Alimentation Couche-Tard Update: High Growth And Undervalued - 122% Upside

Summary

• The convenience industry is very fragmented which presents a great opportunity for large consolidators such as Alimentation Couche-Tard.
• The company continues to post excellent financial results despite the pandemic.
• Alimentation Couche-Tard is a great bet on two fast-growing industries: Cannabis and EVs.
• Alimentation Couche-Tard has started its expansion into Asia and is also pursuing organic growth plans through new store builds and its "Fresh Food, Fast" program.
• The high range of our valuation implies 122% upside, while our low range valuation still implies a respectable 60% upside.

Thesis

Alimentation Couche-Tard (OTCPK:ANCUF) is a global leader of the recession-resilient gas station and convenience store industry. They have a solid balance sheet and a very consistent track record of creating value for shareholders. We believe the company will see tremendous growth despite its already massive size. Their acquisition strategy is exactly what is needed to trigger growth in its fragmented industry, but they are not reliant on acquisitions to grow as 50% of their growth will be organic going forward. With close to 15,000 stores, Couche-Tard has the economies of scale to give them a strong competitive advantage over their rivals. In addition, the company will further boost growth by tapping into the cannabis and EV markets. To top it all off, Couche-Tard is often overlooked by investors, which presents an opportunity to buy a very undervalued company that we think can return over 120% from current levels.

In September, we wrote a bullish article about Couche-Tard. Since no one has talked about them since then, we decided we'll write a follow-up article reassuring that our bullish thesis is still in play. We recommend reading our previous article here as it mentions an overview of the industry and some parts of their growth strategy in greater detail.

Looking into the most recent earnings report:

Although Couche-Tard saw a 22.1% revenue decrease YoY, the drop in revenue does not paint the picture correctly. You might think that a company that mainly operates gas stations would be struggling right now, but Couche-Tard is doing very well despite the pandemic.

• Adjusted diluted EPS was $0.66, representing an increase of 32.0% from $0.50 in the same quarter last year.
• Operating cash flow was actually down about 3.25% YoY, dropping to $880.8M from $910.5M last year. However, lower capital expenditures allowed free cash flow to increase by about 4.4%, to $606.9M from $581.4M for the same quarter last year.
• Return on capital employed improved 230 bps to 17.3% and their leverage ratio stood at 1.13 : 1 compared 1.54 : 1 Y/Y.

Here are some key points noted in their most recent earnings report that contributed to their solid performance:

• "Road transportation fuel gross margin increased by 9.19¢/gallon in the U.S. to 37.48¢/gallon, by US 2.76¢/liter in Europe to US 11.1¢/liter, and by CA 2.16¢/liter in Canada to CA 10.05¢/liter.
• Normalized operating SG&A expenses declined 0.8% as rigorous cost control more than compensated for the additional COVID-19 related expenses."
• Same-store merchandise revenues increased 4.4% in the U.S., 8.6% in Europe and 11.4% in Canada, compared to the same quarter last year (taken from their most recent earnings call).

The current economic conditions helped Couche-Tard have better fuel margins, offsetting the drop in revenue. Also aided by the increase in same-store sales, their solid operating results allowed for another dividend increase and the renewal of their share repurchase program. We will discuss these briefly below.

Alimentation Couche-Tard Renews Share Repurchase Program

Recently, Couche-Tard announced that it renewed its share repurchase program. This will allow the company to repurchase up to 4% of the public float of class B subordinate shares from November 27, 2020 to November 26, 2021.

Couche-Tard said that they believe this is an appropriate use of their funds that will benefit shareholders. They plan to repurchase shares on an "opportunistic basis", according to CFO Claude Tessier.

Couche-Tard Increases Its Dividend by 25%

In its most recent earnings report, Couche-Tard announced its second dividend hike of the year. The first one was a 12% dividend hike back in March. This equates to a quarterly dividend of C$0.0875 per quarter, which is not much at all, but it is growing fast. As mentioned in our previous article, the company's dividend has increased 8 fold since 2011, at a CAGR of 27%.

Historical Operating Performance

Alimentation Couche-Tard has a stellar history of growing consistently. We will discuss these below.

Earnings, Revenue, and Operating Expenses History

Below is a chart showing revenue in blue, operating expenses in purple, and earnings in light green. As you can see, although revenue is not growing in a straight line, earnings definitely are, and operating expenses have been relatively flat for the past 2 years.

Source: simplywall.st

Net Income

An easier-to-read chart of Couche-Tard's historical net income can be seen below.

Source: Finbox

Cash From Operations

The historical cash from operations chart below shows very similar results to the earnings chart.

