Casey's General Stores, Inc. (CASY) Earnings Call Transcript & Summary

Good afternoon. Thanks for joining us for the Annual Jefferies Winter Summit. I'm Matt Fishbein, the grocery and convenience retail analyst here at Jefferies. I'm honored to be here with Casey's President and CEO, Darren Rebelez, for a discussion about the business. Casey's is now the third largest convenience store operator in the U.S. and the fifth largest pizza chain. We believe the company's balanced growth and diversified approach to convenience retailing makes it well positioned to navigate the particularly challenging operating environment currently facing most retailers today.

The first word that comes to mind, Darren, when I think of Casey's relative to other operators is differentiated. And I know there's a lot of news, and there's many themes out there that still tend to weave Casey's together with some of the other peers, but I wanted to focus my questions today on those key differences. And I'll start things off, I guess, with electric vehicles. It's a great example of an opportunity facing the industry where Casey's is positioned a bit differently and potentially advantageously relative to others. So Darren, thanks very much for your time today, and hoping you can provide us with an update on your perspective on EVs and walk us through Casey's positioning there.

Yes. Thanks, Matt, and great to be with everybody today. With respect to electric vehicles, just a couple of thoughts. First and foremost, we think this is going to be an evolution, not a revolution, and it's something that's going to take quite a few years to really become material in the business. If you were to look at -- in our footprint today, we operate in 16 states in the Midwest, and about half of our stores are in more rural environments versus urban. And inside of that 16 state footprint, only about 0.2% of registered vehicles in that footprint are electric vehicles today. So there's a long runway there before the penetration of electric vehicles becomes material. But all that being said, we're still taking it very seriously, and we think we're really well positioned to capitalize on this trend. First -- the first thing about it is, if you look at our existing mix of business today, about 75% of our traffic today is nonfuel-related. So our stores, because of our grocery offer and our robust prepared food offer, really drive a lot of traffic on their own. So we're not as reliant on fuel traffic in and out itself to make our whole equation work. The second thing is, we're positioned on the high-traffic commuting routes that are already in existence today. So regardless of whether the vehicle itself is powered by electricity or by gasoline, people are driving to the same destinations regardless, and so we're well positioned for that. The third thing I'd say that really positions us well is our prepared food business. When you look at the charging experience, it takes about 30 minutes to get an 80% charge on electric vehicle. Well, there's dwell time associated with that. With our prepared foods business, we have breakfast, lunch and dinner offering that makes it more attractive to stop at our store, get a charge, have a meal and really take up some of that dwell time. So for all of those reasons, Matt, we think it's going to take a long evolution, but we think we're really well positioned to capitalize on it when the time tops.

Yes. So what I heard was it's more of a middle of America store footprint geography. It's also about the -- all the transactions that occur in the store because of things other than fuel. So there's already traffic going there for other reasons, but then also just as prepared food business offers that ability for people to go inside and grab a drink or grab a pizza slice while they're waiting for their vehicle to charge. That is a different dynamic than what we currently have with gasoline pumps. And yes, I think that all makes a lot of sense. I guess, transitioning, I guess, a little bit to the operating expense environment, a lot of attention there as well. Ongoing focus from the investment community really, I mean, because of all the headwinds across the entire value chain, so not just in the retail piece, but all the way for manufacturers due to distribution system, et cetera. And one thing we hear a lot is Casey's has these great prepared food kitchens. So doesn't that add a labor component to your operating model that maybe others don't have? So if you can help us with what are the key levers for cost control within the store. And following the recent launch of goodstop, the new sub-brand, how should we think about your potential future fuel versus nonfuel store mix?

Yes, Matt, with respect to our Prepared Foods business, there's no question there is an incremental expense associated with running those kitchens. But we're really proud to say we have an over $1 billion Prepared Food business that operates at a 60% margin, which is really the envy of our industry. So while it does take an investment in some labor to operate those kitchens, we get paid back many times over with the great traffic and the margin that, that category throws off. So we really view it as our key strategic differentiator versus virtually everybody else in the space. And so while it does take some expense to operate those, we're comfortable with that. But that being said, we know we've got to operate our stores efficiently. And so if you were to look today versus 2 years ago, pre-pandemic, we're operating with about 4.5% less labor hours in our stores today than we were a couple of years ago. And that's really -- and that's with a 10% increase in sales over that time period. And really, that's been driven by a couple of things. About 18 months ago, we launched the time motion study to really understand every activity that we're asking our stores to perform and take a look at how we can more efficiently operate those stores. And then we also implemented a labor management tool, which has allowed our store managers to be much more effective and efficient with how they deploy the labor within the store. So we're actually seeing labor hours come down even though sales are going up. More recently with the labor shortage, we've seen some wage rate pressure, and that's hit everybody, and so that's where we've been able to offset some of that through price taking to mitigate the impact of that.

