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CST Brands – Value in the Corner

I came across CST Brands (CST) as I follow spin-off situations closely. CST Brands was spun-off on May 01 2013 from Valero Energy Corporation (VLO). Valero still owns 20% of the company with the rest having been distributed as a tax free spin-off to VLO shareholders. Joel Greenblatt book 'You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits' is an excellent resource for learning about spin-offs and special situations.

I) The Record

The record of spin-offs in last few years has been excellent when there has been value to be unlocked. Following is a summary of the latest results of the Bloomberg capitalization-weighted index of U.S. spun off companies and their historical performance. To see the members’ index weighting, use {BNSPIN Index MEMB}.

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II) Business and History

CST Brands is a recent spin-off so it does not have a long history. The following is the information from the company website.

CST Brands Inc. (CST) is one of the largest independent retailers of motor fuels and convenience merchandise in North America. Based in San Antonio, Texas, CST employs nearly 12,000 Team Members at nearly 1,900 locations throughout the Southwestern United States and Eastern Canada offering a broad array of convenience merchandise, beverages, snacks and fresh food. In the U.S., CST Corner Stores proudly sell Valero fuels and signature products such as Fresh Choices baked and packaged goods, U Force energy and sport drinks, Cibolo Mountain coffee, FC Soda and Flavors2Go fountain drinks. In Canada, CST is the exclusive provider of Ultramar fuels and its Dépanneur du Coin and Corner Stores sell signature Transit Café coffee and pastries. For more information about CST, please visit cstbrands.com.”

III) Operations and Competitive Advantages

Overview

1. One of the largest independent retailers of transportation fuels and convenience merchandise in North America.

2. Nearly 1,900 sites in two geographic segments: Retail-U.S. and Retail-Canada.

2012 revenues of $13.1 billion.

3. Pro forma 2012 EBITDA of $379 million.

4. $455 million of capital expenditures over the past 4 years.

5. Almost 60% of which relates to store remodels and sustaining activities.

Retail – U.S

1. 1,032 company-operated (COOP) fuel and convenience store sites.

2. Sites located in the Southwest and Central U.S.

3. Targeting 15 New-to-Industry (“NTI”) sites in 2013.

Retail – Canada

1. 848 retail sites.

2. 261 COOP fuel and convenience store sites.

3. 507 dealer/agent-operated sites (participate in fuel sales only).

4. 80 unattended truck fuel sites (“Cardlock” sites).

5. Sites located in the provinces of Eastern Canada, including Ontario and Quebec.

6. Targeting 8 NTI sites in 2013.

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These are some of the competitive advantages:

1. Scale of operations in operating locations of Southern U.S. and Central and Eastern Canada.

2. Prime real estate locations already owned act as barrier to entry. Company owns 78% of the operated locations which could we worth between $1.7 B to $2.0 B.

3. Geographic diversity with US and Canadian operations provides stability.

4. Operates in attractive markets with growing population in South West US and Eastern Canada.

5. Has favorable 10-year fuel agreement signed with Valero. Valero is 20% owner and incentivized to success of CST.

IV) Balance Sheet and Profitability

CST Brands has a reasonable balance sheets for a stable cash generating business. As part of the spin-off from Valero CST distributed $1.05 billion to Valero in the using a $500 million five-year term loan (Libor + 1.75%) and $550 million 10-year notes (5.5%). CST currently has $245 million cash and net debt of $805 million.

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V) Management

Kim Bowers, President and Chief Executive Officer

Kim has over 15 years of service with Valero, having served as its executive vice president and general counsel since 2007 until her promotion to her current position in January 2013. Prior to joining Valero in 1997, Kim specialized in mergers and acquisitions with a Fort Worth, Texas-based law firm. Kim holds a B.A. in Spanish and international studies from Miami University (Ohio), an M.A. in international relations from Baylor University, and her J.D. from the University of Texas, School of Law. Kim is a 2009 graduate of the Stanford Executive Program.

