Description

Investment summary

TravelCenters of America’s (“TA”) is an undervalued company that operates in the truck stop industry.  This industry has consolidated over the last decade into an oligopoly dominated by three companies.  I believe that Travel Centers of America’s (“TA”) stock is significantly mispriced by the market due to two main factors: 1) the fluctuation in diesel margins above normal levels and 2) the effect of a recently completed sale lease back transaction.  When fuel margins are adjusted to a sustainable average and redeployment of the sale lease back proceeds are fully accounted for, the Company’s stock appears to have 316% upside from its current levels over the next two years using an 8X (times is represented as “X”) 2017 EBITDA which results in a price target of $29.12 vs $7.01 as of 1/22/16.

Business overview and industry background

TravelCenters of America operates 254 truck stops in 43 states and about 220 standalone convenience stores in seven states. The truck stops are operated under the TravelCenters of America and Petro brand names. The convenience stores are operated under the Minit Mart brand. TA has been public since 2007 when it was spun out of Hospitality Properties Trust (HPT). HPT is a Real Estate Investment Trust (“REIT”) and it owns and leases back to TA most of the Company’s truck stop locations.  HPT continues to own about 10% of the outstanding shares of TA.  

There are approximately 2,500 truck stops in America and are they are split into two distinct and roughly equal sized groups: those owned by the three large national chains and those owned by a large number of “mom and pop” operators, each typically managing between one to three locations. The national chains have steadily been acquiring the smaller operators. These large chains have significant pricing power with their suppliers and are able to negotiate deals with the large trucking fleets.  These deals typically include minimum volume guarantees against preferential pricing based off of wholesale diesel rates.  Many independent owners have joined a buying and marketing group called Roady’s (188 locations) to remain competitive with the big three.

The three large chains are Pilot Flying J (550+ locations nationally), Love’s Travel Stops and Country Stores, “Love’s” (350+ locations nationally), and TA (254 locations nationally). While TA has fewer locations than Flying J and Love’s, the Company has differentiated itself by having the largest average location size (25 acres on average) conveniently located within ¼ mile of major highways with repair facilities at each of its locations.

The Company has a strategy of attracting customers based on a total value proposition rather than just competing on the price of diesel fuel. TA offers a broad range of services such as: diesel and gasoline fuel, truck maintenance and repair, fast food and full-service restaurants, large convenience stores, car and truck parking, showers, gyms, chiropractic services, laundry video-game and entertainment rooms, etc.

TA also launched the reserve-it! Parking program which allows drivers to call or use an application to reserve their space. This is an important program since the National Transportation Safety Act legally limits drivers to 10 hours per day of driving time.  It also differentiates TA from its competitors who have smaller location and cannot offer this service without affecting their profitability negatively.  Check-in can be done as early as 4pm, check-out at 3pm. Therefore, drivers can push closer to their driving limits knowing they will have a place to stop and rest. This operation has proven to be cost effective as drivers prefer to use TA locations and amenities including parking, rather than saving 1 or 2 penny a gallon at a competitor and risk having to drive around at 5-7 MPG looking for a place to park or get their truck serviced.

The truck stops’ range of fast food is diverse as TA acts as franchisee for 18 popular brands such as Burger King, Starbucks, Taco Bell, Pizza Hut, etc. It also offers full service restaurant option for drivers who want a good and healthy meal in a clean and welcoming environment at a reasonable price. The proprietary restaurant brands are Country Pride, founded in the Midwest and counts more than 90 locations coast to coast and Iron Skillet, focused on fresh salad bar and full buffet.

Convenience stores at the truck stops are also part of TA’s amenities. Along with a selection of specialty coffees, they offer a grab and go option for the drivers who do not have time to sit and have a full meal. The stores also carry a whole selection of groceries, electronics, maintenance supplies and clothing.  The wide selection of goods is due the needs of truck drivers, who cannot easily park their vehicles in other shopping areas, to buy such goods.

The truck centers also include a comprehensive range of repair and maintenance services. Not only can the drivers get technical training/advice, they can also benefit from preventive maintenance and other repair services, such as emergency roadside breakdowns through TA’s “RoadSquad” center that dispatches over 450 road service vehicles. This area of expertise is maintained daily by nearly 3,000 highly skilled technicians with ASE and TIA certifications.

