Description

Casey’s General Stores (CASY) is the nation’s 3^rd largest convenient store operator with stores located in the Midwest, Texas, and other parts of the south.  It’s a well-run company with a long track record of both organic and inorganic expansion, in addition to solid EPS growth and cash generation.  CASY was last written up on VIC in April 2022.  It turned out to be an excellent recommendation, but not for reasons articulated by the author, who focused on more event-type thesis points that have not played out (i.e., monetizing owned real estate, refranchising, outsourcing owned distribution, and a possible acquisition of the company).  Instead, the stock performed nicely the old-fashioned way: continued store growth, margin expansion, sound capital allocation, and a bit of multiple expansion.  My thesis today is similar: I think CASY is an excellent company operating in a favorably structured industry that has a long runway for growth.  Using restrained assumptions, I underwrite a low-teens 5-year IRR that has upside into the mid-teens.  I realize this might lack the sex appeal of some other VIC write-ups, but I happen to think that a higher conviction low-to-mid-teens IRR over many years is quite interesting.

What is Casey’s?  I’ll keep this brief.  CASY is the 3^rd largest c-store operator in the U.S. with ~3,000 stores (projected year-end fiscal 2025).  Most of the stores are in the Midwest, but recent acquisitions, notably the pending acquisition of Fikes for $1.15 billion ($980 million after tax benefits), have expanded the company’s range into Texas and other southern states.  The company is also the 5^th largest pizza company in the U.S. and has the 4^th most liquor licenses among U.S. retailers.  “Inside sales” account for just under 2/3rds of gross profit, with the remainder coming from fuel.  Inside sales are higher margin (low-40s %) and growing faster.

CASY’s is notable for a few reasons:

1. High exposure to rural areas: 2/3rds of its stores are in less competitive rural areas.
2. Significant white space for expansion as ~75% of towns with populations of 500-20k in CASY’s distribution footprint do not have a Casey’s store.
3. 70% of inside transactions do not include a fuel purchase.
4. Vertical integration: CASY operates its own inside distribution through three distribution centers; in addition, ~60% of fuel is delivered from its own tanker fleet.
5. Owned real estate: the company owns nearly all its real estate.
6. More reward members (60% vs. 40% for the industry) drives customer loyalty.
7. Private label: ~5% of sales going to ~10% (compared to 10-15% at grocery stores).

These factors, along with strong management execution over the years, has made for very happy shareholders.  Over the past twenty years, the stock has generated an annualized total return of 17.5%, compared to the S&P 500 at 10.7%.  Not bad for a boring little company.  And it remains a small(ish) company, with a market cap and enterprise value of $13.8 billion and $15.1 billion, respectively. 

What’s the investment thesis?  Big picture, I have a “keep doing what you’re doing” investment thesis with a few key parts:

1. Favorable industry structure.  The c-store industry is incredibly fragmented.  Of the ~152k locations in the U.S., 63% are owned by operators with 1-10 stores.  Another 6% are owned by operators with 11-50 stores.  Only 21% of locations are owned by operators with more than 500 stores.  With soon to be ~3k stores, CASY is thus a major player.  But what’s exciting is that it is both absolutely small (~2% market share) but relatively big, which conveys numerous competitive and scale advantages to the company.  Most of CASY’s competitors are small, unsophisticated players who lack the scale and resources to compete in an increasingly complex business with ever greater technology and regulatory requirements.  Even worse for this cohort, larger players like CASY are increasingly able to offer better products (e.g., fresh food, groceries, dry goods) that are either impossible or cost-prohibitive to offer. 
2. Long runway for growth.  Historically, CASY has pursued a “buy and build” strategy.  From FY-10 through FY-24, the company added more than 1,300 stores, 53% from acquisition and 47% from new builds.  This nearly doubled the company’s store count.  If anything, I think it’s likely that the company’s store growth accelerates in the coming years, mainly from M&A.  As mentioned above, CASY’s smaller rivals are simply outgunned as they’re forced to compete against larger players who have scale benefits from logistics and operating costs, robust IT platforms and loyalty programs, and, critically, more and better inside products.  CASY can buy these businesses at very accretive prices, usually mid-single digit multiples or less after synergies (even Fikes, a strategic acquisition, is only 7.3x after tax benefits and synergies).  Furthermore, CASY’s has massive whitespace in its distribution footprint with ~75% of towns in its targeted rural demographic lacking a Casey’s location.  It’s not difficult to imagine CASY with 50-100% more stores in ten years (compared to +60% over the last ten years).
3. Focus on less competitive markets.  Casey’s operates mainly in rural areas with little to no competition – and the competition that does exist in these markets typically consists of small, unsophisticated operators.  Roughly 2/3rds of its stores are in towns with less than 20k people.  This is, obviously, a highly desirable footprint in which CASY can press its competitive and scale advantages.  Even better, the U.S. rural population is growing again, driven by migration out of cities following the urban Covid experience and the WFH movement.  These markets also under-index to EVs, which is more of a theoretical than practical risk for the foreseeable future.
4. Margin leverage opportunities.  Management has a few levers to pull to enhance margins (outside of fuel margins, which are another story).  As noted above, the company has built a significant distribution footprint that is currently underutilized.  Also, CASY is making a big push into more profitable private label products, which could easily double from 5% to 10% of inside sales.  Old fashioned operating expense leverage is also on the menu, and management’s track record here is impressive.  In FY-23 and FY-24, a highly inflationary period, same store opex ex-credit card fees grew only 2.8% and 2.7%, respectively, compared to inside same store sales of 6.5% and 4.4%, respectively.  Lastly, there’s an opportunity to increase inside sales related to fuel sales.  Today, only 25% of gas sales involve an inside sale.  Could this be higher?  Other markets suggest that it could be.  In Europe, 50% of fuel sales include an inside purchase.  Perhaps a longer charge for your EV means a slice of pizza and a Coke?
5. Strong cash generation and ample balance sheet capacity to support growth.  CASY generates a lot of free cash flow and does so consistently.   Over the past five years, operating cash flow grew at an 11% CAGR, which approximated the CAGR in gross profit.  And despite significant store growth during that period, the total investment in working capital during that period was positive $87 million.  Operating cash flow converts at a high level, averaging ~93% of EBITDA.  This has provided a reliable source of cash for expansion, with the bulk of this cash flow reinvested into new stores, remodels, and acquisitions.  It also means that management is less reliant on CASY’s balance sheet to finance growth.  Even after the Fikes acquisition closes, net leverage will be just over 2x, implying significant dry powder should management find larger M&A opportunities in the near term.  Should it wish to do so, management could easily run the company with 4-5x turns of net debt (though I think this is unlikely).  And remember, CASY owns nearly all its real estate, which is another source of funding optionality.

While they are not key to my investment thesis, I would be remiss in not highlighting sources of long-term optionality at CASY.  In addition to tapping its portfolio of owned real estate, the company could refranchise, adopt a different (more aggressive) capital structure, and/or enter other lines of related business, such as automated car wash.  CASY could also outsource its distribution, which is currently done internally, to free up cash and “simplify” the business.  (I think it’s highly unlikely that management would pursue this option, but it exists.)  Lastly, the company could be sold.  Of all the optionality scenarios, I think this is the most likely.  The largest c-store player in North America, Alimentation Couch-Tard, has, on at least one occasion, tried to purchase Casey’s.  Given the company’s attractive growth potential, strong cash generation, and healthy balance sheet, I think there are many buyers, including private equity, that would love to own the business.

What are we playing for?  I underwrite CASY in two ways: first, I run a normal model out five years and calculate the IRR; second, I assume a larger store count (for purposes of this write-up, +50% and +100% from the end of FY-25) to frame a “what’s possible” kind of analysis and resulting IRR.