I guess the curve ball of all of this has really been the uptick in Omicron cases over the past couple of weeks. And I believe in the time since your Q2 earnings call, there was a Supreme Court decision regarding vaccines and were testing for all businesses about the specific employee count threshold. And that was particularly relevant for Casey's given that most of your competitors are typically smaller operators that may not be subject to that type of costly requirement, so undue pressure there relative to others just for being a larger business. So if I think about the absence of federal requirements, how is Casey's currently mitigating the risk of infection, the risk of that reduced store count or temporary store closures because of it? And what policies, if any, would the company have in place if there continues to be an absence of that federal requirement?

Well, Matt, as you know, we've been at this for a couple of years now, actually. And so unfortunately, I have to say, I think we're getting good at it now in terms of how we manage through COVID. And from the very beginning, we prioritized the safety of our team members, our guests and our communities above all else. And we really took a lot of measures early on to do that. We've had a task force in place now for 2 years to really help us manage through all the complexities of this environment, whether it's the regulatory side or just on the health and safety side. We took a number of initiatives immediately once COVID hit, installing plexiglass shields in our stores, mandating social distancing, mask wearing, enhanced cleaning, temperature checks for people coming to work, really all designed to try to keep people safe and reduce the spread. More recently, once the vaccine was made available, we allowed for vaccine incentives, so people would actually have -- get a bonus for getting vaccinated. And all of those measures have really helped us keep our infection rates relatively low compared to our geography, and so we haven't had to experience as much of the shutdowns and reduced hours that we see some others going through as a result of that. And so as we look forward, we believe that what we're doing today has been effective. And so we intend to keep those policies in place, and then we'll have to see how the course of the pandemic evolves. And if we learned anything is that -- over this time period is that this pandemic does evolve and ebbs and flows, and we need to be flexible to make those adjustments as needed. But I think we've done a good job of it so far, so I'm confident we'll be able to continue to navigate it in the future.

Yes, it makes sense. Another component to that, too, is what the higher cases are doing to your partners and suppliers. And I know that if you look around the retail space, a large component of many retailers' growth is the new unit growth and new stores. And that's kind of been, at this point, not as robust and healthy as, call it, 3 years ago, across the space simply because you have construction labor shortages, you have construction companies also facing their own difficulties with cases, construction materials, and in the case of retailers like yours, the facings for the particular things that you're selling. All these things that are slowing down the potential unit growth. But when I look at Casey's, I've seen that it posted very consistent unit growth over the past decade, and that's really been driven by the strategic balance between the new builds and the acquisition. So a 2-part question here. What do the M&A and the building permitting environments look like today? And is the current M&A environment still supporting a potential acceleration in industry consolidation? Because I know that was something that we have been talking about over the past 6 to 12 months. And then the second part, how is that wholesale fuel business acquired with the Buchanan Energy acquisition expanding that acquisition target profile? And should investors really expect Casey to make larger or more frequent acquisitions relative to the 10 years prior because of this new capability?

Okay. Yes, I'll start by saying that they're really -- one of the key components, one of the key pillars of our strategy is to accelerate our store growth, and that's either through organic or through M&A. And the reason we like to have that balance of both is that M&A can be a little bit choppy. Not every company that we would be interested in is for sale at the time we're looking for it and the price we're willing to pay for it. And so having that organic growth capability allows us to continue ratable store growth regardless of what that M&A environment is, and we never find ourselves in a position of having to pay up or overpay for something to maintain our growth trajectory, we just have the ability to toggle back and forth between the 2 as the situation dictates. So with respect to the M&A environment, certainly, the last year was really good for us. We saw a lot of deal flow come through, and we're able to capitalize on that, had very attractive multiples in geographies that we already operate in. It really has worked out well for us strategically. We think that environment is going to persist. If you think about everything that's going on around us with COVID, labor shortages, supply chain challenges and just the increased complexity of the business overall, it's becoming increasingly more difficult for smaller operators to compete and thrive in this environment. We're seeing a lot more people being interested in getting out of the business than we have historically. So I would expect that there'll be more deal flow again this year, and we'll just have to see how that evolves. Now with respect to the wholesale fuel business, when we acquired that business from Buchanan Energy, it was really -- the goal there was to give us a tool in our toolbox to help us integrate other acquisition opportunities. And so when you look at the universe of potential acquisition targets, some of them already have a wholesale fuel capability, and so having that capability in-house allows us to integrate that in, and that may have been a target we wouldn't have considered before because we weren't in that business. The second thing it allows us to do is take some of those nonstrategic assets we may pick up in an acquisition and dispose off of them in a more profitable way. So if we find a store that's maybe a little bit too old, too small, rundown, really isn't in an attractive trade area, instead of having to sell it out, we can just sell it to an operator to tie them up with a fuel supply agreement that allows us to have an income stream in addition to getting the money back from the sales. So it just makes the economics of any transaction we look at more attractive. Now Matt, something you had mentioned earlier was about our new sub-brand called goodstop. The goodstop is yet another tool in the toolbox that help us integrate those acquisitions. So when we think about the acquisition integration hierarchy, we first start off with assets that we want to make the Casey's brand, the flagship brand, and that's a store that we'll be able to put a kitchen into, sell our prepared foods and have a full complement of our assortment. The next step down is if we have a site that may be in good real estate, maybe high volume fuel, maybe high volume in the store but just doesn't have the right physical plan to be able to put a kitchen in, we don't want to call that a Casey's because there's an expectation with that brand. So we created goodstop as a sub-brand that would allow us to operate those stores. They're still highly profitable, allow us to leverage our rewards infrastructure, allow us to leverage our purchasing capacity and power but not dispose of them. And then the third piece, if it doesn't fit those 2 categories, that's where we could put it into the wholesale business. And now we feel like we have a much more robust tool set to be able to go out and do deals and then integrate them more effectively.

