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    Fiscal Fitness

    As economic natural selection takes its toll, retailers must invest, conserve and prune.

    By Matthew Enis

    In the early 1970s, a former vice president of Shell was out of gas — literally. After leaving a secure position with Big Oil to join the burgeoning ranks of independent convenience store operators, the completion of his first store unfortunately coincided with the historic oil embargo of 1973. When the store opened, no gas was available for his tanks.

    "My background was made up entirely of gasoline; I didn't know a thing about the convenience store business," said industry veteran Bob Seng. "At that time, though, I realized that we needed an edge, something different, something that was very profitable."

    Seng adapted quickly, creating an innovative foodservice plan — submarine sandwiches to go, made to order within 60 seconds. His supervisors used stopwatches to train employees.

    Seng succeeded, as did other c-store compatriots who saw change as key to survival. While the cost of change may seem high during turbulent and uncertain times, passiveness in a changing marketplace often exacts a much higher price.

    A growing number of industry experts are predicting that as many as a third of the industry's current stores may be shuttered by the end of the current decade. With competition intensifying, chains that wish to remain in the game will have to raise the ante.

    "You have got to reinvest in your business," said Stan Sheetz, president and CEO of Altoona, Pa.-based Sheetz Inc. "And that involves reinvesting in your people, products, marketing, systems, facilities and your operations; otherwise, you will become outdated."

    The economic downturn coupled with the expansion of hypermarkets into new territories has burned many operators, yet the c-store industry as a whole has weathered similar conditions. During the oil crisis, for example, retailers worried that Big Oil would soon push them out of the convenience business.

    During the recession of the early 1980s, the industry's historical 20 percent annual growth rate screeched to a halt and barely met inflation.

    The recession of the early 1990s led to in-store sales falling by more than $1 billion, margins on key categories, including gasoline, shrinking and credit markets tightening severely due to several high-profile industry bankruptcies.

    It may seem ironic that despite these historical problems — and yet another spate of bankruptcies during 2001 — analysts continue to describe the c-store industry as recession-resistant. It's a feasible definition, although it really only applies to the best operators.

    "Times are tough, but really not much worse than they've been in the past," said Ron McFarland, an industry veteran who now owns and operates Medford, Texas-based North Texas Convenience Stores Inc., a chain of five stores.

    A consistent criticism offered by retailers emerging from the recession relatively unscathed is that many c-store companies spend too lavishly during fat times and pull back too drastically during lean times.

    When an economic downturn coincides with new competitive pressures, such as the spread of hypermarkets, overleveraged companies are ripe for the picking.

    A key to success is staying the course with long-term goals. 7-Eleven's ongoing technology initiatives have flown in the face of Wall Street expectations in recent months, yet the company has sustained same- store sales growth of better than 5 percent during the past two years.

    Similarly, an unsympathetic economy did not prevent Beaverton, Ore.-based Plaid Pantries Inc. from going forward with planned automation upgrades and the introduction of a proprietary gasoline brand last year.

    "You give us a bit too much credit," said Chris Girard, CEO of the 105-store chain. "We had committed to the automation project while the economy was still on an up trend. Had we known what lay ahead, we probably would have deferred such a major commitment."

    As for the gasoline conversion, he said, "Our ARCO contracts were up, and with all the turmoil in major oil: acquisitions, redlining in our market area, drying up of incentive funds, it was a relative no-brainer to go unbranded."

    While Girard's modesty is disarming, the fact remains that Plaid had sufficient funding to move forward with its plans and respond to competitive issues that will remain long after the general economy improves.

    Ankeny, Iowa-based Casey's General Stores Inc. also proceeded with planned upgrades in the face of widespread economic uncertainly. The company converted more than one-third of its 1,332 stores to pay-at-the-pump in 2001 and will convert the remainder during this fiscal year.

    In a recent Wall Street Transcript interview, CFO Jamie Shaffer described Casey's as a conservative organization with a debt-adverse balance sheet.

    Yet the chain will continue to invest in technology. "I think we can do better with what we have, both in terms of sales and margins with improved technology," Shaffer said.



    Better Borrowing

    There is a critical difference between debt aversion and risk aversion. Growth, whether through expansion or infrastructural upgrades, most often requires the acceptance of some debt; risk is an inherent partner.

    Debt aversion means knowing how much risk a company can viably accept, and how associated debt will be managed given a variety of potential business scenarios.

    "A lot of companies ended up overbuilding recently," said Robert Buhler, president and CEO of Open Pantry Food Marts, a 34-store chain based in Pleasant Prairie, Wis. "And operators that drew a lot of funds from conduit vehicles such as FMAC or EMAC [both of which have ceased operation] are probably in a bit of a jam. Their rates and spreads were much higher on a fixed-rate basis."

