Engine Capital LP, together with its affiliates (“Engine”), owns approximately 1% of the outstanding shares of CST Brands, Inc. (“CST” or the “Company”). CST represents a significant investment for Engine. We invested in CST because we believe the Company is deeply undervalued and that there exist opportunities readily within the control of the Board of Directors (the “Board”) to substantially increase shareholder value. Over the last few months, we have shared with you a number of concerns and suggestions around the poor stock performance of CST since its spinoff from Valero Energy Corporation (“Valero”), the significant operational underperformance of the Company, executive compensation, capital allocation, real estate monetization, corporate governance matters, investor communication and board composition. We had hoped, following our discussions, to work cooperatively to increase value for all shareholders. Unfortunately, given the lack of progress to date together with the importance to act with urgency, as described in more detail below, we have little choice but to share our thoughts publicly at this time.
CST has a collection of valuable assets, including (i) a large portfolio of retail stores in the U.S. in populous, growing areas such as Texas, Colorado and California, (ii) a large retail presence in Ontario and Quebec, (iii) a very significant portfolio of real estate holdings, and (iv) an attractive legal and capital structure with a “sponsored MLP” relationship. The public market is not currently ascribing appropriate value for these substantial assets. CST trades at a significant discount to its public peers with Alimentation Couche-Tard (“Couche-Tard”) and Casey’s General Stores, Inc. (“Casey’s”)1 trading at approximately 13x and 10x EBITDA, respectively versus approximately 8x for CST. CST also trades at a significant discount to what it would fetch in a sale given the scarcity value of this at-scale asset, the consolidating nature of the industry and the recent transaction multiples. Based on recent M&A transactions, we estimate that CST would sell for between $50 and $55 per share, implying a premium of around 43% to the current stock price (assuming the midpoint of our valuation range).
Fundamentally, CST is in a strategic quandary. The Board and senior management view the Company as one of the industry consolidators, yet is unable to articulate how it improves operations at its target companies. A consolidation strategy works when the consolidators are the best operators and bring the most value to their targets. As we describe below, CST has consistently lagged the better operators on the key relevant metrics. In CST’s case, it is the targets that tend to have the best-of-breed merchandising practices that CST is trying to acquire2. In this consolidation phase, CST competes with entities such as Speedway (a division of Marathon Petroleum Corporation), Sunoco LP and Couche-Tard. These three companies are top-tier operators that significantly improve the operations of their targets and that can therefore afford to pay more than CST for their acquisitions. As an example, Speedway monitors and manages its business using a statistic called Light Product Breakeven which incorporates merchandising productivity and fuel volumes to determine the fuel breakeven pricing. Speedway’s breakeven cents per gallon is below 3 cents compared to approximately 7 cents for CST3, indicating much better merchandising and operating productivity at Speedway. Additionally, the recent and dramatic decline in value of CAPL is further exacerbating this strategic issue. Without the CAPL currency, it has become even harder for CST to compete for assets against larger players with lower cost of equity. In other words, CST has a higher cost of capital than the three natural consolidators and is not as productive on the merchandising side. CST must quickly demonstrate it can increase its merchandising and operating productivity if it is to be one of the enduring consolidators in the industry.
The recent Flash Foods deal is a case in point. As part of the deal synergies, CST has communicated that it expects a $4 million improvement in gross profit by year three, which equates to an approximately $24 thousand benefit per acquired store. By comparison, in the recent purchases of Hess Retail (by Marathon Petroleum Corporation) and The Pantry (by Couche-Tard), the increase in anticipated gross profit dollars per store was approximately $56 thousand and approximately $39 thousand, respectively4. These better operators can squeeze more profits from their targets and can therefore afford to pay more, which make them the natural consolidators in this space. While it is difficult to evaluate the financial attractiveness of the Flash Foods acquisition because management has not shared any financial metrics of the target, our point is that CST must become a best-in-class operator if it wants to pursue a successful consolidation strategy given the competitiveness of the M&A market.
With this as relevant industry background, we believe that two avenues exist for senior management and the Board to significantly increase shareholder value. One option is for CST to remain a standalone public company, but make the necessary changes to aggressively improve the numerous aspects of its business operations that we highlight below. If management is able to execute on this, we believe CST can compound earnings attractively over the medium to long term given the industry tailwinds which include an expanding convenience store market and competitive advantages over smaller gasoline retail players. The other option is to promptly initiate a review of the Company’s strategic alternatives and explore what buyers may be willing to pay for CST in the current robust M&A market. Engine would be supportive of the option that creates the most risk-adjusted value for CST shareholders.
It is imperative that the Board act with a sense of urgency given the stock performance5 of CST versus its peers and the S&P 500 since the Company was spun off from Valero more than two years ago.
Total Shareholder Return
In order to become a top tier operator, CST needs to immediately improve the following areas of its business:
A. Merchandising Operations
Based on our research, it appears that CST is substantially lagging its peers when it comes to providing compelling merchandise and foodservice offerings, as evidenced by the lagging merchandising same store sales (“SSS”) and higher Light Product Breakeven of CST versus its peers6 in both US and Canada.
US Same Store Sales Growth
CST (U.S. Retail)
Susser / Stripes
Casey’s (Grocery & Other)
Casey’s (Prepared Foods)
Canadian Same Store Sales Growth
CST (Canadian Retail)
The same store sales figures above do not paint the full picture of underperformance because (1) most of CST’s stores are located in states with above average population growth; and (2) the SSS for CST includes a mix shift towards larger New to Industry (NTI) stores.
This is particularly concerning given that the merchandise sales per store at CST is well below the sales of its industry peers7.
Merchandising sales per site per
In other words, CST started from a very low basis but is still underperforming its peers when it comes to merchandise SSS since the spinoff from Valero in 2013. By comparison, Hess, another low merchandising volume network, is seeing significant improvement following Speedway’s purchase.
Engine believes there is significant room to grow this portion of the business with more foodservice penetration (CST has one of the lowest foodservice penetration among its peers), better private label offerings, loyalty card offerings, and