Description

BACKGROUND

TA operates travel centers, standalone convenience stores, and standalone restaurants in the US/Canada. These establishments provide fuel and nonfuel products for its customer base of trucking fleets and motorists.

Business Overview

Roughly two-thirds of revenue is from fuel and one-third nonfuel while gross profit is ~25% fuel and ~75% nonfuel.

Travel Centers [86% of revenues, 90% of pre-corporate, pre-rent EBITDA)

257 travel centers across 43 states (primarily along US interstate highway system) as well as province of Ontario, Canada.

o   179 under “TA” brand name; 78 “Petro Stopping Centers”

o   Own 31, lease 200, 2 operated via JV, 24 owned/leased from third parties by franchisees

o   Company operates 228 while franchisees operate 28 (o/w 4 are leased to franchisee)

A typical travel center is on roughly 26 acres of land with parking for ~200 tractor trailers and ~100 cars, a truck repair facility and parts store, multiple diesel and gasoline fueling points, one or more QSRs, and other amenities that cater to professional truck drivers (showers, game rooms, travel stores, etc.)

Convenience Stores [12% of revenues, 8% of pre-corporate, pre-rent EBITDA)

230 convenience stores across 11 states, operated under the Minit Mart brand name (own 198, lease 29, 3 operated via JV). Typical c-store has 6 fueling positions, ~3800 sq. ft. of interior space, at least one QSR offering, selection of over 3100 nonfuel items. 83 stores have car washes with that number expected to increase by year-end 2018.

Restaurants [2% of revenues, 2% of pre-corporate, pre-rent EBITDA)

46 standalone restaurants across 13 states operating under Quaker Steak & Lube (QSL) brand name (own 7, lease 9, 1 via JV, 29 owned/leased from third parties by franchisees).

Fuel Economics

Industry wide fuel gross margins have averaged ~20c/gal from 2012-17 as compared to 18.3c/gal for TA in that same time period. On average retailers spend 12-16c/gal to dispense fuel, which translates to 4-8c/gal of net profit. There’s typically a modest delay between the time crude oil prices change to when the price at the fuel pump changes. Demand for diesel fuel for any given level of trucking activity is expected to decline over time due to tech innovation and improved fuel efficiency and fuel conservation practices. Fuel revenue fluctuates significantly more than volumes or gross margins; the latter two are better indicators of operating trends

Company Footprint

Travel Center top 3 states: Texas (23 locations), California (13), and Ohio (59) [37% of total sites]

Minit Mart top 3 states: Kentucky (68 stores), Illinois (41), and Missouri (39) [64% of total store count]

Industry

Travel Centers

Key competitors include Pilot Flying J and Love’s which hold the #1 and #2 position with TA at #3. These are the only 3 nationwide operators of travel centers. The rest of the industry is fragmented among roughly 5000 other smaller regional operators. Per the company – although it has fewer locations than the competitors, its sites are typically double the size with more amenities and food service choices. Travel Centers present a value proposition to fleets given the ongoing driver shortage – TCs can improve driver retention and improve driver efficiency following increased regulations around driver hours per day. Per the American Trucking Association: trucks’ share of total tonnage is expected to decline but the total volume transported is projected to “increase substantially more than any other transportation mode”

Convenience Stores

~155k c-stores in the US as of FY’17 of which ~79% sell fuel. Convenience stores sell ~80% of the fuel sold in the US. Relative to other retail categories US convenience stores have seen relative strength and sales growth in recent years. Given the premise of speed/immediacy that the stores cater to, it is not something that competing channels have addressed fully yet (83% of in-store merchandise is consumed within 1-hour of purchase and 65% is immediately consumed, average walk-in to walk-out time is 3-4 min). This is changing however as competing channels diversify and e-commerce grows. QSRs are adapting their menus and remodeling stores to compete in this channel as well. C-stores have been able to continue to drive in-store revenue/profit growth by increasing their focus on foodservice which now represents over 15% of the industry’s total in-store revenue. The remaining 85% of merchandise (largely cigarettes, packaged beverages, and beer) averages ~24% gross margins vs. foodservice at ~44% industry-wide, which underscores the importance of this space in driving growth.

Capital Structure

Relationship with HPT/RMR

TA was acquired by Hospitality Properties Trust (HPT) from Oak Hill Capital Partners in 2007. To maintain its REIT structure HPT then spun-off TA as a separately traded public entity. HPT owns 8.6% of TA common stock (top holder). Of the 257 Travel Centers the company operates, 199 are leased from HPT (78%). TA owes $150m in deferred rent to HPT (deferred during financial crisis) which is due between 2024 to 2030. There remain ownership restrictions that would make a sale of the entire company very difficult (but would not affect sale of just C-stores).

