If You Love Convenience Stores, Will You Love Casey's?

Casey's General Stores (CASY 0.63%) is a midwestern favorite, serving fuel, food, and groceries to rural and suburban communities across sixteen states. But is Casey's the best convenience store, or just the only one available?

In this episode of Industry Focus: Consumer Goods, join Emily Flippen and Asit Sharma as they break down this retailer and discuss what the future may hold for its business.

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This video was recorded on Sept. 14, 2021.

Emily Flippen: Welcome to Industry Focus. My name is Emily Flippen, and I'll be joined by Asit Sharma today, as we dive into America's favorite publicly traded convenience store, Casey's General Store. If you're listening today, it's Sept. 14th, but we're actually pre-recording today's episode. Hey, Asit, how are you?

Asit Sharma: I'm good Emily. I'm happy to be a generalist today as we talk about Casey's General Store.

Flippen: I loved the read in for today's show because I did say this is America's favorite publicly traded convenience store, and I think that sounds like a really wonderful thing to say about Casey's General Store. But I'm not confident that anybody listening, and I'm happy to be proven wrong, can name another publicly traded convenience store. In part because I feel like convenience stores just aren't the most interesting investment, and I'm happy to be proven wrong during today's show. But what I do know is that I am a loyal Wawa fan. If Wawa was publicly traded, I am convinced Casey's would lose its title as America's favorite. But I think until we get to the point of that long-awaited Wawa IPO, we'll have to settle to talk about Casey's today.

Sharma: Yeah. You stumped me on that lead in, Emily, because I can't think of another publicly traded C-store in America. Now, a couple came to mind that are foreign, I think it is Couche-Tard, if I remember correctly, there's a Canadian convenience store chain. There's also a 7-Eleven in Japan. I think they're still publicly traded. But yeah, in the wide world of convenience stores, there's so many fascinating ones strung across the United States. We've got one in your area and in mine a little bit further South, Sheetz, that's rapidly growing, and I think they're also in the Midwest. There's so many but the one we're going to talk about today is one of the more fun convenience stores to walk into and to experience.

Flippen: Yes. This is a Midwestern powerhouse, and I imagine my comments about Wawa and your comments about Sheetz. Maybe you are irritating some people, especially those around areas like Iowa, who possibly love Casey's General Store. They really do have a cult following in the Midwest. They have more than 2,200 stores across 16 states, and they're really centralized in locations that have less than 5,000 residents. Management thinks that by positioning Casey's General Stores which sell things like grocery items, and food, but also obviously fuel, which makes up a large majority of their revenue. By selling these items, they are actually filling a need in these local communities where national chains aren't available.

Sharma: I buy that argument, actually. I think this is something that the management of chains like Dollar Store and Dollar Tree also believe in, because they fill this niche needs. When you're in a rural area, as you say, an area with fewer than 5,000 residents, there's a high probability that's a food desert, there is a high probability, it's a fuel desert, and a high probability which we'll get to in a moment that it's a pizza desert. But maybe you could talk a little bit as I just tease that. Are they making all of their money, their gross revenue from fuel being a convenience store or is there a more diversified story here, Emily?

Flippen: Yes. Around 40% of their gross revenue over the past three years did come from non-fuel items. That's good because the non-fuel item, so again, things you go into the store to buy: grocery or food items, they carry a higher margin, and they represented more than 70% of net revenue in 2020. But it's still worth noting that more than 50% of that gross revenue is coming from fuel. This is a very low margin for them. It tends to be very volatile because as people know, while they may look at their quarterly performance and see revenue up 50% year over year. We're coming off of 2020 where fuel prices were very low and travel was much lower than it was in prior years, so it's an element of their business that's a little bit outside of their control. I'm happy to be corrected, but when I look at this business and analyze its performance, I'm much more focused on that 40% of gross revenue coming from things that are inside of their control, so anything that's happening inside the Casey's stores themselves.

