Finding Quality and Value in the Convenience Store Industry

An attractive industry backdrop - if you know where to look 

The value proposition of a convenience store is to provide customers with convenient access to a wide array of goods, in addition to fuel. Aided by a product mix that leans towards lower-cost items, the convenience retail market has proven to be recession-resilient, as customers trade down during economic downturns. This has resulted in a sector that has historically grown at a steady low-single digits rate. While this overall pace is relatively pedestrian, we believe there are certain players within the industry who can sustainably drive revenue growth and profitability going forward.

The convenience retail industry is characterized by significant fragmentation and intense competition. According to the National Association of Convenience Stores, over 60% of the U.S. market is comprised of stores owned by single operators. 

With that said, there are a handful of large chains operating thousands of stores that sit on the other end of the spectrum. These large operators are able to leverage economies of scale and brand value to wield higher buying power when negotiating with suppliers, launch loyalty programs, develop higher-margin private label product lines, run more comprehensive and innovative fresh food operations, and more. Within the Nicola Canadian Equity Income Fund and Nicola U.S. Equity Income Fund, we own two of these companies: Alimentation Couche-Tard (ATD) and Casey’s General Stores (Casey’s) respectively. In addition to the lower-risk, defensive nature of the broader convenience retail sector, we view the idiosyncratic value drivers for each player as attractive.

ATD: A global leader with a proven playbook for success 

Established as a lone convenience store in Quebec in 1980, ATD has expanded into a global leader in the convenience and mobility industry, boasting nearly 17,000 locations worldwide. Under the ATD umbrella are numerous well-known brands, such as Circle K, Couche-Tard, Ingo, Mac’s, and TotalEnergies. In an investor presentation, the company outlined its business mix, which is divided into two primary areas: Fuel and Merchandise, with each accounting for roughly half of the total gross profit dollars. 

Our positive view on Alimentation Couche-Tard stems from our understanding that the company’s near-unparalleled scale affords it unique cost and investment opportunity advantages. Specifically, ATD is able to negotiate more favourable terms with suppliers and pursue strategic partnerships that underpin a cost structure comparing favourably to most peers. These cost savings are invested both organically and inorganically, contributing to an earnings and cash flow profile that has compounded in the mid-to-high teens on an annual percentage growth basis over the last 15 years.

When discussing inorganic investment, if one were to describe ATD’s approach to M&A (mergers and acquisitions) in one word, it would be “disciplined.” The company adheres to a strict ROCE (return on capital employed) target range of 11%-15% and has generally refrained from overpaying for deals in the past. Remarkably, ATD’s calculated ROIC (return on invested capital) has averaged 13% over the past 20 years, suggesting that the company not only adheres to its target return range for capital deployment but also actively delivers on it. This is an important characteristic we look for in quality compounders, and we view it as evidence of a management team that is effective at allocating capital.

Source: (Left) Capital IQ, ATD filings and presentations, (Right) TD filings and presentations

Casey’s: Uniquely positioned as the scale player within attractive rural regions  

Casey’s operates over 2,600 convenience stores throughout 17 states across the Midwestern US. Due to the company’s high concentration in rural geographies (with the majority of its stores located in townships with populations under 5,000), we believe the company benefits from relatively higher barriers to entry, more rational competition, and a lower overall cost of doing business.

The fundamental keys to success in the convenience retail industry revolve around product breadth and availability. In this regard, Casey’s vertically integrated business model, which includes self-distribution capabilities comprising 3 distribution centers and a truck fleet, enables the efficient provisioning of food, merchandise, and fuel to its network of stores. Additionally, Casey’s offers product differentiation; the brand is well-known for its freshly prepared foods, particularly its made-from-scratch pizza, which ranks the company as the 5th largest pizza chain in the U.S. We believe this should contribute significantly to margin expansion and earnings growth in the future.

Beyond organic opportunities, the company is well-positioned to continue accelerating its well-practiced consolidation roll-up strategy within its established markets, which are only approximately 25% penetrated. In other words, roughly 75% of towns surrounding the company’s existing distribution footprint do not currently have a Casey’s store, presenting over a decade’s worth of growth runway. The combination of the noted tailwinds and attributes has cemented Casey’s status as a stable, long-standing compounder with a history of delivering consistent double-digit returns.

Source: (Left) Capital IQ, (Right) Casey’s 2023 Investor Presentation

How we apply a “Quality” lens to our process  

We'd like to pause for a moment to reiterate our investment philosophy and process and emphasize how the highlighted businesses above fit into this framework. Drawing inspiration from legendary investors like Warren Buffet, Charlie Munger, and Howard Marks, we aim to employ a process that enables us to identify and build conviction in high-quality companies. This often involves seeking answers to various questions:

• Is this a business model we can understand?
• Do we have confidence that the existing competitive advantages and moats (such as network effects, switching costs, intangible brand values, and economies of scale) are sustainable?
• Is management transparent and honest, with a repeatable process and a successful track record in allocating capital?

These questions form the basis for our assessment of quality at the individual company level. Once we reach a conclusion, we compare the quality of the business against other opportunities in the portfolio or our inventory/watchlist of ideas. Finally, to ensure an appropriate margin of safety, we deliberate on valuation, upside/downside return profiles, position sizing, and the potential impact on portfolio characteristics and risk.

We have strong conviction that both ATD and Casey’s meet all of these criteria and embody the key characteristics we seek in the core compounders we love to own within our funds.