Description

Murphy USA Inc. (NYSE:MUSA) operates a large chain of 1,669 retail fuel stores located primarily in the U.S. Southeast, Southwest, Midwest, and Northeast.  MUSA has had a long-term relationship with Walmart and operates the majority of its locations on Walmart parking lots.  Interestingly, in many cases MUSA has purchased the land from Walmart and owns the property.  In fact, we estimate one of MUSA’s strategic assets is its $3 billion in real estate at current market value.  Yet, even excluding the value of the real estate, we believe MUSA shares have ~100% upside over two years.

Within the MUSA store network there are a variety of store types, but they generally fall into three categories: 1,151 Murphy USA locations (these are primarily fuel operations with either small kiosks or small stores up to 1,400 sq. ft.), 360 Murphy Express locations (these are fuel operations with stores ranging in size from 2,800 sq. ft. to 3,445 sq. ft.) and 158 QuickChek stores (these are fuel operations with stores averaging 5,500 sq. ft.).

QuickChek was purchased in early 2021 for $645mm, representing an EBITDA multiple of 13.2x (8.3x post synergies).  The chain, which offers both quick-serve restaurant-style food along with convenience items, was purchased for its best-in-class food and beverage competency, which MUSA was lacking.  MUSA management plans, over time, to cross pollinate the food operating know-how from QuickChek to legacy MUSA locations.  We believe this can generate a large uplift for legacy MUSA stores over time, which meaningfully trail peers in merchandise gross profit contribution ($282k per store vs. $1,289k per store at QuickChek, based on 2019 data).  Pro forma gross profit and merchandise gross profit are detailed below.

Note: 1. Based on the latest full year financials available for QuickChek. FY 19 represent fiscal year ending on 12/31/2019 (pre-COVID)

The overall convenience store industry is dominated by single store operators.  There are 150,274 store locations in the US, with 61% of the stores run by single location operators.  Interestingly, looking back over the last decade single store operators were growing from 2011 to 2017.  Beginning in 2017, the industry as a whole began to shrink (total stores peaked at 154,958 in 2017) and single store operators represented all the decline while the number of chain stores increased slightly.

MUSA is the fifth largest operator in the US and there are several large public store operators: #1 Seven & I Holdings (TSE:3382), #2 Alimentation Couche-Tard (TSX:ATD.B), #3 Casey’s (Nasdaq:CASY), #6 Arko (Nasdaq:ARKO).  Most of the larger store operators are building new locations and buying smaller rivals as the synergies are significant.  New store economics are attractive, a dynamic that is putting further pressure on single store operators with less attractive locations and amenities.

The two primary margin streams for a retail fuel store are related fuel sales and in-store product/food sales.  Regarding fuel margin, this metric is measured on cents per gallon (CPG) earned.  Overall CPG trends across the industry have gone from 12.7 CPG in 2000 to 24.8 CPG in 2019 according to Oil Price Information Service (OPIS) Retail Year In Review.  In regard to product/food, locations are measured based on the sales and margins from the operation of the convenience store.  According to the National Association of Convenience Stores (“NACS”), “inside sales” or product/food sales have been growing consistently over the last decade both in total and on a per store basis.  Inside sales are also recession resistant (growing strongly in 2008, 2009 and during COVID).

The biggest variable is the fuel CPG earned and the total gallons sold.  Interestingly, going into COVID most would have assumed that retail fuel operators would have seen their profitability destroyed.  In fact, the opposite happened.  Small single store operators, who effectively set prices in the industry, were all forced to raise CPG to preserve profits.  The public company operators all raised their margins to keep pace with the smaller operators and saw blow-out profits on fewer gallons sold.  MUSA was not immune to dropping demand and experienced a decline of 11.6% in average per store monthly gallons sold in 2020 compared to 2019.  However, CPG surged 56.5% to 25.2 in 2020 from 16.1 in 2019.  This significant CPG increase drove MUSA EBITDA in 2020 to $723mm from $423mm in the prior year.

Given MUSA’s industry leading fuel volumes per location, the CPG impact to MUSA was the most pronounced of any retail operator.  MUSA (including QuickChek) sold, on average, over 3mm gallons of fuel per location (2019) vs. an industry average of 1.7mm gallons (2019).  MUSA is also the low-price leader in each of the markets it serves.  Its leadership is driven by great locations, many next to Walmart stores, great prices and a leading loyalty program.  Another factor that helped MUSA optimize its fuel business was the roll-out of “Retail Pricing Excellence” in 2018, which centralized and institutionalized the pricing of fuel across all MUSA locations.  This process has now been rolled-out across QuickChek stores.  “Retail Pricing Excellence” is based on a computerized business intelligence system and a team of analysts at corporate that monitor competitors and predict impacts to volume from pricing shifts.  Based on this data, MUSA has dramatically improved its analysis of competitor pricing data to allow it to rapidly change prices at each location – with no local store involvement.

The economies of scale with the convenience store business may not seem obvious, but they are substantial from advantaged fuel procurement (larger operators get better pricing per gallon on fuel), better food pricing from suppliers (CoreMark and McClane), better tobacco rebates from manufactures and better leverage on candy, beer, and soda manufacturer incentives.  While each of these are small individual advantages, together they are significant which single store operators simply cannot replicate at scale.  In addition to these cost advantages, many of the larger players own their real estate, a significant cost advantage versus smaller, capital constrained operators who rent their locations, have annual rent increases, and ultimately run the risk of getting displaced from their location at lease end.