Sharma: I agree. I think that Casey's management also sees it this way. They have been attuned to working with more volume on the fuel side and incrementally improving the margins, which we can talk about in a bit. But all the excitement for Casey's happens when you walk in from the customer side and for management's perspective as well. They've invested a lot in their store presentations over the past couple of years, and they're using technology to a greater degree than they had in the past. In fact, Casey's management team sees part of their food service in the store as a QSR concept, a quick-service restaurant concept. They take their best practices from the quick-service industry. They modeled themselves after companies like McDonald's. In fact, they just launched a breakfast line and this gives you an idea if you're not from the Midwest, what Casey's is. Because if I told you that this is a convenience store chain. In many parts of the country, you're thinking there's some items on the shelf when I walk in. There's maybe one person behind the cash register. There's a fountain for coffee and drinks, maybe there's a little hot dog stand on the counter, this type of thing, or a kiosk with Dunkin Donuts. But Casey's is so much more. They strive to be, as I said, a company that's supplying you food options if you happen to be in these rural areas.

Flippen: I know you've looked at Casey's maybe two, three years ago, I'm curious was that thesis a few years ago for Casey's as well, is that people are going to come in and have a great experience with prepared food, or was it still more your traditional old-school convenient store? Has that changed over the past few years?

Sharma: I think that it was the case then, and it's only more the case now. I looked at this company in 2019, and at that point, they had a new CEO whose name is Darren Rebelez. I hope I'm pronouncing that correctly. Darren Rebelez was very focused at that time on the two big-picture things that you've alighted on Emily. He spoke to investors about improving those gross fuel margins, which were, at that time, around $0.25, $0.26 per gallon, or just think of this as 26% margins on fuel, he wanted to improve those every year. Now, there is a lot that goes into improving your margins on fuel. It's a very complicated business. Volumes can play a part where you promote your higher fuel pricing, that is as a district gets a little more urban, you've got more ability to charge a cent higher and still not lose to competition. It's really hard to explain how long-term their margins are going to fluctuate. But the bottom line is in those two years, fuel margins are up by about 20 percentage points. I don't know how sticky that's going to be.

The other thing that Darren Rebelez has talked a lot about was improving the food service, improving technology. Think of our ability to order via mobile devices that was key in 2019. I think it helped them during COVID where they saw some of their traffic decline. They have a much better digital experience today. The other thing that I will mention about their food is that their loyalty program now is much more robust under Rebelez's leadership. He's finding ways to make sure you get in store when you might not even be thinking about it. The broad strategy looks like this. They've got what they call curation. They hit everyone who's in the loyalty program with a big offer. Then they go down another level, which is more of a targeted promotional message for certain groups. They get the data and they say, here's a big cohort. These are the Emilys who come in twice a week. We know that the Emilys usually do X and so they hit that group. But those make up about 80% of their promotional targeting, 20% is individualized, or they go directly to Emily and say, "Emily, just come in today, we're going to give you 10% off this really nice pizza because we know you love pizza."

Flippen: I do.

Sharma: I do, too. Part of the investment here in the coming years, we're going to see that flip. They are going to use individual targeting. That'll be 80% of how they market and the other forms of marketing, the curation, the segmentation, those are going to dwindle down to about 20%. I really like the long-term things that Rebelez has done since he's come in. Like this introduction of breakfast, which we know has been very lucrative for companies like McDonald's and Wendy's that have nothing to do with the convenience business. The edge here is that Casey's has people preparing food, they say from scratch, I don't think it's from scratch, but it's a lot closer than what's going on in the Sheetz, which also has some people behind what looks like kitchen equipment. It sounds comical to say these things, but they're the types of initiatives that drive margin when your customer base doesn't have a lot of other options. I think that's part of the reason why Casey's is so beloved. I didn't mean to go on this long extended digression here on the strategy, but I think it's genius.

Flippen: I agree with you in part because I think I've had this firsthand experience with Wawa. I know this is a similar experience that people have at Buc-ee's, B-U-C-C-E-E-S, not the Bucky's that was actually acquired by Casey's General Store earlier this year. But people have the experience where they walk in and they almost view the convenience stores as, I'm going to call it, my happy place. They get fancy drinks made like lattes, cappuccinos. They can order specialized food and it's an experience within itself and honestly, I buy into it as an opportunity for convenience stores. I will say I'm a little surprised that their strategy hasn't performed better over the past couple of years. I don't have a lot of businesses to compare it to again, because Casey's is really the only pure-play publicly traded U.S.-based convenience store that is pursuing this strategy. But when I looked at their same-store sales for things like prepared food and fountain, it's actually been negative so far in 2021, negative throughout 2020, and been on a general decline since 2017. I'm surprised it's not performing better. I want to be generous here and say, I'm sure the pandemic has a lot to do with how their business has been handled the last couple of years, but I do wish those numbers were ticking upwards.