RMR provides TA with business management services and receives fees based on fuel gross margins and nonfuel revenues. Fees totaled ~14m for both FY’16 and FY’17. Some services include: compliance related, advice regarding travel centers, advice regarding site selection for new properties, purchase negotiations, capital markets/financing activities.

There has, and continues to be, overlap in Executive leadership and Board membership between HPT, RMR, and TA. The former CEO for example (Tom O'Brien) was also EVP at both RMR and HPT.

As detailed in the next section, capital allocation and operating decisions historically were likely made to enrich HPT/RMR shareholders at the expense of TA shareholders.

REASONS FOR CHEAPNESS

Value destruction by the prior management team has been substantial. The company began as an operator of just travel centers, growing via acquisitions. Beginning in 2013 the company expanded to standalone convenience stores as well, acquiring 30 stores in 2013, 169 in 2015, and another 30 in 2016. Following the acquisitions, the company then spent considerable capital upgrading the stores (rebranding to Minit Mart, adding QSRs, rebranding gasoline, correcting deferred maintenance, etc.)

From 2012-2017 TA spent ~$1.3bn in capital expenditures – EBITDA growth has not been commensurate with this level of investment however. Adjusted EBITDA peaked in 2014 at $181m despite the acquisition of 169 stores the following year. FY’17 adjusted EBITDA of $92m is roughly flat vs. FY’12. Per the company, convenience stores typically reach financial stabilization 1yr after completion of improvements. FY’17 should therefore have seen a significant uptick in EBITDA as all the 2015 acquisitions were fully ramped up, yet EBITDA declined 21% y/y. Leverage also ticked up in this time period as EBITDA declined and the company issued $330m in debt from 2013-15 to help fund its investments.

Additionally, in that same time period (2012-17) TA spent $600m in acquisitions which was offset by ~$900m of asset sales which is primarily sale/leasebacks and sale of renovations to HPT (this relates to Travel Centers only as they are leased, whereas C-stores are primarily owned). The ROIC on these transactions has also been poor. TA incurs a minimum of 8.5% in rent increases in exchange for these sales and it's evident from the numbers that this has not been an economical arrangement and rent expense was already far too high vs. the company’s current earnings power.

It’s clear the prior management team had no idea how to run a convenience store business effectively (or simply didn’t care to) and at the same time the industry has become increasingly competitive. Many of the turnaround activities the company is undertaking now to improve revenues are industry standard and they are simply playing catch up with competitors. This lack of execution was made clear in 2Q’18 when the company took a $52m goodwill impairment charge for its c-stores.

The investor base has understandably been of the view that this company wasn’t being run for the benefit of shareholders which is why valuation has lagged considerably versus comps.

INVESTMENT THESIS

The crux of my thesis is based on the fact that there is a high likelihood that the C-stores are sold within a 12mth time period (absent a significant uptick in EBITDA) and current valuation is pricing in minimal probability of a takeout in my view.

I don’t think this is a great stock to own without sale optionality. Although I see a path for EBITDA to improve 15-20% over the next 2yrs, leverage will still remain high as I don’t think the company is on the path to being FCF positive soon. Additionally, I think there’s investor fatigue around the name given the longstanding corporate governance issues and it would require something major like a large sale to get a material revaluation of the stock. That the new management team is open to strategic alternatives is a positive, there are still arrangements with HPT/RMR that I think are uneconomical and there is still management overlap among the different companies so I don’t think the corporate governance overhang is entirely lifted.

New management in place

A new management team is in place now since January of this year (CEO - Andrew Rebholz, COO - Barry Richards, and CFO). Former Director Barry Portnoy passed away in February and his son Adam Portnoy is now on the board since the start of the year. The former CEO and Barry Portnoy were impediments to strategic initiatives and made the detrimental decision to expand to c-stores in the first place. The new regime is more open to strategic alternatives and has been clear about their willingness to walk away from the c-stores if they can’t turn the business around (and they are actually taking the right steps to attempt to improve the business unlike the prior CEO). They have articulated their view on the c-stores a number of times including on the 2Q'18 conference call - in response to a question the CEO said that they would arrive at a decision whether to divest in several quarters time.  

Note: Management crossover with HPT/RMR remains. CEO/Board Member Rebholz is an EVP of RMR; Adam Portnoy is on the Board of both TA and HPT and is the CEO of RMR. So there is no reason to believe any contracts with HPT/RMR will be lifted. However, there is also no economic reason to not attempt to sell the stores if they can't improve performance and it would actually be beneficial for them to do so. HPT owns a significant amount of TA equity, TA deleveraging would benefit its risk profile and therefore benefit HPT stock, and both Portnoy/Rebholz own TA stock. They could sell the c-stores and get a stock revaluation while still retaining the RMR management agreement as well as all the profitable lease arrangements (as these pertain to the Travel Centers only).