Clay Killinger, Senior Vice President and Chief Financial Officer

Clay has over 11 years of service with Valero, having served as its senior vice president and controller since 2007 until his promotion to his current position in January 2013. Prior to that, Clay served as Vice President and Controller of Valero since 2003. Prior to joining Valero in 2001, Clay was a partner at Arthur Andersen LLP, with service there from 1983 through December 2001. Clay is a certified public accountant, with his B.B.A in accounting from the University of Texas at San Antonio, where he graduated summa cum laude.

VI) Value and Price

CST Brands has been trading in $27 to $30 range over the last three weeks. One share of CST was distributed for every nine shares of VLO, so it is highly likely that a large number of owners of VLO would dispose the shares of CST. Also the market cap of CST is less than $2.5 billion, so many fund managers may also liquidate their CST shares to meet specific mandates for the funds.

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Mritik Capital projects a share price of $60 over the next four to five year period based on certain assumptions listed below. This would imply CST trading at an EV/EBITDA of eight, which is in-line with competitors like Casey's General Stores Inc. (CASY), Susser Holdings Corp. (SUSS) and Alimentation Couche-Tard Inc. (TSX:ATD.A) which currently trade with EV/EBITDA range of 8 to 12. This would represent a 22% annual return over the next five-year period to 2017.

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VII) Catalysts

The market is awaiting a year’s worth of performance as an independent company to fully assess the valuation of the company. Although there may not be any immediate catalysts in next few months I can think of the following catalysts over the next three years.

1. Focus on execution while operating as an independent company could allow CST to improve margins and ROA.

2. Company plans to open 23 NTI (New to Industry) Locations in 2013. There is possibility of significant organic growth over next five years.

3. Company plans to expand food service partnerships, branded and private label products across the stores. These products could lead to higher margin sales.

4. CST could be an excellent acquisition candidate for Casey's General Stores Inc. (CASY), Susser Holdings Corp. (SUSS) and Alimentation Couche-Tard Inc. (TSX:ATD.A) and CEO Kim Bowers being an M&A specialist would be open to this.

5. Company owns 78% of the company operated locations and current real estate value is worth between $1.7 billion to $2.0 billion. As the company pays down $1 billion debt and real estate value further increases, there is the possibility of a REIT spin-off of the property assets to unlock value.

VIII) Risks

As in any investment there are some risks associated with an investment in CST Brands. Following are some of the risks:

1. Convenience store and retailing is a very competitive business. If company does not execute well performance may suffer.

2. CST operates with significant fixed costs and volatile fuel prices can lead to wild swings in profitability.

3. If interest rates rise sharply over next one to two years (which is unexpected) interest expenses would rise and reduce cash flow and earnings.

4. CST expansion of food service partnerships, branded and private label products across the stores may fail to improve overall margin.

IX) Why Is This Cheap?

I see the following reasons for cheap valuation relative to peers.

1. Market is taking a wait and watch approach to see how the newly spun off company will perform.

2. Institutional investors may be selling CST stock due to various reasons why spin off shares are sold. This includes forced selling due to CST being an insignificant position (1 share of CST received for 9 shares of VLO) and market cap of new company CST being only $2.2 billion as opposed to 22.5B for VLO.

3. Convenience stores are generally not considered an attractive businesses. Also CST has to compete with seasoned operators like Casey's General Stores Inc. (CASY), Susser Holdings Corp. (SUSS) and Alimentation Couche-Tard Inc. (TSX:ATD.A) which have excellent managements.

4. Currently there are very few analysts covering this stock and hence the stock is under the radar of many investors.

Disclosure

I own shares of CST Brands.

Comments and questions welcome.

Read more:

1. CST Investor Relations

2. Susser Holdings Corporation

3. Casey's General Sores Inc

4. Alimentation Couche-Tard Inc

5. Joel Greenblatt's Book on Spinoffs

Note:

I have used information from CST Brands investor relations website, investor presentation and financial statements.

About the author:

MritikCapital
Mritik Capital Inc. is a financial advisory firm with focus on identifying quality businesses with durable competitive advantages that are undervalued. Our first goal is to preserve the capital of our clients and look for strategies for enhancing their net worth based on opportunities that present compelling risk adjusted reward.

Please note that investing offers both risks and rewards. Before investing do your own due diligence and consult your financial advisor.