In the first scenario, I model the following over the FY-24 to FY-30 period:

• Store growth of ~5% p.a.
• Gross profit CAGR of ~9% (I focus on this and not revenue because fuel revenue is volatile and not especially meaningful).
• EBITDA CAGR of just over 9%.  This compares to management’s medium-term guidance of 8-10%.  Daring, I know.
• EPS growth of 11-12%.
• In terms of capital allocation, I assume capex averages ~$700 million / year and M&A ~$100m / year (this follows a big year in FY-25).  Excess FCF goes into share repurchases.
• I assume a 22x exit P/E, which implies a ~12x EV multiple.  This is in-line with the company’s longer trading history, but lower than the current multiple.  The result is a low teens (11-12%) IRR.  The IRR would jump to 16% if I assumed the P/E multiple stayed at 26x.

In the second scenario, I model earnings power at 4,500 and 6,000 stores.  The latter may sound like a lot of stores relative to a company that is only now closing in on 3,000 locations, but it would still represent a paltry market share of less than 5% in the U.S.  It’s not crazy.  It would, however, represent a material step up in average annual store growth, depending on how far out we are talking.  In the table at the end of the write up, which is meant to be illustrative, I assume all this happens in five years so that it’s comparable to my base case.  There’s a lot of detail here that can surely be nitpicked, but the punchline is that earnings power per share at 4k and 6k stores is roughly $30 and $40, respectively.  Over a 5-year period, this would represent – again at a 22x exit P/E multiple – a ~14% and 21% IRR, respectively.  That is much more exciting, but I think unlikely to play out in the real world given the steep ramp in store growth that it implies (e.g., ~600 stores / year to hit 6k in five years vs. my base case of ~140 stores / year over the next five years).  So why bother studying this?  I think it’s relevant because I think it's quite likely that CASY will double its store count from here.  The only question is how long this will take.

What could go wrong?  I think there are a few areas to focus on:

1. Fuel spreads.  CASY is currently earning about 40c of gross margin per gallon (ex-credit card fees).  This is high relative to history (20-30 odd cents per gallon).  But after the pandemic spreads stepped up into the mid-30s / low-40s range and have stayed there.  Is this sustainable?  The bull case for spreads is that (a) a variety of costs and regulatory issues are putting upward structural pressure on margins, and (b) that smaller players, having fewer opportunities for inside profits, are under increasing pressure to keep margins high.  The truth is that I don’t know.  And nor, I suspect, does anyone else.  The good news is that inside gross profits, which I would argue are much higher quality earnings, are growing faster.  They constitute ~63% of sales this year and probably more like 70% by FY-30.
2. EV’s.  It’s easy to have a negative kneejerk reaction to EVs as a CASY investor, but I think that fear is misplaced.  I’ve already mentioned that 75% of inside sales don’t involve a fuel purchase at all, so there’s that.  Will CASY trade fuel sales for charging revenue?  And might that customer, having a longer wait, be more inclined to make and inside purchase?  I think it’s likely.  Furthermore, EVs are a tiny part of the car parc (even less so in rural America) and their growth appears to be slowing rapidly.  I do not mean to be dismissive of this threat, but I think CASY’s as a purveyor of convenience is well insulated.  In my view, the real risk is to the multiple.  I don’t think there’s much EV fear in CASY’s valuation today.  Could that change?  Sure.
3. Valuation.  CASY’s valuation is currently at the higher end of its historical valuation range, so there is certainly some mark-to-market risk.  The stock is currently at a ~26x P/E vs. 22-23x historically, and an EV multiple of 12-13x vs. 10-11x historically.  Will it matter over the long term?  As I’ve discussed above, I assume multiple compression back to the historical averages, which still provides an attractive return as underlying earnings power grows nicely.  I think it would be great add during a drawdown (maybe on a sudden drop in fuel margins?), but I’m happy to own the stock here.

For those who want more detail on the company, and/or prefer listening to reading, I would recommend an excellent Business Breakdowns podcast from August 2023:

https://open.spotify.com/episode/7nNIYn1abdaeIAMYzEVcSs

And for anyone still wavering on the idea, remember that Casey’s is based in Iowa, God’s country.  Go Hawkeyes!

Catalyst

Most likely it's "they keep doing what they're doing."  There are optionality levers that management could pull, but I'm not holding my breath.  Nor do I think they're necessary for a good return.