In addition to lacking economies of scale, smaller players are being impacted with minimum wage increases and capital expenses associated with the installation of credit card chip readers for each pump.  With respect to the minimum wage impact on costs, given its scale in gallons, MUSA estimates that higher wages could increase its operating costs roughly 2 CPG, but that single store operators, with fewer gallons sold, could be impacted by 7 to 11 CPG.  The required implementation of credit card chip readers was delayed several times given the cost impact to small operators.  The implementation cost per location is estimated to be approximately $25,000, paid by location owners.  Following the implementation deadline, operators who do not implement chip reader technology will be held liable for all fraudulent charges.  Fraud at gas stations has historically been a big issue, and it is estimated that this liability could be as high as $30,000 per year, per location that does not upgrade.  The actual costs could be even higher if the fraudsters target stations that did not implement the new technology.

As such, the cost of doing business has escalated significantly for single location operators, resulting in limited if any profits.  We analyzed industry data from NACS to better understand the economics of operating a single store.  What we found from our analysis is that single store operators were making on average $107k (in 2019 pre-COVID).  We then used this data to calculate the fuel margin needed to provide 2% annual profit growth.  Based on this data, we see fuel margins rising 4% annually moving forward.

So, what does all this mean for MUSA?

Key thesis point #1: CPG will be permanently elevated from pre-COVID levels and MUSA has an advantageous position due to its industry leading volume per store and low-price position.  Smaller players are under pressure and are showing no signs of reducing fuel margins back to pre-COVID levels.  The MUSA CEO recently commented on this during the October 28th conference call, “Our volumes are higher than the industry average and our public peers, which is a huge advantage. Second, we have demonstrated that with the benefits of our product supply business, our total fuel margins are less volatile over time than our public peers. And with our low-cost structure, we have greater upside exposure to the structural change we are seeing in breakeven fuel margin trends. Last, with elevated prices and increasing price sensitivity across customer segments, our everyday low-price position is advantaged to grow share.”  The sell-side has largely not caught on to this trend.  Not surprisingly, it will probably take the sell-side another year of watching to figure out what is happening before they begin to raise their price targets.

Key thesis point #2: Fuel demand outlook is stable.  Tesla and EVs generally gobble up a lot of headlines, but the transition to EVs will take years to play out.  Projections through 2050 show very little impact from EVs.  Further, as we saw during COVID, lower volumes don’t translate into lower fuel margin dollars as we believe that operators will raise CPG to the level required to keep the profitability of their businesses growing even in a declining demand environment.  One key point is that MUSA’s core customer has a 15-year-old vehicle that was purchased for about $15,000 and has 100,000 miles on the odometer.  Further, many of the MUSA locations are in rural areas of the southeast which lack meaningful charging infrastructure to date.  It will be decades before MUSA’s core customer base has access to EVs.  It is important to remember that the average age of the U.S. light vehicle fleet is 12.1 years (2020) and has been going up every year for 20 years.  Vehicles are lasting longer and longer.

Key thesis point #3: Tobacco profits are very stable and represent 44% of merchandise gross profit.  MUSA is a tobacco destination location.  As most retailers have eliminated tobacco sales, convenience stores have picked up the volume and now account for 85% of total sales.  Per pack cigarette prices have continued to increase (2011 to 2020 CAGR +3.7% per pack) and have offset volume declines (2011 to 2020 CAGR -3.0% per pack).  MUSA is working with tobacco manufacturers to partner on promotions designed to convert smokers to far safer non-combustible tobacco options as the industry moves in that direction.  Given the MUSA loyalty data compiled, MUSA has valuable insights to help tobacco manufacturers monitor customer buying patterns.  These customer insights and buying patterns are highly valuable and MUSA is leveraging this information to earn rebates which the company has re-invested into its advertising and price reductions of tobacco products, making MUSA even more of a destination for this product category.  Longer term we see MUSA’s competitors moving into cannabis and believe that there could be an opportunity for MUSA to pursue as well given the ongoing legalization underway across the US.

Key thesis point #4: MUSA has significant opportunities to deploy capital in highly attractive investments to grow its network.  There are three buckets of such potential: (1) raze and rebuild existing small kiosk locations on Walmart parking lots which cost $2.5mm per location and generate after-tax IRRs of 32%, (2) new Murphy Express locations which cost $3.8mm per location and generate after-tax IRRs of 17%, and (3) new QuickChek locations which cost $6mm per location and generate after-tax IRRs of 21%.  Management thinks they can deploy $300mm to $350mm of capital annually for these growth investments.

Key thesis point #5: MUSA has been very shareholder friendly with both dividends and most importantly share repurchases.  Share repurchases have been a huge value driver at MUSA.  Since spin-off, MUSA has repurchased almost $1.8 billion in stock and shrunk shares outstanding by 43% (under $90 per share).  In the last twelve months MUSA’s board has repurchased $400mm of shares.  In addition, MUSA pays a $1.16 per share dividend.  On October 27, 2021, MUSA announced a 16% increase in the dividend and said it planned 10% annual increases in the dividend for “at least the next five years.”

We see a very bright future for MUSA shares and our projections suggest that shares will be worth over $350 per share by the end of 2023, implying over 100% upside from current prices using a terminal multiple of 10x (in-line with peers).  In calculating this value, we assume MUSA continues to buy back stock at a rate of $200mm per year.  To further demonstrate how cheap MUSA is at current levels, the unlevered FCF yield is ~11% (excluding growth capex investments).

Catalyst

Sell-side wakes up - Street estimates are way too low

MUSA CPG continues at elevated rate

Buyback shrinks float

Continued cash re-investment at 20%+ IRRs dramatically increase earnings power