can continue ("Heads I Win"). On the other hand, I believe if the share price corrected materially, Casey's would re-emerge as a takeover candidate providing investors with some downside protection ("Tails I Don't Lose Much").

Heads I Win

Casey's is a nice Dhandho investment. The business model is simple and unlikely to change materially over the next 5 to 10 years. Despite the change in technology and the rise of retailers like Amazon (NASDAQ:AMZN), the omni-channel threat to the convenience store industry still remains minimal, especially compared to the department stores or big box retailers. C-stores have the advantage of selling convenience (i.e. time) which garners a higher price - and an increasingly higher one as the economy improves and unemployment declines. The management has proven to be capable and has operated the business with low financial risk. In short, it has stuck to its knitting (small town USA) and built a differentiated product offering.

So, here are 5 points that I think support "Heads I Win".

  1. Casey's continues to outperform its peers

In the last 5 years, Casey's seems to have hit its stride. Ongoing store remodels and the decline in oil prices have combined to boost in-store sales significantly. The company continues to have an attractive backlog of store remodels (700-800 cited in the Q4 call) and is renovating approximately 100 in 2016. The result? Casey's has significantly outperformed its North American peers, and the management continues to see great results from the remodels.

Note: Differences in year ends do not make these numbers perfectly comparable. Instead, they highlight the industry trend of rising same-store sales (SSS) and the outperformance of Casey's.

Grocery & merchandise same-store sales growth

2011

2012

2013

2014

2015

Casey

4.9%

6.7%

0.8%

7.4%

7.8%

Couche-Tard (ATD/B)

4.2%

2.7%

1%

3.8%

3.9%

CST Brands (NYSE:CST)

-0.7%

1%

3.3%*

*YTD for CST Brands; all data for U.S. segment from publicly available filings

2. Pizza and the prepared foods franchise

The prepared foods franchise has also been a significant sales driver. In addition to increasing store productivity, it adds higher gross margin products (60%+), differentiates the brand, better utilizes store overhead costs, and continues to build the business away from selling commoditized products like fuel (nearly 75% of gross profit is non-fuel).

Prepared foods same-store sales growth

2010

2011

2012

2013

2014

2015

SSS Growth

4.2%

8%

14.3%

8.6%

11.8%

12.4%

3. History of tuck-in acquisitions

As part of its ongoing investments to renovate and update stores (up to 100 per year), the company also acquires, invests in and improves acquired stores.

While store remodels remain a priority, the convenience store industry remains fragmented with the number of stores declining. Mom 'n Pop chains continue to cede share to regional chains, and the large publicly-traded companies continue to buy smaller chains and stores. Acquisitions always remain a potentially positive option for shareholders if management can find a good asset at the right price.

Number of Stores Acquired

2015

36

2014

28

2013

25

4. Valuation

Despite outperforming on inside SSS, Casey's still trades at a discount to its peer group. The company has a more differentiated business model (82% of stores are in towns with populations less than 20,000), a fast-growing prepared foods franchise, and earns a higher fuel margin.

C-Store: Current forward EBITDA multiples

Multiple

Casey's

9x

Couche-Tard (OTCPK:ANCTF)

11x

CST Brands

12x

Murphy USA (NYSE:MUSA)

8.5x

5. Value in 3 years

Over the last 5 years, Casey's has grown earnings at an average annual rate of 16%.

2010

2011

2012

2013

2014

2015

Casey

2.29

2.35

2.99

2.69

3.26

4.62

y/y change

2.62%

27.23%

-10.03%

21.19%

41.72%

Average

16.55%

If we conservatively assume a lower growth rate of 10% over the next 3 years, EBITDA will be around $710 million. I assume a modest decline in net debt as ongoing investments in store remodels are driving significant SSS growth. Cash needs remain high, and for now, the best place to invest is back into Casey's. I also assume a 1-point multiple expansion as investors continue to recognize Casey's outperformance.

I estimate the stock could be $165 or higher - approximately 45% upside from current levels.

3 years out

1-Year Fwd EBITDA

710

Multiple

10

7,100

Less: net debt

600

Est. value

6,500

Shares

39M

Price per share

167

Upside

46%

Tails I Don't Lose Much

In 2010, Alimentation Couche-Tard was willing to pay $38.50 for Casey's or approximately 7x 2011 estimated EBITDA. Casey's successfully fought the bid and saw same-store sales, earnings and the share price accelerate. Accordingly, its multiple expanded and now sits at 9x next year's estimated EBITDA. Alimentation Couche-Tard moved on - it made several smaller acquisitions, a highly successful foray into Europe, and most recently paid 7.5x EBITDA for Pantry. It too saw a significant share price increase.

With that said, I believe Couche-Tard is still interested in buying Casey's if the price is right. I assume the company would be willing to pay as high as 8x - 1 turn higher than its 2010 bid and 0.5 turn higher than the Pantry - recognizing the niche advantages of Casey's business model (especially relative to Pantry) including SSS performance, the emerging pizza franchise and the dominant locations in small towns. Lower financing rates help too. If Casey's hits a stumbling block and begins to underperform, the multiple of the stock likely declines from the current levels and could re-attract bidders.

The emergence of Couche-Tard provides investors with downside protection of capital. At 8x EBITDA, Couche-Tard could pay roughly $99 for CASY - or approximately 15% downside from current levels. Of course, we'd experience significant pain along the way as the price likely falls to around $70-75 before anyone would bid with the customary premium.

Current Value

Value at 8x EBITDA

1-Year Fwd EBITDA

585

585

Multiple

9

8

5,265

4,680

Less: net debt

800

800

Est. Value

4,465

3,880

Shares

39

39

Price per Share

114

99

A holiday treat

CASY remains one of the few retailers still immune to the Amazon threat. As many traditional retailers brace for the ongoing "unknown" online impact this holiday season, Casey's continues to march to its own beat. Selling convenience (i.e. time) remains a distant objective for online retailers.

October sales continued their strong trend with Grocery & Merchandise up 7.3% and Prepared Foods up 10.5%. Q2 2016 should bring another quarter of nearly 8% Grocery & Merchandise SSSG and nearly 9% in Prepared Foods. The results suggest consumers are feeling good heading into the holiday season, at least in Casey's core Midwest market, with basket and traffic increasing, consumers trading up to premium brand cigarettes, and continued adoption of a strong Prepared Food offering, including Pizza Delivery.

Where I could be wrong

In addition to store remodels, declining fuel prices have been a driver of SSS. If oil spikes significantly, fuel rises and miles driven likely decline. Casey's will see lower traffic and potentially lower sales of high-margin grocery and prepared items.

Further, my "Tails" scenario assumes any buyer has the balance sheet capacity to pursue an acquisition. No buyer means we could be waiting longer than expected and suffer an outsized paper loss.

Summary

These exercises remain focused on being approximately right rather than precisely wrong. Like Dhandho investing, if I can find investments that reduce the probability of a significant loss of capital, the probability of a large gain over time increases. We can find good returning investments with low risk.

Casey's continues to hit solid singles and doubles quarter in and quarter out. If it continues to outperform the industry, upside remains significant. Recent results suggest the momentum is continuing into the holiday season making Casey's a unique retail investment in world where many traditional retailers are struggling to adjust to Amazon and new online competitors.

With that said, if management stumbles for a few quarters or the oil price spikes, the share price and multiple will likely decline as miles driven and in-store traffic decline. In that scenario, I believe there are willing and opportunistic buyers for Casey's unique franchise, which reduces the probability of a meaningful loss on investment.

Disclosure: I am/we are long CASY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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