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    Are More C-store Bankruptcies Just Around the Corner?

    Depressed land values and declining sales don't support the debt many carry. But well-capitalized retailers are poised to take advantage of growth opportunities.

    By Don Longo

    NEW YORK -- The margin call that triggered the decision by Ogden, Utah-based Flying J to file for bankruptcy protection late last year may ring for more convenience and petroleum retailers if national business conditions continue to deteriorate in the months ahead.

    Flying J, which last month named Crystal Call Maggelet, daughter of company founder Jay Call, as the new CEO replacing longtime president J. Phillip Adams, attributed the steep drop in oil prices for causing a credit crisis when lenders called for repayment of loans secured with oil valued at the much higher prices of earlier last year.

    The combination of declining revenues from lower motor fuel prices and spending cutbacks by financially strapped consumers could leave many more retailers short on cash to support their businesses, which have valuations based on much higher real estate values than before the market crash across the nation, said several analysts. However, other industry watchers view the situation as an opportunity for well-capitalized operators with lower debt and access to capital to expand much more easily than at any time in the past 10 years.

    The former camp asserts that many retailers do not look at their businesses dispassionately from a purely financial perspective. If they did, they’d be surprised -- and likely disappointed.

    "You have to be very disciplined about what a piece of property can and cannot do," said Jeff Bush, a managing member of real estate developer, Horizon Properties LLC. "I think there's going to be a lot of pain in the next couple of years."

    Another financial expert, John Fontana, former CEO of Hot Stuff Foods, a leading foodservice supplier to the c-store industry, suggested "if you look at the value created by a business over its cost of capital, you will find that the c-store industry is and has been negative -- the only thing that has supported it is the growing real estate values of the past decade."

    Fontana asserted c-store operators are going to have to find the minimal amount of capital they can use. "This means they have to eliminate anything that does not contribute a high enough amount of sales and gross margin," he said. "They will have to analyze every product line and cull out the non-performers. This is a constant process and since most do not do this, they will die off."

    He added, "Growing asset values divorced from the underlying cash flow trends and performance of the business cannot be supportable long term." As profits continue to fall, he anticipates the asset values of many c-store retailers will no longer support the debt of those businesses, and "we will see defaults, loans called and sales of properties by lenders."

    A More Disciplined Approach

    This type of Economic Value Added (EVA) analysis -- a term coined by international management consultancy Stern Stewart & Co., www.sternstewart.com -- is not done by enough retailers, agreed Bush.

    "EVA is simply a more disciplined way of looking at what your business is producing based upon performance," said Bush, who has done development work since 1976. He was vice president of Johnson Oil when it was acquired by Alimentation Couche-Tard, and served as vice president of finance in charge of acquisitions in the U.S. as the Canadian-based company began a series of deals including Mac's Convenience Stores, Dairy Mart and Clark during the 1980s. "Very few operators would have any idea how to calculate EVA."

    Bush said it took him several years to get the owners of Johnson Oil to "even listen to the concept." When they did start to use this method to calculate returns, it led to one of the owners initiating a study of the company and ultimately resulted in the decision to sell -- even though the company was consistently obtaining returns of more than 20 percent.

    "This is the reason most companies cannot build new sites," Bush explained. "The cash flow will not support the cost because land values and construction costs are too high. For example, Circle K had a moratorium on building new sites because it can't make the numbers work. Other people in the industry complain that Circle K will not pay enough for sites, but all they are doing is valuing the sites based upon their performance."

    Commenting on Flying J's Chapter 11 filing, Bush noted when the refiner and travel center operator's inventory values fell, it could not generate the cash to meet its debt requirements -- hence the capital call and then the bankruptcy filing. "The same effect is occurring with the real estate value most c-stores are sitting on. It is being devalued, and as sales drop, profits will drop and operators will not be able to meet their debt loads," he predicted. "For some, it will be this year. For most, it's going to be a very trying five years."

    Terry Monroe, president of American Business Brokers, facilitates mergers and acquisitions among convenience stores, particularly sites with single-store owners. He pointed out banks are reluctant to lend, casting a freeze on many potential industry deals. However, he said in many cases the underlying financial problems can be avoided if the owner of the store or stores would take the time to review each site at least twice a year and apply a "risk/reward ratio" to the store.

    Store owners should review whether their money invested would be best-served if it was put into some other venture that would produce the same or greater value return without all the liability that comes from operating a business. "They should sell, trade, lease or remove every poor-performing store and replace it with a new store, which is what the public wants to see and shop in anyway," said Monroe. "Unfortunately, too many operators are either too lazy or in denial to take the initiative to do anything about it."

    This type of analysis, according to some experts, also helps explain why so many companies -- including the Big Oil companies and the industry's largest chain, 7-Eleven -- are exiting direct ownership of stores and moving more toward franchised models.

