Where Casey's General Stores Inc. Fell Short

Image source: Casey's General Stores. 

Convenience stores represent a very fragmented market. One of the biggest players is Casey's General Stores (CASY -0.28%), which focuses on building clusters of stores in small-town America. The company is based in Iowa and got its start in the Midwest, but it is moving to both the South and East rapidly.

While some might think of this as a relatively boring industry, Casey's focus on becoming one of the biggest pizza companies in the country has gotten investors excited lately. Shares have tripled over the past five years, and the bump in the company's "food and fountain" comparable-store sales (comps) is one of the biggest reasons.

The thesis for investors is simple: People go to Casey's to get their (low-margin) gas, but as they go inside, they buy more groceries, cigarettes, and most importantly (high-margin) prepared foods -- with pizza being the primary food that's bought. While gas might make up the bulk of revenue, it's things that are bought inside the store that contribute the most gross profit dollars.

The company has done a fantastic job of capitalizing on this opportunity, and should be lauded for seeing a niche that was underserved. Investors, however, need to be careful about management overpromising and underdelivering. That's what happened this year, and it seems like the table is set for it to happen again. Casey's reported Q4 2016 results Monday and held a conference call with analysts Tuesday morning.

But first, just the numbers

 Data source: SEC filings and Casey's General Stores investor relations.

When it comes to convenience stores, investors shouldn't pay too much attention to revenue numbers. That's because the price of gas can fluctuate widely, and management has little control over this. Like you saw above, it also is a very low-margin aspect of the business.

Where Casey's met expectations and where it disappointed

One year ago, management set out goals for the company's comps and margins in its three main categories. As you can see below, they met almost all of those, with one very notable exception.

It is the shortfall in food and fountain that I find the most concerning. This is the central thesis to an investment in Casey's.

No doubt, any company would die for comps above 5% in any category. But the assumption of double-digit comp growth in prepared foods is already baked into Casey's stock price -- and if the company continues to fall short of these projections, investors will pay the price.

Management continually stated during the conference call that the reason for the shortfall was simply because the rollout of many growth initiatives -- a mobile food ordering app, 24-hour service, pizza delivery, and major remodels -- were weighted heavily toward the fourth quarter.

But even then, comps during the fourth quarter were 8.2% -- well short of the 10.4% management foresaw for the year. That should give investors pause.

It's also worth noting that the company either built or acquired 56 new stores during the fiscal year, but this fell well short of the 75-113 new locations that management said it would accomplish during the past 12 months.

"Cautiously optimistic"?

When management released its outlook for fiscal 2017, it said that it expected food and fountain to grow by 10.2% -- basically the same outlook it gave last year. Given the company's failure to live up to expectations in 2016, analysts were surprised.

When pressed by analysts as to why the company would give such a high estimate, CEO Terry Handly said that the company was confident that the aforementioned growth initiatives could help get comps "back in the double-digit area" and that they are "cautiously optimistic."  

Cautiously optimistic? That struck me as an odd way to put it. After falling 20% short of its comp growth and then restating the same goals for the current year, I would classify that goal as overly optimistic.

It's also worth mentioning that a number of analysts questioned whether Hy-Vee's new convenience stores -- which are usually placed in front of their namesake grocery stores and offer prepared food as well -- were becoming a serious competitor. Management said they were a competitor, but left it at that.

Where we stand right now

Given the nearly 5% sell-off in the stock as of 1:45 p.m. Tuesday, the market has concerns as well. Management made clear that the pace of store openings will accelerate in the coming year. That's a good move, as the company wants to establish itself in new markets it thinks it can exploit.

Currently, the company trades for 21 times trailing earnings and 20 times 2017's expected earnings. That's not overly expensive or cheap, but I believe the performance of the company's food and fountain comps will be the primary determinant of where the stock heads over the next 12 months.