A Tale of Two Gas Stations: Long Susser Holdings, Short CST Brands

The following is a guest post from Tsachy Mishal of TAM Capital Management, who presents a look at a gas station pair trade, if you will.  Tsachy also runs the blog Capital Observer.

Market Folly readers will recall that hedge fund Scout Capital recently disclosed a position in CST Brands and this write-up presents a different viewpoint.


A Tale of Two Gas Stations: Susser Holdings & CST Brands


Susser Holdings (SUSS) and CST Brands (CST) both operate gas stations with convenience stores attached. Susser Holdings came public in 2006 with private equity backing, while CST Brands is a recent spin-off from Valero (VLO). On the surface a spin-off would seem far more attractive than a private equity backed IPO, but looks can be deceiving.


Business

Over 80% of Susser’s gas stations are located in Texas, the second fastest growing state in the US. CST’s gas stations are located across the southern US and Canada, with about a third being in Texas. CST mentions Texas numerous times in their Form-10 as a stand out economy and a driver of growth From the CST Form 10:

"The economy in Texas has fared better than many other parts of the U.S., partly supported by a solid economy, a relatively stable housing market and strong population growth and job creation. We have also benefited from the significant increase in economic activity in Texas that has resulted from the increased oil and gas drilling activity in Texas. We have a large number of convenience stores in Texas, and these operations have benefited from the increase in population resulting from employees of the oil and gas industry who have moved to Texas to support that industry."

On the basis of location, Susser has a clear advantage over CST with a much greater percentage of its gas stations being in Texas.

Susser earns the majority of its profits from convenience store sales while CST Brands is more heavily dependent on fuel sales. In 2012 59.7% of Susser’s gross profits came from merchandise sales, while 40% of CST Brands’ gross profits came from merchandise. The reason for this is that Susser’s average convenience store footprint is 3,600 square feet, while CST’s average footprint is 2,200 square feet.

Susser’s larger footprint allows it to sell fresh food and earn more from its convenience stores. CST Brands realizes that it is preferable to have a larger convenience store footprint and is planning larger footprints for its new stores but that doesn’t help its existing store base.

CST’s heavy dependence on fuel sales is a negative for a number of reasons. As Americans have been driving less and driving more fuel efficient cars, fuel usage in the US has been declining. By contrast, convenience store sales have been steadily increasing. Additionally, 2012 was an abnormally profitable year for fuel sales that is unlikely to be repeated.

As oil prices decline, gas stations are slow to lower prices. The $35 oil price decline in the second quarter of 2012 was a bonanza for gas station owners. In 2012 fuel gross margin for CST brands increased by 2 cents a gallon or $40 million, primarily as a result of this extreme downside volatility in fuel prices.

It is very unlikely that we see such an extreme move in oil prices this year. As a result, year over year fuel gross margin should decrease by close to 2 cents a gallon resulting in lower year over year earnings and EBITDA for all gas stations with a disproportionate effect on CST Brands due to its reliance on fuel sales.


Operation Performance

In 2012, Susser had same store merchandise sales growth of 6.6% and per store fuel gallon growth of 5.8%. CST does not provide historical same store sales numbers but does provide “per store” figures. In 2012 “per store” merchandise sales actually showed a slight decrease while per store fuel gallon sales showed a less than 1% increase.

In the first quarter of 2013 CST provided SSS figures for the first time and showed US SSS down 1.6% compared to Susser growing 4.2%. This is likely attributable to CST’s older stores and larger dependence on cigarette sales, which have been in secular decline. Cigarettes make up 40% of merchandise sales for CST compared to 19% for Susser. Dollar stores have recently moved into this category, which will increase pressure. Susser has clearly enjoyed superior operating performance to CST Brands.


Management

The Susser family has been in the gas station business since the 1930’s. Sam L. Susser, the CEO, joined the company in 1988, when Susser operated five stores and had revenues of $8.4 million. Sam Susser grew up in the gas station business, has 25 years of experience and a proven track record.

Kimberly S. Bowlers is the CEO of CST Brands. Below is her bio from the CST Form 10:

"Ms. Bowers was elected Chief Executive Officer and President of CST effective January 1, 2013. Ms. Bowers served as Executive Vice President and General Counsel of Valero from October 2008, and previously served as Senior Vice President and General Counsel of Valero since April 2006. Before that, she was Valero’s Vice President–Legal Services from 2003 to 2006. Ms. Bowers joined Valero’s legal department in 1997. Ms. Bowers was elected to the board of directors of WPX Energy, Inc. on December 30, 2011."

