Current developments at convenience-store operator The Pantry (NASDAQ:PTRY) illustrate how a buying binge and high debt can magnify tough industry conditions. Strangely enough, that could end up being a good thing for potential investors.
Higher oil prices have worked wonders for the bottom lines at integrated oil giants such as Exxon Mobil (NYSE:XOM), BP (NYSE:BP), and Chevron (NYSE:CVX). Unfortunately, they've been squeezing margins at gas stations, making it difficult to pass these costs on to consumers. These conditions flattened The Pantry's first-quarter results, and although gasoline gross profits grew strongly in the second-quarter results released yesterday, oil prices may be booming again.
The problem during Q2 was that higher merger integration charges and related expenses increased the selling, general, and administrative (SG&A) line, turning an 11% advance in sales into a nearly 8% fall in earnings. Even worse, management lowered earnings guidance for the full year, because of higher interest expense and additional refinancing costs from new debt taken on to acquire other convenience stores.
The Pantry has been carrying a fairly heavy debt load, with a 62% debt-to-capital ratio. It's already bought more stores in the first six months of this year than all of last year. As a result, interest on its debt is eating up more than half of its operating earnings.
Fortunately, sales trends in its higher-margin merchandise are doing well. The Pantry has a reputation for being aggressive on the acquisition front, and for cutting costs to boost profitability at newly purchased stores. This has translated into at least 30% sales gains on average over the past three years, and 15% cash flow growth. And debt has been much higher than it is currently.
If gasoline margins hold up, and The Pantry avoids major pitfalls in its buying binges, investors could make out well, since the stock is approaching its lows for the year. Archrival Casey's General Stores (NASDAQ:CASY) pursues similar growth strategies in buying out smaller mom-and-pop operators, and it may be a safer bet. It has lower debt, and it's less aggressive on the M&A front -- but it also carries a slightly higher price-to-earnings ratio. In any case, the convenience store industry remains very fragmented, providing industry consolidators an added growth avenue.
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Fool contributor Ryan Fuhrmann has no financial interest in any company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to discuss any companies mentioned.