I believe that this full range of services gives TA a competitive advantage over the two other large chains and independents which only offer some of these services at some of their locations. While market share data is not readily available, anecdotal evidence, comments by management and fuel volume sales would suggest that TA is doing well competitively.

Events leading to the current low share price

The very steep decline in gasoline and diesel prices in the fourth quarter of 2014 and in the first quarter of 2015 allowed TA to achieve unusually high fuel margins on its sales at the pump thus creating one-time windfall profits. Despite making this clear during the earnings call for both of those quarters, some sell-side analysts remained overly optimistic with regards to second quarter 2015 results and touted the stock aggressively prior to the earnings releases. So while the June quarter was solid (albeit with some one-time acquisition related expenses), it missed analysts’ numbers causing a selloff in the stock.

The second event that has put negative pressure on the stock relates to a sale lease back transaction that TA announced a few months ago. I believe that this transaction will prove to be very accretive to shareholders (see below) but the street has certainly not seen it that way. The transaction was complicated by the company’s desire to avoid a tax event via a 1031 election. This necessitated a staggered closing schedule so that TA could reinvest the sales proceeds in new convenience store acquisitions to avoid triggering a taxable gain. In order to provide some clarity about the impact of the transaction, the company provided pro-forma numbers showing that the sale lease back transaction will necessarily result in higher lease payments but not showing the positive effect of what the proceeds would be spent on: new acquisition and greenfield developments. As a result, several analysts lowered their numbers causing the stock to fall further.

Financial Analysis and Forecast

In the following discussion I have attempted to address two key factors in valuing TA: normalizing the diesel fuel margin and factoring in the impact of new investments. While I do forecast numbers on a quarterly basis, due to seasonal fluctuations and uncertainty about short term fuel prices, I believe that looking at annual numbers is more meaningful.

Normalized fuel margin calculation

In order to get a more accurate picture of what the future fuel margins might look like, I went back and adjusted numbers for 2014 and 2015 to be more in line with historical trends. Since 2009 the Company has successfully steadily raised fuel margins as measured by cents per gallon profit. This has resulted in raising margins from 11.9 cents/gallon in 2009 to 16.8 cents/gallon in 2013. If we assume that in normal circumstances this trend would have continued but at a slower pace, it seems reasonable to allow for margins of 17.1 cents/gallon in 2014 and 17.3 cents/gallon in 2015. With these adjustments TA would, understandably, have had lower EBITDA than it actually achieved in ’14 and ’15. The chart below illustrates the effect of the normalized fuel margins on historical EBITDA and shows where I forecast future EBITDA based on flat fuel margins of 17.3 cents/gallon.

I believe that using flat fuel margins for future years is conservative for two reasons. The first is the Company’s historical ability to slowly increase fuel margins over a period of years. TA has been quite successful in competing on total cost, not just fuel price, when negotiating with its large trucking customers. The company points out that total costs include lost drive time (and fuel consumption) if a driver cannot find a parking space or if he has to wait a long time at the pump (TA has the biggest parking lots and usually has more fuel bays than the competitors). Also TA’s facilities all have truck repair bays where the driver can quickly fix minor issues or get an oil change without having to make a second stop at a repair shop. For these extra facilities, trucking fleets seem willing to pay slightly more for fuel while saving money in aggregate.

The second reason why fuel margins may improve over the next few years is that TA has been expanding into owning a large number of convenience stores. The C-stores acquired in 2015 will add about 10-12% to TA’s fuel volume sales over the next 12 months as the stores ramp. The C-stores mostly sell gasoline at retail margins which tend to be higher than the negotiated diesel margins obtained at the truck stops and should add some positive upward pressure to overall fuel margins.

Adding the acquisitions and greenfield developments

By September 30, 2015 TA had closed on the acquisition of 150 C-stores costing $293 million (“MM”); virtually all of which were bought at the very end of September. This had the effect of including the payment for the stores on the balance sheet (i.e. lower cash) but virtually no positive impact on the P&L from sales/profit at the new stores. In fact, the P&L was negatively impacted from one-time acquisition expenses and from a ramp in G&A to oversee the new acquisitions.

At the end of October, TA closed on an additional 44 C-stores for $92MM, which will have only a limited impact on Q4 results, partly from timing and partly from lower sales due to disruptions as TA converts the acquired stores to its systems and inventory model. I expect meaningful contribution from both acquisitions beginning in the first quarter of 2016 and improving EBITDA performance throughout the year as the stores fully benefit from TA’s management/control systems and purchasing power.

