Alimentation Couche-Tard: Update From Our Latest Letter

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Alimentation Couche-Tard is one of the world’s largest convenience store chains. The company’s name is French for “food for people who stay up late.” Couche-Tard has over 14,000 stores across North America, Europe, and Asia. Brands include Circle K, Couche-Tard, and Macs.

Source: CRE Connect

Convenience stores are attractive because they are durable, predictable, and recession-proof. Industry sales grew 5% through the dot-com bubble and 8% through the great recession. 

Convenience stores also have some pricing power. Baskets tend to be small — a candy bar and drink only cost a few dollars — so consumers don’t notice or don’t care about a 4-5% price hike. It is only a few extra cents out of their pocket.

Like AutoZone, Couche-Tard primarily sells time and convenience. Patrons consume 80% of merchandise within an hour. Couche-Tard has 50% higher gross merchandise margins than Walmart because people will pay up for instant gratification.

Profits are split equally between merchandise and fuel. Merchandise profits were flat year over year as lower margins offset same store sales growth. The fuel business had another banner year. Gross profit increased 25% and margins expanded to 49 cents per gallon. Margin expansion more than offset a 4% volume decline. 

Industry-wide fuel margins have been trending higher for years. Since 2008 they’ve increased an average of 4.2% per year. However, it was bumpy — two steps forward and one step back. Fuel margins may take a step back in the short term before continuing their march higher over the long term.

Source: August 2022 Presentation

Fuel margins will continue to expand because of inflation. The convenience store industry is highly fragmented — single-location operators own 60% of stores — and sub-scale operators must earn high fuel margins to break even. They pass along higher rent, credit card fees, electricity, and labor by raising fuel prices.

Couche-Tard can control costs better because of its decentralized management, scale, and fuel procurement network. Expenses have grown 3.4% since 2020, which is below inflation. As a result, Couche-Tard earns industry-leading margins and returns on capital. Couche-Tard earned 22% on its equity and 16% on capital in the most recent quarter.

Though Couche-Tard is the second largest convenience store chain in the US, it only has a 5% market share. There is ample opportunity for further acquisitions and consolidation. Couche-Tard has a long growth runway ahead.

Absent a large acquisition, we expect management to continue buying back shares. Over the past year Couche-Tard repurchased 4.4% of its shares. The board recently renewed their buyback program, which authorizes repurchasing 10% of shares.  Buybacks increase our ownership of Couche Tarde without us spending more. We applaud this approach and hope it continues.

Couche-Tard also raised their dividend 22% this year. The dividend has grown 10-fold since 2012, a 25% CAGR. Dividends are less than 13% of earnings, leaving plenty of room for growth.

Skeptics worry about declining fuel consumption as EV sales rise. We do not believe EVs pose an existential threat to Couche-Tard.

Couche-Tard is the leading operator of charging stations in Norway, the world’s most electrified country. Circle K has 1,100 chargers there across 260 locations. Last year they also sold 7,800 chargers for at-home and at-work charging. Norway began preparing for life after fossil fuels twenty years ago, and is at least two decades ahead of the US. 70% of all new cars sold in Norway last year were EVs compared to less than 5% in the US. The country is a laboratory where Couche-Tard can experiment and figure out what works. This is a major competitive advantage.

EV-charging customers in Norway are much more likely to buy merchandise than a fuel customer. About 15% of gasoline customers buy merchandise during their few minutes at a pump, while 40% of EV drivers do so during the 20–30 minutes their vehicle is charging. The time and money spent inside is also higher. EV-charging customers buy three times more merchandise at each stop. Merchandise margins are three times higher than its fuel margins, so this is welcome. The Fresh Food Fast initiative offers hot food to cater to these customers.

EV customers spend less outside — say, $20 per charge vs. $50 for gassing up — but considering the wholesale cost of electricity, gross margins on charging might be 70%. That’s well ahead of Circle K’s industry-leading 10% gasoline margins. High margins may net out lower sales.

Now the bad news. Most charging in Norway happens at home or at work. 50%–60% of charging is at home and 20% is at their destination. Only 20%–30% of charging happens at stations like Circle K versus 100% for gasoline. Higher merchandise and charging profits are offset by lower traffic. Overall, higher margins and more merchandise sales will likely offset lower traffic.

Couche-Tard recently opened its first charging stations in North America. Tesla built the chargers at the Circle K in Austin while Circle K built its own in South Carolina and Quebec. Building charging stations is expensive, so Couche-Tard is proceeding cautiously. Level 3 DC fast chargers are capable of charging a battery to 80% in 30 minutes, but they cost more than $100,000 each. Few chains have the resources to build their own chargers, but Couche-Tard is one of them.

We expect Couche-Tard to continue selling fuel profitably for many years and perhaps decades. Broad EV adoption in the US faces challenges from lack of electric power and transmission to shortages of key battery materials. The CEO of Rivian, RJ Scaringe, recently explained:

Semiconductors are a small appetizer to what we are about to feel on battery cells over the next two decades. Put very simply, all the world's cell production combined represents well under 10% of what we will need in 10 years. Meaning, 90% to 95% of the supply chain does not exist.

The problems facing EVs are solvable, but the solutions will take time.

Couche-Tard’s management aims to grow profits 15% per year over the next five years. They have a great track record of success. The company is a disciplined and opportunistic capital allocator. If a large deal comes along at the right price, the company may add thousands of new stores and suspend buybacks. If the company doesn’t find any acquisitions, we expect more buybacks and slower store growth.

Over the long haul we think Couche-Tard can produce:

• 4-5% of yield, mostly from buybacks;

• 4-5% growth in gross profits (fuel and merchandise); and

• 1-2% store growth (new builds and acquisitions).

Couche-Tards initiatives should also make the company more efficient and drive more higher-margin merchandise sales, boosting margins.

Today investors get attractive growth, a rock solid balance sheet, exceptional management, and a recession-proof business for roughly 15x earnings, in-line with the broad market averages. Couche-Tard is an above-average business trading at a below-average price.

For on about Alimentation Couche-Tard, see Dan’s April 2021 write up.

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