Given these arrangements and management overlap will be ongoing I'm not assuming any multiple expansion in my valuation.

Industry M&A is very active and TA C-stores are a viable target

Channel-blurring has made the C-store environment increasingly competitive as QSRs and grocery stores are now competing for foodservice customers (the highest margin products) and product variety and healthy options have become a key factor influencing the incremental customer decision. Given these trends, convenience stores are increasingly moving toward larger format stores (via expansion renovation) – there are more LT capital requirements necessary now to remain competitive. At the same time healthcare and labor costs have been increasing, putting pressure on c-store operating expenses. All of these factors point to scale being a huge factor in remaining competitive and improving profitability.

Industry consultants note that brand equity matters significantly as customer preference is for stores with a predictable and consistent offering. Ongoing M&A has therefore made it increasingly difficult for sub-scale firms to compete as the larger companies increasingly dominate the landscape.

In short, growth is necessary to maintain competitiveness and acquisitions are the only way to materially increase store count as land/zoning/location issues make large number of new builds impractical. Industry-wide unit growth has slowed considerably in the past 2yrs underscoring this point.

Industry M&A has been very active in the past few years and management teams at larger companies have strong a track record of integrating acquisitions. Couche-Tard (C-T) has completed 3-5 acquisitions per year for the past several years as has 7-Eleven. In addition to large transactions such as 7-Eleven/Sunoco and C-T/CST there have been many acquisitions of mid-size and smaller chains as well: Roadrunner Markets, PDQ Food Stores, Jet-Pep, Honey Farms, among others.

The universe of potential acquirers for TA’s stores is large. There are ~20 operators larger than TA. In addition to the larger C-store operators PE has been involved and recently oil companies have been making a return to company-operated locations. Andeavor (formerly Tesoro) recently re-entered store operations via acquisitions – added 538 net new stores in the past year. The fact that TA has 230 stores puts it in a sweet spot where it could make a material addition to both a mid-size or large player.

Poor performance doesn’t preclude acquisition and Minit Mart brand equity not a deciding factor

A successful regional brand can make a difference in attracting an acquirer (for example Couche-Tard acquisition of Holiday Stores) but very often the targets are rebranded after acquisition. So whether or not TA’s Minit Mart stores are a dominant brand is not a deciding factor. Likewise I don’t believe weak operating results are necessarily a deal breaker for acquirers. This is supported by the wide range of acquisition targets by larger chains over the past few years. Looking at Couche-Tard (C-T) acquisitions for example:

Holiday: leading market share in the Upper Midwest and top quartile assets with respect to fuel and nonfuel sales volumes and very high brand awareness within the region

The Pantry: relatively weak fuel volumes and structurally lower fuel margins (13-14c); below industry average sales per store and below average merchandise volumes per store

CST: strong footprint (4th largest chain in NA) but multiple quarters of negative sales comps up until acquisition; exceeded target synergies

Ultimately the larger chains are highly adept at integrating their own business model to acquired sites very quickly and the synergy potential is huge which can bring a formerly uncompetitive site to be a top quartile performer. C-T has improved top line results across all its acquisitions driven by factors such as: store resets, adding private label, changing store layouts, adding C-T signature items, and pushing targeted promotions. The larger chains benefit from a vast amount of data regarding best practices to drive revenue growth.  

Additionally, store-by-store profitability can vary significantly – although The Pantry had on average below industry margins C-T’s store level analysis suggested the acquisition made sense as they planned on closing certain sites. Similarly, TA results indicate c-store earnings vary widely: in 1Q’18 33 stores accounted for 62% of fuel volume decline and 35% of operating income decline and in 2Q’18 26 stores accounted for 41% of fuel volume decline and 100% of operating income decline.

Travel Center – Segment Earnings Likely to Grow

Although still in early stages, TA’s nonfuel initiatives are gaining traction and should drive y/y EBITDA growth for the segment to help offset c-store weakness.

o   Onsite Truck Service Program has seen work orders increase 44% and 50% y/y in 1Q/2Q’18

o   Reserve-It Parking reservations are increasing 40%+ in 1H’18

o   Signing new customers in 1H’18

The company purchased a tire retread plant recently which they believe should increase tire sales overall as customers typically like to use a single source for all tire related purchases and they were previously unable to provide this. There is also low hanging fruit as it relates to cost cutting – some very basic things the prior management team didn’t do that are currently being implemented and should flow thru to 2018/19 earnings (consolidating tech and accounting functions for example, systems upgrades). Management plans to escalate its franchising program which would have a strong impact on profitability once scaled up. Very little has been done in this regard over the past few years – only 28 stores operated by franchisees. In general, travel centers are a relatively more defensible business/less competitive as compared to convenience stores. Secular industry concerns (trucking declines, fuel efficiency, etc.) are likely priced in.