Sharma: Well, one of the things that we don't expect out of convenience stores is they'll have a lot of pricing power. Some of the initiatives that I talked about can contribute pricing power, but you need volume, too. The idea of same-store sales declining is surprising in this picture. The other thing that I'll note along that line when I looked at this business a couple of years ago, they were getting a lot of profit from prepared foods, which they still are. I think the prepared food and beverages segment had at that time about 62% gross profitability, just leading the business in gross profitability. It's still really high today, but it's trailed down by a couple of percentage points, I think now it's about 60.5%. I was a bit surprised because my expectation was that they would be able to improve gross margin with these types of loyalty investments, with the mobile investments. Part of this may have to do with some gas competition, though. We do know that the C-store space is competitive, so more competitors are coming in. As soon as you get within a couple of mile radius of another gas station, that's the driver of traffic into your store. If price is normalized among two gas stations, once you're not the only player in town in a population of 5,500, you might lose some traffic that normally would be yours. You can do a lot of these, what I call near-genius moves, but still not see the benefits.

I'm wondering if some of the encroaching independent gas stations and other chains are now forcing Casey's to compete on price on that fuel level in a bigger way than they were before. If that's what's hurting traffic, then this might be something that doesn't get solved overnight and I haven't really followed this company. So great that you were proposing to do this one, Emily, because I looked at it in 2019 and I wrote about it. But at that point, maybe something in my mind was telling me, I like this. It's such a great brand in the Midwest, but it seems like it could be vulnerable to some competition. I'm really curious to know if that's actually what's happened over the past couple of years.

Flippen: I think there is a silver lining here and they did have their quarterly reports on the 8th of September, so pretty recently. One of the things that stood out to me with their private-label sales. To your point, I think this is something that Casey's launched, I believe it was a year or two ago because of maybe losing a bit of margin on the pricing power. When you go private label as inherently a larger margin for yourself as a retailer, and so they're seeking private label items, things like chips and snacks and nuts, Casey-branded items in their stores. They had a goal of over the next three, four years, reaching 10% private-label sales in their store. That's the industry average. They expected to have to build up to that over a number of years. I'll tell you what the private label sales have just taken off. I think they are around 1% after the year they launched, their most recent quarter was over 4%, and they're ahead of target in terms of expanding that private label business of getting to 10% in 2-3 years. Amazing performance in terms of their private-label sales. That says something positive to me about some of the loyalty, I guess. When you walk into a Casey's and you trust buying the Casey's nuts as opposed to the Planters peanuts, for instance. Maybe there's some loyalty there and maybe they can expand that private label up to 10%, which could make a meaningful change in terms of their margin profile.

Sharma: Absolutely. If the drivers of same-store sales really start to pick up, then you get some momentum. This episode I think is going to air roughly close to two years to the date that I wrote about the new CEO coming on board and his initiatives, his thoughts at that time. Largely they've executed on that front, but looking at the stock chart, since then, the company has only appreciated 15% in those two years. Sometimes, however, you fix one lever and make it so strong that when the next lever is just pulled at equal weight, you double the effect. What if they start to see better traffic if let's say some of the pulls into the business, like this individually targeted marketing message, they're going to be rolling out to various customers in their loyalty program. If those things start to drive more traffic versus having to pull people in via competitiveness of gas prices against competitors, then maybe the stock has some fuel not to overuse a word we've said a lot today that will help Casey's realize the fruit of all this labor, investment in technology, investment in food, in doing breakfast, all the kinds of really innovative looks that management has thrown at this company.

They need one good piece of momentum and whatever that is, that's dragging down the same-store sales, I believe part of that's probably traffic. Once that normalizes, if it does, I think you can see some better results. But Emily, you mentioned when we were prepping for this episode that if you look on an earnings basis, they're looking good, that margin profile is coming through. They had the highest adjusted EBITDA -- earnings before income, taxes, depreciation, amortization -- in Casey's history in this last quarter and they had their highest earnings per share this past quarter. Put that in the context of what looked like really big revenue growth for us was like 50% year-over-year revenue growth?

