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SAN ANTONIO — Engine Capital LLC, a shareholder of approximately 1 percent of the outstanding shares of CST Brands Inc., issued a letter Wednesday to the convenience store retailer describing a game plan to “substantially increase shareholder value.”
“Fundamentally, CST is in a strategic quandary,” the New York City-based venture capital firm wrote in its letter. “The board and senior management view the company as one of the industry consolidators, yet is unable to articulate how it improves operations at its target companies."
The letter goes on to say, "CST has consistently lagged the better operators on the key relevant metrics. In CST’s case, it is the targets that tend to have the best-of-breed merchandising practices that CST is trying to acquire. In this consolidation phase, CST competes with entities such as Speedway (a division of Marathon Petroleum Corp.), Sunoco LP and [Alimentation] Couche-Tard. These companies are top-tier operators that significantly improve the operations of their targets and can therefore afford to pay more than CST for their acquisitions.”
According to Engine Capital, CST’s recent acquisition of Flash Foods Inc. is a case in point. “CST has communicated that it expects a $4-million improvement in gross profit by year three, which equates to an approximately $24,000 benefit per acquired store,” Engine Capital wrote. “By comparison, in the recent purchases of Hess Retail (by Marathon Petroleum) and The Pantry (by Couche-Tard), the increase in anticipated gross profit dollars per store was approximately $56,000 and $39,000 respectively.”
Engine Capital asserted that San Antonio-based CST must consider two options going forward — either it should remain a standalone company and aggressively improve a number of aspects, or initiate a review to explore what buyers would be willing to pay for the company in a “robust” merger and acquisition environment.
If CST chooses to remain a standalone company, Engine Capital believes it should fix the following:
- Merchandising Operations: “Based on our research, it appears that CST is substantially lagging its peers when it comes to providing compelling merchandise and foodservice offerings.”
- Capital Allocation: “According to CST’s 2020 plan, a large component of its growth will come from NTIs [new-to-industry] stores. While we agree with the strategic merit of growing new store openings and increasing the portion of gross profit that comes from merchandising, we are concerned by the unlevered return metrics of the organic growth program.”
- Real Estate: “We do not believe the market is properly valuing the significant real estate holdings of CST.”
- Executive Compensation: “We are concerned the current compensation structure fails to align executive compensation with the most relevant metrics for shareholder performance."
- Corporate Governance & Board Composition: “We note the company maintains a classified board [of directors] and a combined position of chairman and CEO. In light of this governance structure, we question whether there is proper accountability and oversight at the board level.”
- Investor Communication: “We have significant concerns about the way CST communicates with its stakeholders.” Engine Capital stated one example is CST not “disclosing adequate details regarding its return of capital on its NTIs.”
Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo Securities LLC, issued a research report acknowledging CST’s stock is undervalued “no matter how you slice it.”
“After reviewing Engine Capital’s letter, we broadly believe its thesis is sound and its arguments should be seriously considered,” she stated.
To be a “consolidator of choice,” CST must become a better operator, she added. “We have long viewed CST’s inferior merchandise performance as an opportunity, as there represents a long runway of growth, both in same-store-sales and margins, through key initiatives. We give CST credit for the sequential improvements it is making in merchandise, but agree that in order to facilitate an effective consolidation strategy, CST needs to have a strategic advantage.”