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Third Avenue's SUSS & CST Bets

|Includes: CST, Susser Holdings Corporation (SUSS)

Per Third Avenue's 3Q letter:

Susser Holdings

Susser Holdings ("Susser") (NYSE:SUSS) traces its roots back to 1938 when Sam and Minna Susser opened two service stations in Corpus Christi, Texas. Seventy five years later, the company is the second-largest non-refining convenience store operator and motor fuel distributer in the state of Texas and one of the largest company-operated convenience store chains in the U.S. (operating under the Stripes® banner) with operations in Oklahoma, New Mexico and Louisiana as well. We view Susser as a compelling long-term investment opportunity for a host of reasons:

• Growth: Susser has a strong track record of growing organically and via acquisitions under the leadership of CEO Sam L. Susser (grandson of Susser's founder).

Since Sam joined the company in 1988, Susser has grown from five stores and revenues of less than $10 million to more than 500 stores and revenues of more than $5 billion,completing 13 significant acquisitions along the way (not including Susser's wholesale distribution operation which also supplies fuel to more than500third-party locations). Impressively, Susser has grown same-store sales every year since then as well, and generally delivers among the strongest per-store statistics seen within the industry. With more than 90% of its stores located in Texas,the state's booming economy and strong demographic trends (young, rapidly-growing population, low unemployment, ranked number one in job growth) should continue driving strong growth for Susser for years to come. In addition, Susser should continue to take market share through 1) the accelerating buildout of higher-volume and more profitable big-box stores (two to three times the cash flow of its smaller legacy stores); 2) price-disciplined acquisitions (the convenience store industry remains highly fragmented, with numerous mom-and-pop operators); 3)entrance into under-penetrated Texas markets; and 4) increased offering of more profitable diesel fuel.

Management: Based on conversations with Susser's management, other industry executives and industry analysts, it has become abundantly evident to us that Susser's management team, while relatively young, is highly competent, innovative and laser-focused on creating long-term value for shareholders.Importantly, management has earned a reputation for being best-in class with regard to utilizing sophisticated technology systems for data gathering and analysis to improve all areas of its operations (e.g. fuel pricing, inventory management, labor utilization, and shrinkage)-a significant competitive advantage in our view. We are also encouraged that insiders own close to twenty percent of the company,creating a strong alignment of management's interests with those of outside long term shareholders.

• Laredo Taco Company: In the early 2000s Susser created a proprietary food service concept named Laredo Taco Company ("LTC") that serves freshly made tacos and Mexican food in a growing number of its convenience stores. LTC is arguably Susser's strongest competitive advantage today as it generates 1) incremental customer traffic, 2) much higher margins than fuel sales, and 3) the sale of other high margin merchandise with most transactions.

• Susser Petroleum Partners: In September 2012, Susser spun off its Susser Petroleum Partners ("SPP") wholesale fuel business into a Master Limited Partnership (NYSE:MLP) structure that provides fuel to Susser, as well as to third parties. While this structure creates a degree of "analytical noise" as it relates to the company's reported GAAP financials, it creates a more appropriately valued "currency" for SPP that it can use for growth and acquisitions while it effectively lowers Susser's cost of capital. Moreover, in addition to being the controlling general partner and majority limited partner of the MLP, Susser also holds a hidden asset of sorts in the form of Incentive Distribution Rights (IDRs) which effectively entitle Susser to an increasing portion of the MLP's distributions as it grows. While the distributions will likely be modest over the near term, SPP has attractive growth opportunities over the long-term through organic growth, acquisitions, and Susser stores being "dropped down" into the MLP via sale-leaseback transactions. The business model also provides a significant competitive advantage to Susser as it is able to take advantage of SPP's combined retail and whole sale fuel purchasing volume to obtain attractive pricing and terms.

• Financial position: Since coming public in 2006, the strength of Susser's balance sheet has steadily improved. In the wake of the SPP initial public offering and resulting proceeds, Susser has been able to refinance its debt at attractive rates and ultimately reduce its net debt to about one times EBITDA3 (down from about four times EBITDA in 2007).

• Valuation: Despite being recognized as among the highest-quality businesses in the convenience store industry, we were able to invest in Susser's retail operations at an implied valuation4 of less than six times trailing EBITDA, which represents a glaring discount not only to broader industry valuations but also to private market transaction values.In addition to its high-quality operations, we would argue that Susser deserves a premium valuation for its ownership of Laredo Taco Company in light of the brand's strength within Texas and the relatively high valuations ascribed to similar public "quick service restaurant" concepts.


Fund Management added a second, related holding in CST Common (NYSE:CST). With nearly two thousand locations throughout the U.S. and Canada (operating primarily under the Corner Store ® banner), CST Brands is the second-largest independent retailer of motor fuels and convenience merchandise in all of North America. CST came onto our radar coincident with its recent spin-off (May 1, 2013) from Valero Energy Corporation, one of the world's largest refining companies. As a result of only recently becoming an independent entity, the company's shares appeared to be temporarily "orphaned," with little sell-side sponsorship, for example, and no readily accessible financial data. CST enjoys a steady, cash-generative business in part because of its relatively broad geographic exposure, with operations spread across nine states in the U.S. (predominantly in the Southwest) and Canada (predominantly Quebec and Ontario). Encouragingly, CST's single largest geographic exposure is the state of Texas (at about a third of CST's store base), giving CST the most exposure to the state's fast-growing economy (based on store count) of all independent convenience store operators. New incentives for management and an ability to allocate capital accordingly will likely help to accelerate corporate growth since former parent Valero appeared to view CST as simply an outlet for motor fuel distribution rather than supporting the potential within its store base.
In addition to growth in the store base,CST also appears particularly well-positioned to improve its margins over the coming years. We see margin improvement coming from multiple sources, including 1) new larger-format stores that are more profitable than legacy stores, 2) increased focus on food merchandise sales which are much more profitable than fuel and cigarette sales and 3) improved technology systems to better manage inventory and costs (currently upgrading its SAP system). In addition to these initiatives, we expect CST management to make acquisitions in an industry that remains fragmented and characterized by smaller, less efficient operators. The Fund's current cost basis equates to an undemanding (in our view) eight percent free cash flow yield.