Another area in which TA has been investing is in the greenfield development of 5 new truck stops, which are expected to open in 2016 and into 2017 with the first one having opened last week. These are quite large properties designed to showcase the best of TA’s service offerings and are expensive investments with an estimated aggregate price tag of $118MM. The good news is that TA has already agreed to sell and lease back these holdings to HPT as they come on line, thereby freeing up capital for additional acquisitions.

Forecast

In the charts below, I have tried to demonstrate how I get from my “normalized 2015 EBITDA” to my projected 2017 numbers. I have kept my expected fuel margin flat from the normalized 2015 level of 17.3 cents/gallon. (Charts are designed to emphasize annual changes in millions of dollars and are not to scale.)

As you can see, the largest part of the increase is from the contributions from the already acquired C-stores. I expect the biggest increase to hit 2016 with a smaller increase in 2017 as the stores are fully ramped. In aggregate I expect the stores to contribute $55-60MM of EBITDA, implying that TA paid a multiple of 6.4-7x which is in line with the company’s comments. This is where we can see the accretive nature of the sale-lease back transaction. Once TA has fixed up and aggregated a number of properties, it is able to sell them at about 12x while reinvesting the proceeds in small acquisitions costing 6.5-7x.

I expect that businesses acquired prior to 2015 will continue to ramp modestly, driven mostly by the 2013 and 2014 acquisitions.

I expect that same store sales for the rest of the business and general operating efficiencies can contribute a modest 4% increase in EBITDA annually.

Finally, I expect a very modest contribution from the Greenfield developments in 2016 increasing to $3MM in 2017. By way of comparison, I would expect these truck stops to contribution $9-10MM when fully ramped, probably in the 2019 timeframe.  Please remember this number is after doing a sale leaseback with HPT, so the return on investment to TA is extremely strong.

I have also added a small contribution of $5MM in 2017 from additional acquisitions that I expect TA to make with the funds it gets for selling the greenfield property to HPT. If TA reinvests the $118MM it will get from the sale-lease back at 6-7x, these acquisition should contribute full year EBITDA of $17-20MM.

The result of these separate events will be for TA to increase its EBITDA from a normalized $113MM ($156MM reported) to $200MM for the year ended 2017.

Comparable company analysis and valuation

TA’s two main competitors, Pilot/Flying J and Love’s, are both private companies.  There are a number of convenience store operators that are public, though many of them have other fuel related operations including wholesaling, transport and refining.  The most similar companies are Alimentation Couche-Tard (ATD/B Toronto Stock Exchange), Casey’s General Stores (CASY) and CST Brands (CST) as they only sell fuel and convenience items.  The other public companies that have convenience store and retail fuel operations are Delek US Holdings (DK), Marathon Petroleum (MPC), Murphy USA (MUSA), Phillips 66 (PSX), Sunoco LP (SUN), Tesoro Corp (TSO) and Valero Energy (VLO)

For valuation purposes I like to use enterprise value (“EV”) to earnings before interest taxes depreciation and amortization (“EBITDA”) EV/EBITDA multiples to determine valuation.  As you will see from the chart below ATD, CASY and CST all trade at significantly higher EV/EBITDA multiples than TA.  I have used an 8 times EV/EBITDA multiple for determining my target price on TA, which is 20% to 30% discount versus peer trading multiples.  Using this 8X multiple yields a target price of $29.12 based on my 2017 EBITDA projections which includes the benefits of all current acquisitions and a normalized profit margin on fuel sales.  If an investor prefers to use a PE multiple for determining future share price this yields a 2017 price target of $23.39 based on the average 21.2 multiple of its peers as TA is penalized for D&A related to its recent acquisitions and capital investments.

Please see the table below for this analysis.  

Conclusion

TravelCenters of America is an attractive in6.vestment as it trades at significant discount to other similar public companies despite its position in an oligopolistic industry with increasing economies of scale.  TA’s current price of $7.01 per share as of 1/22/16 offers 316% upside to my target price of $29.12 based on an 8X EV/EBITDA multiple of 2017’s projected EBITDA.  

Catalyst

1.  Increasing earnings and cash flow from redployment of sale lease back proceeds.

2.  Potential purchase of the business by a vertically integrated oil and gas company.