Motley Fool Hidden Gems Investing - Stocks for the Road

Episode Date: September 15, 2024

If you’re looking for a stock that’s been a multi-bagger over the past five years, then check the gas station next to a Walmart.  Mary Long caught up with Motley Fool Canada’s Jim Gillies for a look at three companies you can find on your next road trip. They discuss: - An industry where investors can ignore sales growth. - What shifting consumer tastes mean for convenience stores. - One company “taking over a mountain no one else wants”. Companies mentioned: TSE: ATD, OTCMKTS: SVNDY, CASY, TKO, WMT, MUSA Host: Mary Long Guest: Jim Gillies Producer: Ricky Mulvey Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

But investing, we talk about the cash flow and how much cash a company and a business is valued on the cash it can make from now until the end of time, discounted back to the present at an appropriate discount rate. That's kind of stock valuation 101. But I think that misses a key point of the game of investing. And that is, well, what if management are morons? I'm Ricky Mulvey, and that's Motley Fool Canada's Jim Gillies. My colleague Mary Long caught up with him for a quick road trip.

They've got a look at three gas station stocks, including one going for a big acquisition, one selling frozen pizzas, and a market smasher that Jim personally owns. Our first pit stop is at Alimentacion Couchetard. Jim, you want to rank my French before we keep going? That's a solid 9 out of 10, Mary. That's well done. I will take 9 out of 10 when I can get it, honestly. Americans and Canadians both will probably recognize the Circle K brand, which Couchetard

owns, but this is a convenience store company with a pretty global presence. They've built that global presence largely through acquisitions. To say that they have a good track record with those acquisitions is probably a bit of an understatement. Since 2004, they've integrated more than 65 deals into the store network, now have nearly 17,000 stores worldwide. That includes licensees. Jim, successful acquisitions can be hard, but CouchTard seems to have figured out how to do

them well. What is the secret? Well, Mary, the secret is blocking and tackling. I actually don't even know what that means. I hear it a lot in conference calls when people talk about, what are you going to do to be successful? They, oh, we're going to block and tackle. And I presume it's a football reference, but I'm a hockey fan, so I don't really know. No, look, I think you've already said the answer. And the answer is they have a system. And they honed the system when they were a lot smaller. They've really been, I think it was from the year 2000 is really when they really started ramping this up. It might have been even a couple of years earlier. But they started small. They were smaller, of course. And so

they kind of honed a process, if you will. And they have a system and they also have a growth imperative. I think they're about $70 billion, $72 billion market cap, Canadian dollars, not greenbacks, but they are continuing because I guess they think there are still more worlds to conquer. They've had a little bit of a pushback and they've got a couple of failed acquisitions recently. They lost out on, I don't remember the name, Speedway or something. They lost out to the parent company of 7-Eleven on that one, I think in 2020. I think that's Seven and I Holdings. They also made a play for a French grocery store chain, which is a bit far afield from their standard things. The company's called Carrefour.

They lost them, I think, in 2021 or 2022. Carrefour wasn't interested. Although the Team Canada fools we were joking is that management here just really wanted a trip to Paris and said, oh, well, we'll call it due diligence. But no, I think they are one of those classic growth through acquisitions who they have a process and that is what they're going to follow even as they get larger and larger. You briefly mentioned Seven and I Holdings and CouchTard kind of came into the news recently because they made, we're going to switch between American and Canadian dollars, I guess, because I've got my American dollars, but CouchTard made a $42 billion offer for the 7-Eleven parent company, Seven and I Holdings. That was earlier

this summer. It sounds like yesterday, today, we're recording this September 6th, Seven came back asking for more. So that's certainly not a done deal, but we're talking about acquisitions. What do you make of the potential deal between CouchTard and Seven and I Holdings? I think it would be great. And I think it's unlikely to happen, or if it does happen, it is going to be a very difficult multi-year slog. You are correct. It was about 12 hours ago. Well, it says 12 hours when you'd be listening to this a week or so from now. Yesterday on the 5th of September, late on the 5th of September, the Japanese parent of 7-Eleven, that would be Seven Eye Holdings, officially said it was not interested, not in the best interest of Seven

and I and other stakeholders. And the quote is, we are open to engaging in sincere discussions should you put forth a proposal that fully recognizes our standalone intrinsic value and addresses our concerns regarding the closing in the current regulatory environment. translation, it's going to be really, really hard to buy in Japan, which is notoriously kind of standoffish to foreign acquisitions, although they have loosened their regulations there within the last year or so. As well, your offer is too low. We need more. I think it probably would face some regulatory issues in North America when a street corner with a circle K on one corner and then kitty corner to that is a 7-Eleven. They're both owned by the same company.