The ability to consistently produce positive and growing cash flows from operations is very important to us because operating cash flow shows the true picture of a company's profitability.

Source: Finbox

Return on Invested Capital

Next, we have return on invested capital, which is a metric we look at all the time. ROIC is a capital efficiency ratio used to measure a company's ability to create value for both debt and equity stakeholders of the company.

The formula for ROIC is:

Net Operating Profit After Tax/Average Invested Capital Over Period

Couche-Tard's ROIC has always been over 10% in the past 10 years, which is very respectable.

Source: Finbox

Return on Capital Employed

ROCE: A capital efficiency ratio used to measure a firm's profitability relative to the capital employed. Capital employed is defined as total assets minus current liabilities.

Couche-Tard has a strong ROCE averaging 15.4% since 2011, and their target going forward is to keep it above 15%. ROCE has been driven by strong organic growth as noted in the image below.

Source: Investor Presentation

To provide context to Couche-Tard's exceptional historical operating performance, Casey's General Stores (CASY), which is one of the top players in the convenience store industry, had an ROIC and ROCE of 11.1% and 13%, respectively.

The company's operational consistency has resulted in consistent share price appreciation over the years. In the past 20 years, Couche-Tard's stock increased by over 11,500% (adjusted for dividends). An interesting positive correlation between operating cash flow and share appreciation can be seen below. We have no reason to believe that the company won't continue to keep growing fundamentally, which should cause the share price to follow.

Data by YCharts

It is worth noting that the company's fundamental growth has outpaced the stock's total return. This presents great value, which we will outline below.

Updated Valuation: Alimentation Couche-Tard Is Undervalued

To value Couche-Tard, we used the same method from our previous article, except we updated the numbers. For this valuation method, we calculated the company's sustainable growth rate to forecast the next 3 years of earnings growth. We arrived at a sustainable growth rate of 23.6%, which is similar to their 3-year earnings CAGR of 24.9%. The formula for sustainable growth rate can be seen below, along with the rest of the valuation inputs.

Source: Author

We used the sustainable growth rate to calculate a 3-year forward EPS estimate of $4.68.

To calculate the discount rate, we used CAPM, with a 6% equity risk premium (as recommended by Duff & Phelps). The beta we calculated for Couche-Tard was 0.87. This gave us a discount rate of 5.34% for the valuation.

Source: Author

The calculations above led us to a low range valuation of $55.05 per share and a high range valuation of $76.23 per share. The low range valuation assumes a future P/E multiple that is in line with its current multiple, and the high range valuation assumes that Couche-Tard will revert to its historical 5-year P/E ratio of 19.04.

The valuation represents a potential upside of 122% from current levels if it reaches the high end of the range. The low range valuation still presents a very respectable 60% upside.

Strong Financial Position

Couche-Tard has been able to grow organically and through acquisitions without getting themselves into a big pile of debt. They have ample liquidity to grow in the years to come.

From Couche-Tard's most recent earnings report: "The Company is in a stronger cash position than ever, with access to ~$6B through available cash and its revolving unsecured operating credit facility."

Their debt to equity levels have also been improving, which can be seen in the image below. Currently, the company's debt to equity ratio is healthy at 53.1%.

Source: simplywall.st

Growth Catalysts Are Still Intact

The 3 growth catalysts that we mentioned in our previous article are still intact. We recommend that you read that article, but to briefly list those catalysts, they are:

1. Industry consolidation through acquisitions.
2. Moving into the cannabis market.
3. Moving into the EV charging market.

There is actually another growth catalyst that we didn't mention before, and it is organic growth, which we will talk about in more detail below.

More Organic Growth To Come

Couche-Tard is shifting to a balanced growth strategy where 50% of growth will be organic and the other 50% will be M&A. We really like this approach because it shows that Couche-Tard actually knows how to make their underlying business grow and, therefore, is not reliant on acquisitions to grow. The 50/50 mix will still allow them to consolidate the market through acquisitions, but it will require them to be even more cautious when acquiring, which is good news in our opinion.

Source: Investor Presentation

Part of the organic growth will come from new store builds, as mentioned in their earnings call. Besides that, there is also their "Fresh Food, Fast" program. The picture below can give you an idea of what the program is about.

Source: Circle K Website

Fresh Food, Fast is an excellent way to increase organic growth by optimizing current locations. It is also not going to add much to operating expenses because it will only add a "relatively low increase in hours worked at store level" according to Brian Hannasch.