In other words Ms. Bowers, the CEO of CST Brands, has been a lawyer her entire career and has little operating experience. I’m certain she was a very capable lawyer but that does not make her a capable CEO. If experience counts for anything, then Susser has the superior management.


Valuation

Considering that Susser has the superior store locations, a superior business mix, superior performance and superior management one might conclude that Susser should trade at a premium to CST Brands. One would be wrong. Susser Holdings trades for less than 6.3 times EV/LTM EBITDA, adjusting for their ownership in SUSP (slide 21).

CST Trades for roughly 8 times EV/LTM EBITDA. Instead of trading at a premium Susser trades at a greater than 20% discount to CST Brands. This does not take into account that had CST been a public company they would have incurred additional expenses. Additionally, on a forward basis I believe Susser trades at a greater than 30% discount to CST Brands.


Conclusion

CST Brands is a case of “You Can Be A Stock Market Genius” gone awry. In investors haste to buy a “spin- off” they have valued a poorly performing company at an undeserved premium to one if its closest, better performing peers. There are too many geniuses out there right now.


Catalyst

CST Brands has not given any forward guidance so investors have had to create their own earnings models. Many investors seem to have simply extrapolated forward an increase in earnings and EBITDA from 2012 to 2013 for CST. This ignores the one time bonanza in fuel margins in 2012 ($40 million) and the increased costs of being a public company ($20 million). When CST reports second quarter earnings it should become clear that estimates are pie in the sky.


Full disclosure: TAM Capital Management is long Susser Holdings (SUSS) and short CST Brands (CST).

Embedded below is a .pdf copy of TAM Capital's thesis:




We've posted some other investment theses from TAM Capital here.

Crimson Wine Group (CWGL): Bull Case on a Unique Spin-off Opportunity

The following is a guest post by Tsachy Mishal of TAM Capital Management who presents the bull case on Crimson Wine Group (CWGL) which was recently spun-off from Leucadia National (LUK).  Tsachy also runs the blog, Capital Observer.

Crimson Wine Group: A Unique Spin-off Opportunity

Crimson Wine Group (CWGL) is a unique spin-off opportunity. Crimson Wine was separated from Leucadia National Corp (LUK) prior to its acquisition of Jefferies. The stated reason for the spin-off is as follows:

“Jefferies has advised Leucadia that Jefferies’ management deemed Crimson as less strategically relevant than Leucadia’s other subsidiaries, ascribing a value to Crimson no greater than approximately its book carrying value. As such, in assessing and negotiating the terms of the transaction with Leucadia, Jefferies’ management advised Leucadia that Jefferies viewed the pre-transaction divestiture of Crimson through the Leucadia winery business separation an efficient and desirable method of divesting Crimson, as compared with a post-transaction sale or other divestiture. It was therefore agreed between Jefferies and Leucadia that that the separation occur prior to consummation of the transactions, without reducing the book value of Leucadia by more than $197 million and that it be effected without Leucadia retaining any material liability with respect to Crimson.”  

My interpretation of this is that there was a disagreement about the value of Crimson between Jefferies and Leucadia. Jefferies did not believe Crimson was worth more than stated book. That would imply that Leucadia management believed it was worth more than stated book value since they decided to spin this off. If Leucadia management were willing to accept stated book as the valuation than there would be no reason for the spin.

Leucadia management owns a significant portion of the company with Chairman Ian Cummins owning 8.7% of the shares and Joseph Steinberg owning 9.7% of the shares. I believe it is significant that they felt it important to carve out this asset rather than to allow it to be valued at book value. This is especially important because this asset only makes up about 2% of the combined company. If it were worth anywhere close to stated book it would hardly be worth it to spin this off.

It is also worth noting that Leucadia management is in a much better position to value these assets as they have owned some of them for over twenty years. The Jefferies position is understandable in the context of a large financial company. Pro forma for the deal, Crimson would represent approximately 2% of book value. Financial companies are generally valued based on book value. It is unlikely given how small Crimson is relative to Leucadia that the market would ascribe value above book. So even though Leucadia thought it was worth much more than book, Jefferies thought they would never get credit for it in a large financial company.


