Convenience stores, or c-stores, compete with a host of other retail formats such as supermarkets, drugstores, and discount-warehouse clubs. Since c-stores aren't usually superior in terms of either price or assortment range, the location of the store becomes a key differentiating factor. That's why CST Brands (CST) stands out from its peers Susser Holdings (NYSE: SUSS) and The Pantry (NASDAQ: PTRY) given its significantly higher level of real estate ownership.
The c-store industry is vulnerable to fuel-price volatility and economic downturns. Increases in wholesale fuel prices depress profit margins, while consumers are more likely to drive less and cut back on merchandise purchases in bad times. As a result, c-store operators such as CST Brands, with a lower portion of fixed expenses in its cost structure, are better positioned to preserve profitability.
CST Brands owns 79% of the c-stores it operates compared with its peers, which typically own about half of their store locations. This difference is reflected in CST Brands' lower rental expenses as a percentage of sales. Rent accounts for only about 0.4% of CST Brands' revenue. In contrast, Susser and The Pantry have rental expenses making up about 1% of their respective top lines.
Lease expiry risk
Besides rental hikes, the loss of prized retail locations is another risk associated with an over-reliance on leasing. The c-store industry has very low barriers to entry, and this can be seen from the fragmented nature of the competitive landscape. According to data from the National Association of Convenience Stores, more than half of the 100,000-plus c-stores in operation are currently run by single-store operators. The incumbents like CST Brands typically already occupy the prime locations, but they risk losing the best locations to new entrants when leases expire.
More than one-third of The Pantry's c-store leases are up for renewals for the next few years until 2017, but this is partly mitigated by the fact that close to 90% of the leases come without renewal options. While Susser is in a less vulnerable position with only about 10% of leases expiring within the next five years, it is still susceptible to renegotiating a new lease at higher rates.
In comparison, less than one-fifth of CST Brands' locations are leased and most of them come with renewal options.
Flexibility of land usage
Aside from limited downside risks, CST Brands is taking advantage of its preference for owned rather than leased store locations by rolling out its new store concept, called new to industry, or NTI.. Compared with its existing stores, NTI stores boast a more open and modern store design to increase customer appeal. They also carry a larger proportion of higher-margin food offerings and private-label products. In addition, parking, a key driver of customer traffic, is also expanded under the new NTI store format.
Its peers are also moving in the same direction. Susser has doubled its average retail store size from 25,000 square feet to 50,000 square feet over the past decade, while The Pantry has greatly expanded its food-service offerings, adding six and 16 new quick-service restaurants (QSRs) in fiscal 2012 and 2013, respectively.
But CST Brands still has the edge. In July 2013, CST Brands opened its largest store to-date in Three Rivers, Texas. This new NTI store comes with sufficient parking spaces to accommodate vehicles of any size from trucks to motorcycles, something made possible by its ability to freely configure its store layout and floor plans. Instead, if CST Brands was leasing, it would have been more difficult for it to implement changes such as expanding parking.
CST Brands is my top pick among listed c-store operators, as it has the fewest downside risks with respect to increased rent and loss of prime locations. More importantly, it is leveraging on the flexibility associated with real estate ownership to grow further via its new store format.