Visit MritikCapital's Website


Rating: 4.0/5 (26 votes)

Comments

grox01
Grox01 - 1 year ago
This looks promising, but how to value it now?

Does the Corner Store's numbers includes all the brands?

Thank you,
MritikCapital
MritikCapital - 1 year ago
Hi Grox01,

Thanks for reading the article and commenting on it.

Yes the numbers are consolidated and includes all brands. The company is relative to peers undervalued. Although the stock has moved up a bit since it was trading "When-Issued". Given the focus of the management and strategy as a new company I am hopeful of upside from value creation. The real estate value does provide some downside protection.
s.manos
S.manos - 1 year ago
Great Article! I also got in CST in the 'When-Issued' Market and it has gone up indeed! A few other things I love about CST:

1) They are in the retail industry YET they do not have to compete on pricing, as long as they are located in convenient locations and the stores are designed conveniently ( in and out within a few minutes).

2) The gaz business in Canada is actually a very good business as it is regulated and has already gone through a consoliation. They do low to mid 20s cents /gallon in CAD:

trinathdasari666
Trinathdasari666 - 1 year ago
Article looks very promising and very informative ...
Crosshair
Crosshair - 1 year ago
Any explanation as to why margins (EBITDA/Revenue) are set to grow 23% from 2.89% to 3.55%?

Assuming margins stay fixed at 2.89%.

2017 EBITDA: $16,285 * 2.89% = $471MM

Enterprise Value: $471MM * 8 = $3,768MM

Enterprise Value - Net Debt: $3,768MM - $1,276MM + 245MM = $2,737MM

Shares Outstanding: 74MM

Value per Share: $2,737MM / 74MM = $36.99 (a far cry from $60...)

Also, I'm not following your math.

Assume you're correct that margins will grow to 3.55%.

2017 EBITDA: $577MM (as stated)

Enterprise Value: $577MM * 8 = $4,616MM

Enterprise Value - Net Debt: $4,616MM - $1,276MM + 245MM = $3,585MM

Shares Outstanding: 74MM

Value per Share: $3,585MM / 74MM = $48.45 (How do you get $60.61??)

Crosshair
Crosshair - 1 year ago
I figured out the issue - your spreadsheet is not updating your cash line, i.e. in 2017, you only show $245MM in cash, when, presumably, this would have grown since 2012. I'm now able to work out how you get to $60.

But, again, my question remains regarding EBITDA margins - what accounts for the 23% increase?

MritikCapital
MritikCapital - 1 year ago
Hi Crosshair,

Thanks for reading the article and uncovering the issue in the spreadsheet. I will be correcting the spreadsheet and updating when I am back home later in the weekend. As to the improved margin I am counting on the dedicated management to make improvements and also larger weighting of higher margin item sales.

Thanks
MritikCapital
MritikCapital - 1 year ago
Hi S.manos, Trinath,

Thanks for reading the article and comments.
Crosshair
Crosshair - 1 year ago
Hi Mritkl Capital,

No problem. Thanks for pointing out this investment idea - it looks very interesting.

Crosshair
MritikCapital
MritikCapital - 1 year ago
Hi Crosshair,

I have updated the xls with the corrected formula for Price that now correctly includes the net debt and uses fixed cash column.

Pc = (J21*J5-J12+J11)/J14

Pricre = (EV - NetDebt)/NoOfShares.

Something for us to consider is how management will use the free cash flow since this business is going to be cash flow positive. I don't believe management has articulated their capital allocation strategy yet. The following are the possibilities:

1) They pay down debt.

2) They use it for accelerated organic growth or acquisitions.

3) They pay a dividend or buyback shares.

All 3 of these will increase the per share intrinsic value of CST. I think if interest rates stay slow for extended time it is better to keep some of the leverage. Anyway for the purpose of my price projection to 2017 I have assumed cash generated to build net of taxes which I think is conservative.

Let me know if you have more feedback once you review.
MritikCapital
MritikCapital - 1 year ago
Hi,

CST Brands latest Quarterly SEC Filing was published today along with this press release.

MritikCapital
MritikCapital - 1 year ago
Thoughts on CST Brands valuation in Barrons article about spinoffs.

Please leave your comment:


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