Clearing the Confusion About Gasoline Retailing

The oil and gas industry's take on gasoline retailing had been pretty clear. Many sector majors viewed their gas and merchandise sales operations as non-core and divested the business. That was when Energy Transfer Partners (NYSE: ETP  ) acquired Susser Holdings (NYSE: SUSS  ) and Marathon Petroleum (NYSE: MPC  ) bought Hess Corporation's (NYSE: HES  ) retail assets. Questions abounded. Why would Energy Transfer, a natural gas transport master limited partnership (MLP), want a fuel-pumping convenience store operator? What would motivate Marathon, an oil refiner and transporter, to purchase Hess Retail? Had the gasoline-retailing paradigm changed? Let's see if we can find some answers.

A successful spinoff
Valero Energy's
spinoff of its convenience store/gas selling operation, now called CST Brands, demonstrated the industry's general view of the retail business. Though CST is a large and successful operation, it just wasn't a great fit for a refining powerhouse like Valero. There was another good reason for the separation, however. Prior to the split, CST Brands would deliver free cash flow and have expansion opportunities. The division was often short-changed, however, as most of management's time and allocated capital would flow to the core refining business.

Though not part of Valero's plans, CST Brands does have an admirable franchise. It operates over 1,000 fuel-pumping convenience stores in nine U.S. states, with a concentration in Texas and Colorado, and another roughly 800 locations in eastern Canada, which generate about 40% of total company revenue.

As a stand-alone enterprise, CST can more fully benefit from its significant presence in Texas. Business is doing very well there, supported by a lower-than-average unemployment rate and a strong housing market. The company's Texas-based distribution center also helps parlay that regional focus into greater profitability. The site provides support for increased private label goods and fresh food offerings, which are a critical for driving sales growth and profit margin expansion in the gasoline retailing business.

Investors can't complain about Valero's decision to spin off CST Brands. The companies have done very well since the distribution. Valero shares are up more than 30% over the last year, though probably not solely due to the separation. CST Brand holders also profited. Their shares have risen around 9% since the split.

A win-win deal
Oil explorer Hess Corporation had a similar plan to spin off its gasoline retailing business. Marathon Petroleum interrupted that endeavor, however. Marathon purchased the convenience store and gas selling operation, called Hess Retail, for roughly $2.6 billion. The buyout seems good for all involved. Hess gets to divest a non-core asset at a good price, and Marathon gets to leverage its refining and transport business with a choice asset.

Hess Retail is a force in gasoline retailing. Operating over 1,000 fuel and food outlets from Florida to New Hampshire, it is also the largest Dunkin' Donuts franchisee by site count. Hess has initiated a plan to boost profits by trying to increase the size of customer purchases. It has improved in-store environments and expanded into more lucrative proprietary brand and fresh food offerings. To draw more customers, it has also tightened its relationship with well-known consumer brand partners, such as Wendy's and Dairy Queen.

Hess Retail looks a good fit for Marathon's retail business, called Speedway, which runs nearly 1,500 convenience stores. Speedway now adds an East Coast presence to its stronghold Midwest market territory. The combination also creates the nation's largest company-owned and operated convenience store chain when measured by revenue. A reasonable 0.20 times sales purchase price for Hess Retail, not far off from CST Brands' current market worth of around 0.19 times sales, looks like it helps make the deal a likely winner.

A buyer when others were selling
While Valero and Hess divesting non-core operations seemed logical and Marathon Petroleum adding to its retail presence appeared reasonable, Energy Transfer Partners' acquisition of Susser Holdings was puzzling. There weren't many hints that the MLP might even consider expanding its fuel and merchandise sales business.

The pipeline operator defended its $1.8 billion purchase, however. It noted that there would be significant synergies from the addition of Susser to Energy Transfer's $21 billion retail operation, a business that came via a 2012 acquisition of fellow pipeline operator Sunoco. The Susser buy also appears financially sound. It is expected to be immediately accretive to distributable cash flow, a key consideration for MLPs, with cash flows probably growing as the acquisition gets integrated.

Susser Holdings is an attractive property. Its 600 retail locations have helped achieve sustained earnings growth. With a focus on Texas, the company has capitalized on a good business environment as well as demographic changes occurring in its markets. Recent performance seems to confirm the company's prowess. Sales rose 5.8% and gross profits grew 5.4% last year when compared to a year earlier. An impressive 9.2% jump in merchandise sales helped propel those gains.

It appears that Energy Transfer Partners had to pay a premium for this inviting asset. The price, at 0.29 times annual sales, suggests the MLP might have bigger plans for the combined retail powerhouse. In fact, while the combination's benefits were fully emphasized, Energy Transfer's intent to eventually separate out the entire retail business was also mentioned.

Bottom line
So what does all of this mean? It appears that the tendency toward large oil and gas sector participants divesting fuel retailing is still in place. Energy Transfer's surprise purchase looks to be merely a preliminary step for a future separation. There does seem to be a new trend appearing within the gasoline-retailing sector, however. Size is starting to matter. Both the Marathon and Energy Transfer buys have created behemoth gas retailers, dwarfing their nearest competitors. Investors may want to investigate this new dynamic. It might offer some intriguing and profitable possibilities.

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Bob Chandler

A dedicated Graham-style value man, Bob bought his first stock in 1986 and though he’s a miserable market timer, longer-term calls let him earn a meager living from his investments. With an MBA and MS in Accounting, Bob relies more on Hetty Green's advice for successful investing: "Buy cheap and sell dear. Act with thrift and shrewdness and be persistent."

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8/27/2015 4:07 PM
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