    Many of these companies borrowed money based on projected earnings from gasoline margins that have since dried up. "If a company has evolved its economics around making 15 cents per gallon on gasoline, that's not right," said Sheetz. "If that 15-cents-a-gallon goes away — and it has — then [expenses] have to go away also."

    Unfortunately, debt payments and interest are expenses that cannot be cut — as highly leveraged companies have learned.

    Buhler, a former banker, said that companies looking to borrow should pay very close attention to figures such as their fixed-charge coverage ratio. (EBITDA plus lease expenses, divided by interest plus lease expenses indicates a company's ability to service interest and leases.)

    And a company's ability to accept debt should be based on real earnings, not pro forma financial statements. "The industry has a habit every 10 years or so of borrowing money that has a low prospect of being paid back," said Girard.

    Capital markets have been spooked by the recent bankruptcies of Duke & Long, Convenience USA and Fas Mart; serious problems continue to surface at other chains. In addition to the defunct EMAC and FMAC, other large players, such as Shell Capital, have simply chosen to discontinue lending, despite their more stable history.

    Still, money is available. Most major oil brands have MAC (mortgage acceptance company) programs. These loans can be some of the most competitive in the industry, since the floating interest rates offered by these lenders are most often tied to the commercial paper rate (the interest that high-quality corporations pay their lenders for short-term loans) of the MAC's underlying brand.

    Many smaller operators have also found good deals through local banks or the Small Business Administration. Larger organizations, such as Citigroup and GE Capital, are still lending to the industry as well.

    Money is still available to operators with a solid business model and realistic plans, said Scott Morris, president of Hauppauge, N.Y.-based Credit America Funding Corp., which has remained bullish on the industry, continuing to fund small and medium-sized operators.

    "Competition is like war," he said. "When faced with a larger force, the smaller competitor can't attack head-on, or they're going to lose." Morris cited a northeastern client that operates within Wawa's territory. Instead of opening a store opposite a Wawa's and attempting to compete on price or foodservice, the operator has successfully opened sites in rural towns where Wawa doesn't have a presence.

    A similar strategy has protected Casey's during Wal-Mart's growth in the Midwest. About 60 percent of the chain's stores are located in towns of 5,000 or fewer people — areas too small to sustain a hypermarket. These locations act as a hedge, shielding the company and its margins from new predators.

    "Back in the 1970s the convenience store business was as easy as opening a store on a corner," said Sheetz. "That's not the way it works anymore."

    While obviously a smaller retail force than Wal-Mart, Sheetz is regarded as one of the fiercest and most efficient competitors in the industry. The company has shown willingness to take hypermarkets and big oil by the horns, selling gasoline at minimal margins if necessary.

    Lost profits on gas are easily made up inside the Sheetz outlets with their award-winning foodservice programs — something to which hypermarkets have no competitive answer.

    The program has taken the company two decades to build, yet as Sheetz and Seng both noted, it does not take long to see returns from a well-executed program.

    "There's nothing magical about us," said Sheetz, noting that he and his family did not have a foodservice background when the program was developed. Success did not come easily, either.

    "When we went into foodservice," he said, "we committed 100 labor hours per store per week. Today, we use three times that, but there had to be that initial investment to develop a credible offer."

    According to the 2002 CSNews Industry Report, many operators have thrown up their hands in frustration, opting to quit the fast-food business or simply rent space in their stores to major franchisees.

    Sheetz said that there is a danger in viewing foodservice as a fix while overlooking more serious problems, such as poor location. And significant changes often require the same personal investment that operators used when opening their first store.



    Constant Change

    Lack of good financial/operating information, unwillingness to do "major surgery," managing by hope versus reality, excessive overhead and underperforming assets are problems that can bring a company to its knees financially, said Girard. Looming larger, however, may be the failure of many retailers to recognize changes in the business model and adapt accordingly.

    "You can ride around this country and find stores that look the same as they did 20 years ago, and they're having problems," said Sheetz. "It's not because they didn't get into foodservice or they didn't add restrooms or they didn't promote their coffee well enough — they just didn't change at all."

    Convenience stores don't have to stay on the bleeding edge of retail innovation, but remaining a viable competitor requires keen observation of local markets and a willingness to take risks.

    For example, McFarland, among the first to install ATMs in his area, admitted his initial concern about the investment. "Who would think that people would be willing to pay $1.50 to take $20 out of their checking accounts?" he said.

    But magic bullets like foodservice and ATMs appear to be running their course, with no miracle categories on the horizon. That, coupled with intense competition from mass retailers and grocers, is prompting industry leaders to launch a new tack: Prune bad sites and reinvest in good ones.

    For c-store operators close to the brink, Girard, who helped return Plaid Pantries from bankruptcy to profitability in the 1990s, offered this advice: "Conserve cash, cut the bleeding, fully cost out every profit and cost center, and get rid of the dead wood — underperforming stores and, unfortunately, people."

    By Matthew Enis
    • About Matthew Enis

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