    "This (economic analysis) is why I refuse to be in corporate locations or in areas that require large investment," one retailer who asked to remain anonymous told CSNews Online. "The industry simply cannot support itself as it once was able to."

    Chris Neenan, founder of The Lapis Group, a business consultancy based in Summit, N.J., acknowledged, "there are a fair number of marginal players in trouble."

    However, the former partner with the Boston Consulting Group with over 20 years of experience in consulting, corporate finance and private equity, pointed out things are not as bad for the c-store industry compared to other retail channels. "Consumers are trading down. Macy's customers are shopping at Walmart; Whole Foods customers are shopping at ShopRite; and Starbucks customers are turning to self-service coffee at c-stores," he noted.

    Opportunity in the Chaos
    Neenan continued, "Look at all the sandwich chains that are trying to get under $5 for a sandwich. This has interesting implications for the c-store industry as consumers move from sit-down restaurants to value-priced takeaway. People are still going to eat. If I were a well-capitalized c-store, I would invest in value products in hot food for takeaway."

    Fontana, however, said "it drives me crazy" to see a c-store retailer try to save money by reducing labor in the foodservice area, but keep the clerk who is pumping gas, even though the higher profit margins are in foodservice.

    He's quick to point out, though, it's not just about having foodservice, but quality foodservice. "The best food in your market attracts the most customers."

    Neenan also sees growth opportunities in the current recession for some convenience store chains. The recession favors alert, well-capitalized operators with low debt and access to capital, he maintained.

    "Mergers done in recessions outperform mergers done in good times," he noted, explaining the acquiring company most likely got a great deal on a distressed operation. "In some ways, there are more opportunities for the stronger retailers to take advantage than they've had in the past 10 years."

    Is the Sky Falling?
    A different school of thought is offered by Andy Webber, who thinks EVA advocates are acting a bit like "chicken little." Webber, who has recently partnered with NRC Realty Advisors in the real estate company’s M&A/Financial Advisory area, has been CEO of Corner Capital Partners, a Santa Barbara, Calif.-based investment banking, financial and strategy consultant for multi-unit retailers.

    The convenience store industry's sales and profits are not down as much as those in other retail channels, he said, "and the chief benefit of our business -- convenience -- is probably not included in the EVA," which he describes as a "somewhat esoteric" application taught in business schools.

    Additionally, the convenience store industry offers critical infrastructure -- distribution points for current and future energy consumption, whether it be hydrogen, fuel cell, electric or some other form down the road, in addition to other convenience offers like food, FedEx, etc., Webber maintained.

    "I don't see our industry suffering from major foreclosures and bankruptcies for the main reason that our industry went through a de-leveraging in the past five to seven years with the evaporation of the demand for securitized mortgage paper in 2001," he said.

    Like Webber, a c-store retailer from a large chain of stores in the Midwest also isn't buying the predictions of doom and gloom. "Well-run convenience stores, like other well-run businesses in other industries, will continue to be solid as long as they control expenses, generate profit growth at a greater rate than expense growth, and spend their capital dollars wisely," said the executive, who asked to remain anonymous.

    A good example of this is Wawa, which operates close to 600 stores in the mid-Atlantic region. It began planning for a recession last July, taking steps to curtail plans for rapid growth while putting its balance sheet in order. Now, the retailer is as well-positioned as any to exploit opportunities in the market. (For more, see "Wawa Reveals How to Survive a Recession" at CSNews Online by clicking here.)

    And, being highly leveraged doesn't necessarily bode ill for a convenience retailer who has taken the proper precautionary steps coming into the recession. Jesus Delgado-Jenkins, president of Mother Hubbard's Cupboard, a chain of 17 convenience stores in the Quad Cities area of northwestern Illinois, told CSNews Online that when he purchased the first 13 stores of the up-and-coming chain, "we were highly leveraged, but we maintained a lot of cash on the balance sheet -- against the advice of the bank."

    A former U.S. Treasury Department official, Delgado-Jenkins anticipated the recession and enacted a series of measures to reduce the retailer's cost-structure. For example, a year ago, all but four of his stores were 24-hour operations; now, only four stores are open for 24 hours.

    Overall sales are slightly down (3 to 5 percent) from a year ago, but that's due to the reduction in operating hours. "If not for the fewer hours, sales would be flat and profits are up," said Delgado-Jenkins.

    Like most economists, Neenan of The Lapis Group foresees a slow recovery from the current economic mess. "I would watch the consumer," he said. "The economy depends less on what the financial markets are doing and more on what the consumer is doing."

    He recommends convenience retailers plan for a very mediocre 2009. "Put an amount of cash aside in reserve, but don't be so cautious that you bypass opportunities for expansion at a bargain," he said.

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