Core-Mark Achieving Better Leverage, But Volatility And Valuation Are Issues

Summary

• Core-Mark shares have remained volatile, but the company is continuing to see healthy same-store growth in the non-cigarette business and improving operating leverage.
• Cigarette sales are likely to continue to erode, but non-cigarette sales are far more profitable and Core-Mark is benefiting at least in part from a switch from cigarettes to vaping.
• Core-Mark looks fully valued at a double-digit forward EBITDA relative to what will likely be high single-digit EBITDA growth over the next 3-5 years.

Wholesale distribution isn’t that volatile of a business, but looking at Core-Mark (CORE) shares, and particularly the overreactions around earnings reports, you’d think this was a biotech, or at least a popular trading target. In any case, while the company does appear to be back on track as far as leveraging its infrastructure and driving better margins go, the share price isn’t a particular bargain today. Given how these shares have traded over the last few years, though, it may be worth keeping on a watchlist so as to buy after another market freak-out.

An Ongoing Shift In How C-Store Customers Get Their Nicotine Fix

Core-Mark has continued to report ongoing declines in cigarette sales, with mid-single-digit same-store volume declines more or less the norm now. Although convenience stores (C-stores) may still have an opportunity to pick up some incremental volumes from other companies/businesses exiting cigarette sales, the reality is that cigarette consumption is on a steady downward trend. Price hikes will offset that a bit, but this remains a business that I believe will continue to erode over time.

The good news is that cigarette sales aren’t a particularly profitable part of Core-Mark’s business. The gross margin of cigarette sales is only a little above 2%, while non-cigarette revenues carry gross margins closer to the 12% level. Consequently, while cigarette sales are roughly double non-cigarette sales as a percentage of revenue, non-cigarette products generate close to three times the gross profits for the company.

And it is not as though the decline of cigarette volumes is a total loss for the company. Vaping continues to grow in popularity, and has become a meaningful driver for Core-Mark’s non-cigarette sales growth, with the “Health/Beauty/General” category (where Core-Mark includes vaping products) up 24% in the first quarter versus 1.4% overall reported growth in non-cigarette sales.

Analyst’s Disclosure:I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.