Valuation

There are two ways to tackle the valuation of Crimson. The first is by book value and the second is through earnings power. I will attempt to do both starting with book value. Below is the pro forma balance sheet given by Crimson. Stated book value is $7.82:

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ASSETS
Current assets:
	Cash and cash equivalents		21,329
	Accounts receivable, net		5,287
	Inventory		41,487
	Other current assets		663
	Total current assets		68,766
	Property and equipment, net		108,485
	Goodwill		1,053
	Other intangible assets, net		20,403
	Total		198,707

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LIABILITIES
Current liabilities:
	Accounts payable		857
	Accrued expenses		5,393
	Customer deposits		1,178
	Total current liabilities		7428
	Total liabilities		7428
EQUITY
Common shares, par value $1 and $.01 per share			245
Additional paid-in capital			277,176
Retained deficit			-86,142
	Total equity		191,279
	Total		198,707

Breakdown of Wineries 

Crimson Wine Group is in the winery business and owns several vineyards. Crimson lists the value of its property and equipment on its balance sheet as $108,485, which includes the vineyards it has acquired. Crimson has acquired its vineyards over twenty plus years. The land is listed at cost even though the price has appreciated materially. Below is a breakdown of the value of their vineyards:

Pine Ridge Archery Summit - Pine Ridge and Archery Summit are Crimson Wine Groups most valuable wineries.  Pine Ridge Vineyards was acquired in 1991 and has been conducting operations since 1978, Archery Summit was started in 1993. In 2001 they were put on the market by Leucadia for $150 million as seen in this Wine Spectator article. Napa Valley winery prices trade at record prices and at significantly higher prices today than they did in 2001. I believe that this property is worth at least $150 million.

Seghesio Family Vineyards- Seghesio was acquired for $86 million in May 2011.

Chamisal Vineyards- Chamisal acquired for $19.2 million in August 2008.

Double Canyon- Crimson acquired 611 acres in Horse Heaven Hills, Washington for an undisclosed price in 2005 and 2006. A conservative estimate of their land and equipment there is $10,000,000.

The table below summarizes the value of Crimson’s wineries:

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Winery	Value
Pine Ridge Archery Summit	$             150,000,000
Seghesio Family Vineyards	$               86,000,000
Chamisal Vineyards	$               19,200,000
Double Canyon	$               10,000,000
Total	$             265,200,000

By assigning a value of $265 million to Crimson’s property & equipment and zero value to its intangible assets the book value becomes $326.3 million or $13.34 cents a share.

By looking at Crimson’s past earnings it is difficult to justify the current price. For the first nine months of 2012 Crimson reported 19 cents of pro forma earnings. However, the future outlook is brighter as earnings are set to ramp up.

Crimson has been significantly increasing production in recent years.  Between 2009 and 2012 it increased production from 117,000 cases to 296,000 cases.  At the same time gross margins have increased from 23% to 52%.  This increase has followed production increases in a relatively straight line as Crimson moves to much higher levels of capacity utilization.  Revenue per case has been between $185 and $235.  After bottoming in 2011 at 185, revenue per case increased again in 2012 as a result of greater contribution from Seghesio which has a higher than average ASP.  During the same period opex has consistently grown slower than sales. 

The Form 10 discloses that in 2013 they will be able to increase production by 58,000 cases at Chamisal and 50,000 at Seghesio.  This leads to total production of 404,000.  Assuming revenue per case of $195 and a slower than historical ramp in gross margins to 55%, this leads to net income of nearly $17 million.  Net income is equal to EBIT because they have no debt and NOLs shield them from cash taxes.  Cash flow will generally be better than net income as maintenance capex is half of D&A.

I estimate that Crimson will earn 70 cents in EPS in 2013 and roughly 79 cents in free cash flow per share. There are two pure play wine companies, Treasury Wine and Concho y Toro. They trade at an average of 20 times 2013 earnings estimates and 14.5 times FCF. Based on these valuations CWGL would be worth $14 on an EPS basis and $12.25 on an FCF basis (once one adds back $22.3 million in net cash). That works out to an average of $13.13, not far from my $13.34 estimate of tangible book value. It is important to remember that CWGL is under earning because its capacity utilization is low.


Conclusion

Crimson Wine Group has all the ingredients of a successful spin-off. The company has savvy management with a large ownership interest, the stock is too small for institutions to hold and there is no sell side following. From the current price of $7.78 the stock has roughly 70% upside to a conservative valuation.


The author is long shares of CWGL. Under no circumstances does this constitute investment advice. Under no circumstances does this information represent a recommendation to buy, sell or hold any security. The information is for educational purposes only. Positions may change at any time without notice.