I think U.S. regulators will probably raise the proverbial Spockian eyebrow a little bit, but I think it's a bold deal. I haven't verified this. I haven't verified this, but if this deal does successfully go through, it would make Custard the fourth largest retailer in the world after names like Costco, Walmart, and Amazon. I don't know if you've heard of them. This is a gas station, so fuel revenues still make up the bulk of revenues for the company, but we have seen total sales in that segment slip between 2023, 2024. There's a lot to love about CouchTard. It's performed quite well in recent years, but a knock against it might be maybe that its sales growth recently has been kind of slow, kind of uneven. Why do we see that

slowness, that unevenness? Is that just volatile fuel prices being volatile and the price to pay for being in this space? Yeah. Give me $140 barrel oil again, and you're going to see sales growth. You'll be fine with the sales growth. We'll put it that way. I ignore sales when it comes to these types of things. That's reliant on gas simply because of what you said. It's so volatile. I think it's better to focus on profitability metrics up and down the income statement. Yes, you can even go with EBITDA if you want. Operating profit returns on equity. You want to focus on margins, like gross margins, for example. You want to see profitability is steady and as they grow and grow and grow, they still are able to maintain their

margins. So gross margins aside from one year during COVID where they somewhat made bank for some inexplicable reason, probably because people were only comfortable going to those stores rather than other places. Gross margins here typically run 17%, 18%. Operating margins run 5% to 6%. Nice, boring, consistent. Ignore the sales number because as you say, it will bounce around a lot that you have no control over too. And when it comes to margins, they see much higher margins on inside sales. So stuff like food, lottery tickets, et cetera, that are sold in store. Something that I caught is that nicotine products account for almost 40% of CouchTards merchandise sales, again, those inside store sales. So how might shifting consumer tastes,

like a turn away from cigarettes, or even just thinking about the gas piece, a push towards EVs impact CouchTards or just let CouchTard or just any gas station player in the space? Well, I'm actually shocked in North America when I see anyone who's smoking anymore. Like, you know, and I mean, I'm I'm old enough to remember when there was a when there was a smoking area at my high school. People don't you try and tell my kids, you know, like you'd go to a bar and there'd just be a haze of blue smoke about three feet above everyone's head. And that was normal. Right. Yeah. You know, you're like shaking your head going, no, I don't remember that. You're old, Gillies. A lot of the damage to the cigarette case is already done, I think,

and was done several decades ago. We're in a caretaking mode. They've proceeded to go ahead just fine. You've also got things like vaping, like nicotine pouches, the different ways to deliver you your um you know your nicotine cravings i don't personally have nicotine cravings but you know some people do and there's little things too like you're you're not going to have known about this because you're in colorado and i'm in ontario but this very week mary this very week the ontario government now allows the sale of beer wine and alcohol in corner stores and convenience stores this has literally happened this week typically don't you have to go to the lcbo oh well look look at you showing off there you go yeah lcbo beer store but a few years ago

they started allowing grocery stores to do it and and they finally they finally are allowing it in the corner stores like circle k so i could just as easily say well why will that not drive sales at uh at like a circle k and other kustard outlets rather than worrying about the nicotine purveyors to pull off the other thing and i think you're probably going to see as we i mean we are seeing a pullback in electric vehicles or at least the yeah a lot a lot a lot of people are like kind of more turned to plug-in hybrids electrical vehicle sales uh unlike once you get rid of a certain company you know which we won't name but uh you know a lot of the the vehicles from the legacy automakers you know like if if you want yourself a ford mach-e trust me you can find

inventory. There's a lot of inventory out there and you'll get a good deal because they're just not moving. But I think you're going to probably see more and more EV charging stations at places like Circle K. I wish this was a visual medium today because I would show you a picture I snapped last year because I drive my daughter to school every morning. There's a Circle K down the street from her high school. I snapped the picture in the morning because not only does a Circle K have your gas station and the Circle K banner out front, but there is both a Tim Hortons kiosk in there, so you can get your coffee fix, and a fire and flower store within a store, which is a cannabis store within Circle K. That is the most Canadian picture I've ever seen. You

get your Timmy's, you get your cannabis, you get your gas. They've got this network where they will sell and they'll try different things and they'll bring in the Timmy's kiosk where they think it works. I would ask anyone going to the Fire and Flower, please consume whatever you buy when you get home, not in your car while you're driving, so close to a high school, thank you. But there are levers that these guys can pull to keep their business going and I think they're pretty good at it. You're a value investor. CouchTard is trading at the lowest PE ratio of all the stocks that we're going to talk about today, less than 20 times earnings at the moment. What's not to like? No argument from me.