Compelling valuation

Stock is not pricing in any M&A potential: currently trading at 5x FY’18/4.7x FY’19 consensus estimates (6.0x my FY’19 estimate), as compared to a historical trading range of 4-7x forward EBITDA. Stock is currently trading at just 30% of BVPS and ~60% of assets are property & equipment.

VALUATION & PRICE TARGET

C-Stores Acquisition Value

Comparable Transactions

Comparable transactions from the past few years have traded anywhere from 7-13x EBITDA. There are many idiosyncratic factors to consider regarding the takeout multiple. I’d be surprised to see TA get a high-end multiple but at the same time $100-$200m added to the takeout price doesn’t really move the needle for a large acquirer. The transaction multiples below are pre-synergy whereas using segment EBITDA for the valuation indirectly includes some amount of synergies so some discount to the multiples is warranted.

Using FY’17 segment EBITDA of $41m and 8-10x acquisition multiple range yields a c-store value of $324-$406m.

Book Value

The aggregate investment for the 228 C-stores acquired from 2013 thru 2016 is $443m (including costs of renovations). Following the $51.5m goodwill write-down in 2Q’18 this brings the value to $391m which equates to a 9.6x FY’17 EBITDA multiple

Pro Forma Valuation following sale of C-stores

FY’17A EBITDA Scenario = $7-11/share target price

$465m for the Travel Center segment and $10m for Restaurants. PF SG&A of $135m which is $10m below the current run-rate (note FY’17 SG&A had non-recurring $10m litigation related expense item). This is based on commentary following the acquisitions but could prove to be a conservative estimate. PF rent of $265m (doesn’t change much as C-stores are primarily owned). Mid-case net leverage improves to 1.3x following sale of the c-stores business. Debt pay down will save $27m in interest per year – whether the company is FCF positive depends on how aggressive they are with growth spend. Maintenance capex is fairly high for this business.

FY’19E EBITDA Scenario = $9-13/share target price

For c-store segment, I don’t see an obvious path for a material increase in segment EBITDA even if revenue improvement measures are successful as I think the cost structure is problematic. Every $4m of EBITDA adds roughly $1/share of value so the valuation is very sensitive to margin assumptions.

For TC segment: assume continued fuel volume declines; improvement in nonfuel revenues for FY’18/19 as new initiatives gain traction and new sites are added (same-store nonfuel revenues have been on an upward trend since early 2017 and 1H’18 same-store revenues improved 4.1% y/y); gross margins improve as all the new initiatives are much higher margin; assume site level operating expense increases; overall see potential for $23m of segment EBITDA improvement by FY’19 (+60bp margin improvement) which is a modest 2.4% 2y CAGR.

There are also percent rent stipulations in the rent agreement requiring TA to pay 3% of nonfuel revenues in excess of the base year of 2015. HPT has waived this fee for the most part but it will likely come in to play if growth increases materially.

Downside / No sale scenario

If c-store results improve materially then it’s possible the company won’t pursue a sale but the shares would likely have upside in this scenario. If consensus estimates prove correct then there’s likely material upside to current valuation as well though I think these estimates are too high.

Given commentary around the need for Travel Center growth I don’t expect the company to generate positive FCF in the next few years. Deleveraging organically will be difficult as the company is still at a point where it needs to spend more to earn more. This is a capital intensive business model and travel centers have a long payback period (3y min to get to full earnings). Management has commented that customer feedback is for more locations in additional corridors. New shipping distribution centers are being built and trucking/freight patterns are changing – having a presence on state highways and secondary routes is necessary to attract and retain customers. Additionally the company plans on introducing a TA Express concept to enable expansion near highways on smaller land parcels as well. All of this will require ongoing capital expenditure.

I also don’t see much downside from current levels as compared to the potential upside in a 12-mth horizon. Given the importance of TA to HPT’s portfolio (both the real estate and common stock) I don’t think they would let the company file. Given the hard asset value here I think the stock would likely find a floor around $2.75-3/share (-30-35%).  

RISK FACTORS

No interested buyers for c-stores

High leverage and ongoing growth capex spend

Relationship with HPT and RMR still ongoing

Catalyst

Sale of c-stores

Earnings improvement