By Ryan Fuhrmann, CFA
Convenience-store operator the Pantry(Nasdaq: PTRY) continues to fire on all cylinders, reporting strong 2006 results. The stock could continue its healthy run going forward, but a couple of items could also derail its prospects.
The Pantry released fiscal 2006 results yesterday morning, reporting an impressive total revenue increase of 34.6% to $6 billion, and a 54.3% increase in net income. Better yet, same-store sales advanced 4.9%, continuing a four-year trend of positive comps. Merchandise gross margins also improved, while gasoline comps grew 3.1% for the year. (Here’s a Q4 numbers breakdown.)
Convenience stores generate the bulk of their sales from gasoline; for the three fiscal years prior to 2006, gas accounted for 68% of the Pantry’s total, but it jumped to nearly 77% this year as gas prices increased rapidly. Selling gas is a very low-margin affair; the Pantry makes less than $0.07 per gallon. Fortunately, customers also buy prodigious amounts of beverages, tobacco, and food while filling up their tanks. Merchandise gross margins were a much higher 37.4% for the Pantry this year, having exceeded 36% for four years now.
The gas station industry is highly competitive and mature, but the Pantry and rival Casey’sGeneral Stores(Nasdaq: CASY) have proven adept at growing their store bases via internal means and regular acquisitions of mom-and-pop stores. There are few big operators; 7-Eleven competes in the space, and grocery-store chain Kroger(NYSE: KR) operates a number of convenience stores, but other than that, only Village Super Markets(Nasdaq: VLGEA) shows up in the publicly traded realm.
The Pantry and Casey’s manage to generate operating cash flow far in excess of reported net income. The Pantry generates impressive cash flow, but spends more than it creates internally to expand its stores and buy out competitors. As such, it must rely on debt to keep growth chugging along.
The Pantry’s debt levels are my biggest concern. I don’t quite understand what the hurry is to acquire market share, since it would be less risky to better align annual internal cash generation with M&A activity. However, the strategy has worked out so far, juicing overall growth and benefiting shareholders.
Casey’s appears to have a more conservative acquisition strategy, but its valuation is much higher, and it operates in the slower-growing Midwest. Trading at less than 14 times next year’s projected earnings, the Pantry is more favorably valued and operates in the faster-growing Southeast Sun Belt region. Both firms should be able to grow unabated for years; the industry is highly fragmented, and Americans are as dependent on gasoline as ever. But acquisitions are fraught with peril, and a heavy debt load will only exasperate any merger snafus or industry difficulties at the Pantry.
For related Foolishness:
Stock up on investing advice with a free 30-day trial to the Foolish newsletter of your choice.
Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to discuss any companies mentioned further.