Next up, we'll head over to Casey's, which is a Midwestern US chain. It operates both convenience stores and gas stations, but it leans way more into the convenience store piece. They are really big on pizza, especially, allegedly, haven't tried it myself, breakfast pizza. They're also really big on being an underserved area. 72% of Casey's stores were opened in places with less than 20,000 people. Jim, that kind of strikes me as an interesting business plan. Go where no one is. I love that. I call that taking over a mountain no one else knew they wanted. And the example I always use when I bring up that kind of term is pro wrestling, right? All of life can be understood through pro wrestling. Ricky will agree with you on that.

I was going to say, you could hear the eyes rolling, but I'm serious, right? But Vince McMahon, everyone just kind of would turn their nose up at pro wrestling for years and years and years. And Vince McMahon and the WWF, or now WWE, now part of TKO Holdings, basically went national and then went international, took over all of the old territories where there used to be. There there'd be a Texas Wrestling Federation and a Carolinas and a Florida and up in Calgary, Alberta. And basically, the WWE just went through and took over everything. And all along the way, everyone's like, well, yeah, but it's fake fighting. It's pro wrestling. It's not serious. And you wake up one morning and it's this worldwide phenomenon dominated by one company.

Yeah, there's a couple of smaller entities. And now it's merged with the UFC. And everyone just kind of hand-waved it away all the way along as Vince McMahon built his empire. He's now largely out, but that's another thing. And that's kind of, to bring it back to Casey's, what a fantastic idea. Underserved areas, right? We're going to go in, we're going to be the incumbent. Yeah, Circle Cake might come in later, 7-Eleven might come in later, but we've already been here for a decade or a decade and a half. People in the community know we're here, might just continue you go. Inertia is a powerful thing. Habits are a powerful thing. You can probably keep the breakfast pizza though. I'm not terribly interested about that. Yeah. The comparison that you make is

apt because the business plan certainly seems to be working for Casey's. It's more than doubled the performance of the S&P over the past 10 years. What is it doing? You might pass on the breakfast pizza, but it seems that they're doing more than maybe just making really awesome, beloved pizza. Well, I am reminded, I think it was Babe Ruth. A reporter once says to Babe Ruth, hey, babe, you got paid more than the President last year, and Babe Ruth shoots back, yeah, but I had a better year than him. I think that's the Casey story. I've not looked terribly close at this company. I've glanced at it from time to time. But look, if you take a look at it, the profitability growth has outpaced the market. They have a five-year operating profit growth

of almost 17%. They started from a low valuation a decade ago. They get good and steady returns on capital. Those things together add up to a market-beating investment. And as you say, it's roughly doubled what the S&P has over the past decade. The gross margin on food sales at Casey's, this is going to be a common theme with any of these companies that we're talking about today, is close to 60% while margin on fuel is closer to 10%. The thinking goes that fuel is what gets people in the door at a lot of these places, but around 70% of Casey's inside transactions don't even include fuel. So at that rate, why even bother with gas at all?

Because you don't want to lose the other 30%. I mean, really, that's it, right? And what's the relative value of said transaction? So, you might get a lower margin, but I get a higher margin on the $10 of chocolate bar and soda I'm buying, but the $75 in gas I just put in my car, I might go like 10%, but the dollar value of profitability is not going to be that dissimilar. and then of course you also do have you know some people are buying fuel and buying you know buying the junk as well and so they go into the store yeah so i think it's probably it's like well we have to offer it look when we're all driving flying electric cars you know they'll probably stop offering gas but until then i think it's probably pretty safe they're trading

at around 28 times earnings does that make you like them even more less well i am more interested in cash flow multiples and cash flow metrics than I am in accounting earnings. But I think the 28 times earnings is probably best viewed when you view it towards a range. You could use EV to EBITDA or EV, I hate EV to sales, but that's another story. But you can use whatever metric you do. You want to do a time series and see where we are vis-a-vis, say, the last decade. And when you look at Casey's, most of those valuation metrics or their pricing metrics really, but most of those are today towards the high end of their historical range. I tend to be of the opinion that most of the time, gravity is the thing and long-term average will win out. I'd probably look at Casey's