In regards to the current developments of the program, Hannasch said:

"We continue to be very pleased with developments in North American food program, which is the biggest project ever undertaken by Couche-Tard. In United States, we met our target of introducing 1,500 Fresh Food, Fast locations by this fall, and now we offer in 11 of our U.S. business units. Our focus remains on the quality and ease of our fresh food offer, both for our store team and our consumers. Stores with Fresh Food, Fast have been performing very well relative to test stores or control stores in the same markets, and we’re also tailing our offer to meet the tastes and preferences of our local communities. Based on these results to-date, we plan to roll out the program to additional 3,000 locations by the end of next fiscal year."

This can be found in the earnings call.

As consumers, we believe quality is very important when it comes to food & beverages. If food is of great quality, people will return for more in the future (assuming the price is right). Here is an interesting video we found on YouTube that shows the quality that Circle K strives for.

Moving on to acquisitions, there has been a new one since our last article: Couche-Tard Acquires Circle K Hong Kong For US$360M

It has been anticipated for a long time, but it finally happened, Couche-Tard is now expanding into Asia. The company reached an agreement to buy Convenience Retail Asia Limited. Convenience Retail Asia's business includes 373 stores across Hong Kong and Macau that operate under Circle K branding. There is likely going to be more Asia expansion in the future, as that is part of management's plans.

When talking about expansion into Asia, CFO Brian Hannasch stated:

"We mentioned in the past that we find many markets attractive and mostly in Southeast Asia, so the Philippines, Indonesia, Vietnam, could be Thailand also to name a few. So, our focus is to enter a market with favorable demographics, good population growth, GDP growth, increasing earnings power and an expanding middle class also is very favorable to our store. So, as well a country that already counts on a good c-store infrastructure as we are not looking to spend years building from the ground up or greenfield our operations in these countries. So, we’re looking for networks that have a meaningful footprint on their markets, but also a strong growth potential."

Alimentation Couche-Tard has a great history of creating shareholder value through careful and prudent acquisitions, so we are optimistic about their Asia plans. Chairman of the Board Alain Bouchard talked about expanding into Asia in 2017. It's been 3 years, which proves that the company considers acquisitions very carefully.

EV Charging Stations Developments

The company is continuing to expand into the electric vehicle charging station sector. In the most recent earnings call, Brian Hannasch stated:

"We’ve also rolled out Circle K brand in chargers in Norway. We now have over 1,000 chargers on our sites, including more than 500 of those in Norway, with 2,700 Circle K chargers, in people’s homes and offices. We added more in the last quarter than we did in the previous year for the home charging. We now have 90,000 customers who have signed up for our Circle K charging app on their phone."

He also went on to say that Couche-Tard is working with different partners to deploy chargers in North America. He expects to start with Quebec first, and then expand into California next. No exact timeline was given, though.

As you can see, Couche-Tard has lots of growth ahead for them through multiple channels.

Risks

The risks are the same as the ones mentioned in our other article. We will briefly discuss them here. Couche-Tard operates in an industry with low barriers to entry, meaning almost anyone can come in and steal business from them if they operate better. Also, as acquisitions are half of their strategy, this can put pressure on them to acquire, even though there aren't always great acquisition opportunities out there. However, the company has shown great discipline with acquisitions in the past, and has shown that they can operate efficiently while keeping customers satisfied. Therefore, we don't view Alimentation Couche-Tard as a risky stock.

Conclusion

1. Alimentation Couche-Tard is a company that we are projecting will grow at about 23.6% per year for the next 3 years, but it is priced like a mature, low-growth stock, presenting a great opportunity to buy the company at a low price.
2. Despite the pandemic and the drop in revenue this year, Couche-Tard has managed to produce record earnings. The company has a great track record of consistent growth in operating results which has caused the stock to return over 11,500% in the past 20 years.
3. The convenience industry is very fragmented, offering Couche-Tard the ability to grow through acquisitions (which are done prudently).
4. The company plans on growing organically as well through things such as new store builds and their Fresh Food, Fast program.
5. As we mentioned in our previous article, Couche-Tard is a smart bet on two fast-growing industries: cannabis and electric vehicles. Instead of trying to pick a winner in a pool of young, cash-burning weed companies, you can pick a profitable company that can potentially leverage thousands of its locations. In addition, while the EV companies pour billions of dollars to battle it out for market share, Couche-Tard will simply be providing all of them with charging stations. Therefore, they will profit off the EV trend regardless of which companies survive. While waiting for these new and exciting markets to develop, you will be owning shares of a high-growth industry leader.

Note: Alimentation Couche-Tard's primary ticker is listed on the TSX. The stock is more liquid on that exchange than the OTC exchange.

Disclosure: I am/we are long ANCUF. 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.