Flippen: It was.

Sharma: Is that going to stick around or what's going on there?

Flippen: I don't expect it will, and I think that's maybe where I struggle with this business looking forward. Again, when you think about more than 50% of their revenue coming from things like gas demand and fuel prices. That's a bit unpredictable, especially over the short term, over the long term, probably stabilizes out. But I also just think it comes down to execution on the part of Casey's management. You've been following this business longer than I have. Maybe there's a bit more, I think trust built up in this new CEO in terms of their ability to execute. I think I find myself getting a little bit concerned over things like labor shortages. They had a really good year last year because of the pandemic. They cut back on staff, they cut back on hours. But as those people started coming back to work into 2021, labor costs and operating expenses have expanded. There's a 24% expansion in operating costs year over year, and nearly 40% of that came from labor expenses alone. Convenience stores in general, somewhat low-margin business. I think whether or not this ends up being the type of business that beats the market over the next five years comes entirely down to some aspects of things that are outside of their control, like fuel demand. But also can management execute on generating store traffic and customer loyalty at the same level we've seen other private convenience stores perform in? I don't know if I have a great answer to that, but they're certainly trying.

Sharma: I think for me, the external factors are really hard to deal with so I'm not a buyer of Casey's. Again, this is maybe why I took a deep look into it a few years ago. Haven't really followed it closely, but I want to put us in the shoes of someone who already owns the stock, who maybe lives in the Midwest and is a fan of this really popular brand and just interested in owning a local business. What would you say to that person looking forward to the next five years? My part of it would be, hold onto those shares. I know they've underperformed the market for the last couple of years, but I don't feel here that they are in a declining position. I think those external factors you mentioned are really strong. I am wary of gas price competition, but I think this is a management team that is executing pretty well. I think they've got decent chances, all things considered to make money. By that, we mean that if you're holding the stock, it should rise. That's all we mean by making money. That's different from maybe beating the S&P 500 index. I think it could perform alongside the index if certain things fall in place. That is, they can get some yield off of the private label. They start to see yield from having basically kitchens in-house that attracts more of a non-gas-related or a non-fuel-up-related visit.

There are ways over time they can have more of a dependable revenue stream. But to me, despite the fact that the stock hasn't really performed very well, It's not a sell if you're holding the stock. I would say, I'll go out on a limb and say my advice is, you can hang on to it, especially if you are a fan of Casey's store. You would know the brand better than we do. If Emily was in the same position, she owns some Wawa shares, I'm guessing, maybe she would consider hanging onto those if this had been your experience, but I'll be quiet now to hear your perspectives before we head out the door.

Flippen: We've been doing this too long because I had this whole thing prepared about how I was in no position to judge because if I was holding Wawa shares, I would certainly continue to hold them if they were in this exact position. I'm a huge fan of that business. I'm right there alongside you if you're a big fan of Casey's and it's a place that you also visit on a nearly daily basis as I do Wawa. Shout out to Wawa. Then not a bad business by no means a bad business. It'll definitely be one to watch, though. I'm really excited to see how management executes, but until then, Asit, thank you so much for always coming on and providing your insights. I know this one's pre-recorded palooza. We have a lot of taping to do before we all head out on vacation so there's a lot of work. I and our listeners appreciate it.

Sharma: Well, Emily, it's been great fun for me as it always will. My parting shots for you and listeners, I'm going to get some coffee this afternoon because we've been doing our pre-taped palooza, and you and I are going to be apart. I think you're away next week. I'm away the week after. I'm going to get some coffee to fuel up, but shout out to Casey's because they are putting in new coffee in their convenience stores with a grind to drip machine. It's a little higher end, it's going to be that much better.

Flippen: Higher end than Wawa.

Sharma: Yeah. Wawa, you better bring your game in the coming quarters.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say "Hey," shoot us an email at [email protected] or tweet us @MFIndustryFocus. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I'm Emily Flippen. Thanks for listening and Fool on.