as, this is probably a dollar cost averaging. If I want to build a position, I'm probably looking to buy in thirds or even fifths. I'm probably taking my time, dollar cost averaging every three or six months, maybe taking a look, maybe adding a bit more cash here and there. This is not one I would run into and make a 10% position on day one. Both of the companies that we've talked about thus far have pretty impressive track records, both handily outperforming the S&P over the past 10 years. This next one, though, blows them all out of the water. And you brought this to my attention when we were talking about this. It's up over 820% in the past 10 years, over 1200% since its 2013 IPO. It is, drum roll please, Murphy USA, a gas station chain with a whole

lot of stores located right next to Walmart's. So those are pretty impressive returns. Probably important to know that the company buys back its stock very aggressively, basically halved the total number of shares outstanding since it spun off from Murphy Oil in 2014. They implemented a dividend in 2020. They've made a point to increase that each year, if not most quarters. What notes have you got from management on their capital allocation strategy, Jim? Oh, I have no notes. Of the three we're talking about today, this is the one I own. Actually, I own this one individually. I own CouchTard via index funds in Canada. I'm sure Casey's is somewhere in an index fund that I own as well. But no, I own Murphy directly because of what you've described.

Their capital allocation is, I think, second to none in their space. They make a lot of cash. Investing, it is shocking to me how many times we will see this fall through. But investing, we talk about the cash flow and how much cash a company and a business is valued on the cash it can make from now until the end of time, discounted back to the present at an appropriate discount rate. That's kind of stock valuation 101. But I think that misses a key point of the game of investing. And that is, well, what if management are morons? What if management spends it all on gold toilets, giant monuments of excess to themselves, and hoses out equity cookies like it's no tomorrow, and so has to buy back their own stock to offset dilution. Those are things

that the company might make a lot of cash, but if management just completely wastes it all, the value of that company is significantly less than it otherwise would be. With Murphy, however, I think their capital allocation is fantastic. Again, it's why I own it personally and have for a while. I love the fact that they have been so aggressive at retiring their shares. They generally throttle it with valuation a little bit. They might take down a little bit of leverage when the valuation ratios are higher. They might take a bit more down the stock when they're a bit lower. It's going to shock people who usually think I'm so negative, but I'm not. I'm actually optimistic. I just like to think I'm fairly realist. These guys get 10 out of 10 from

me. Anything that's a yellow flag or that you've got an eye on that could give you a more bearish angle on the company or something you're worried about? I'm not really worried about too much here. The valuation's a little, I mean, the pricing ratios are a little pricey. I think last I looked, 25 times earnings, which is fine. It's not great. I think the story started to get out a little bit. They did up their leverage a little bit. They got about $1.7 billion in debt, which kind of came with the acquisition in 2021 of, I think that was QuickStop when they bought that. But no, this is just a well-run, how do I put this delicately? This is a well-run- Don't be delicate.

Yeah, it's true. When have I ever been delicate? This is a really, really well-run company that has outstanding capital allocation. Using the cash it generates in the service of shareholders via multiple means, buybacks, dividends, intelligent, well-timed acquisitions, and investing for growth, maybe a bit of deleveraging, trading at a reasonable but not compelling price. One of the interesting things about Murphy's is it has a massive focus on affordability. They highlight in earnings presentations that like 63% of their customers are living paycheck to paycheck. And that's up from the year prior. They want to serve that group of people. Does that apply a different kind of pricing pressure to Murphy that maybe

other players in this space don't have to worry about as much? I'm not sure I would agree with that. I think the pricing pressure part. I think what I would somewhat sarcastically suggest that given what inflation has done and economic conditions of the past couple of years have done, maybe this is just a function of more people are living paycheck to paycheck. That's a little cynical. Again, this is the variant of what I talked about with Casey's where how I look at, they focus on smaller and underserved communities under 20,000 people. They're going after a mountain, no one else knows what they want. When you are in a competitive industry, which this is a competitive industry, right? No one says,

I don't think anyone, like I have yet to meet the person that says, look, I'm a Circle K man. I will not walk into, I will not walk into a Murphy. I will not walk into a Casey. I will not walk into 7-Eleven. You know, I think you have to have a niche. I think you have to have a differentiator. And so we know what Casey's is. And I think we kind of know what Murphy's is here. And also it doesn't help if you're a gas station, if you are offering the lowest price, that's often what gets me in the door at a gas station, regardless of where I am. Yep. That one-tenth of a cent lower, I'm going to cross three aisles of oncoming traffic just so I can get it. Yep. Jim, thanks so much for hanging out today and talking about these often

untalked about companies with me. Appreciate the time. My favorite kind. It was a pleasure going on this road trip with you. Thank you. as always people on the program may have interests in the stocks they talk about and the motley fool may have formal recommendations for or against so don't buy or sell anything based solely on what you hear i'm ricky mulvey thanks for listening we'll be back tomorrow