Yes. And on top of that, layered on all of these different pieces of the business, I think something that also gets taken for granted is the fact that you have a self-distribution model that gets more and more leveraged and you get a fixed cost benefit from more stores being in the system, and that's made particularly relevant today just given all the supply chain challenges that retailers and manufacturers are having. So if maybe we can talk a little bit about that, too. Is that self-distribution model more of the competitive advantage in this environment given presumably better visibility, better procurement terms, et cetera? Or is it more of a transitory hinderance competing with warehouse and distribution labor from the likes of well-capitalized technology players and also trucking labor? How do you think this environment would impact that self-distribution business?

Yes. Our self distribution capability is absolutely a strategic advantage for us and particularly in this environment. And I can tell you for a fact, having looked at a lot of other stores and other chains in the industry because of the potential for acquisition, we've been able to see in stores the difference in our in-stock position versus others, and I really attribute that to our self-distribution. And when you think about how the -- most of the industry works, it makes sense. If you're using a third-party wholesale supplier to distribute the goods for resale, those operator -- those wholesale suppliers have multiple customers. So they go out and procure the products from the manufacturers bringing in the warehouse, and now they have to really distribute those products across all of their customer base. So they have to kind of spread the [welcome] little bit. And really, nobody gets the full allotment. Where we go out and procure those products for the manufacture, bring them into our warehouses, it's a 100% to our stores, and so we find ourselves in a much better in-stock position than we see with our competitors. The other thing I really like about that is just what you said, Matt, is we have the physical infrastructure already in place. So every time we do another deal, every time we open up another store, we just become that much more efficient throughout that entire supply chain because we're adding more capacity into those existing DCs. So we really like that control. We like that visibility, and it's really accruing our benefit right now.

Yes. I mean it all kind of plays into that 3-pronged fuel, C-store prepared food approach that's differentiated but that is also supported by this fourth differentiation of the self-distribution model. And in this environment, I can see how it does create an advantage, and it does diversify your revenue streams, et cetera. But if you can remind us, given that hopefully we're not in this type of environment forever, how is that resiliency of the model been tested during not only just the pandemic but through other twists and turns and operating conditions like an economic recession, periods of inflation/deflation, that type of thing? What are things for us to keep in mind?

Well, I think there's a couple of things. First of all, what comes in mind is this has been a unique situation versus some of those other kind of challenges that we've faced over time. And really, the first thing I think of is the demand shock for fuel. When lockdowns took place, fuel really took a dive. And I think it really highlighted the resilience of our business model and being able to take price on fuel, expand margins to compensate for that loss of volume and still have great profitability. So I'd say the ability to take price and toggle price to respond to either operating expense increases on the one hand or volume shocks on the other hand is a really unique characteristic for our industry and for our business model in particular. The second thing I'd highlight is our Prepared Foods business. Now if you look at how the restaurant industry overall performed during COVID, it was tough. And a lot of restaurants went out of business, a lot of others struggled mildly. Our Prepared Foods business, after about the first 6 weeks, once everything started to relax a little bit, has performed exceptionally well in this environment and continues to do so. And so the resiliency of our Prepared Foods business has been exceptional throughout this entire period. And I think it's -- those things have really reflected in record profitability over the last couple of years in spite of the fact that we were in a really challenging environment and our ability to grow our store base at the same time. So I think it's a real testament to the resiliency of our business model, and arguably, one of the most challenging environments we've ever found ourselves in.

And you brought up another important point that I hadn't touched on yet, the fuel margin component. It remains -- the fuel margin levels remain high relative to pre-pandemic levels, and that industry consolidation kind of supported the fuel margin expansion through 2019, but now we're seeing more of the higher operating costs supporting fuel margins potentially now and more into the future. And I think more and more investors are buying into the idea that, okay, these fuel margins are probably not going to revert immediately back to 2019 levels, but for us to see that type of reversion back to a 2019 level or even partial -- receiving partially if we're at mid-30s like you had put out there today with the business update, could that go back to low 30s or high 20s. What would we have to have happen, whether it's the economy or within the business, for that reversion would take place? And I guess another question just related to the business update now that I think of it is, relative to where we were before the start of your fiscal year, is that mid-30s number something that you would have ever thought could happen and still be around now?

Well, if I back up a minute and we go back to well before COVID ever came about, about 10 years prior to COVID hitting, the industry was on a gradual increase in margin expansion and on fuel. And that was simply the result of consistently rising cost to operate the business and in an industry where it's largely small operators that don't have a lot of scale or capabilities to pass on increased cost except through fuel price, and so we were seeing that expansion already occur. Obviously, with COVID, that create a shock to the system. And so as I was speaking about before, we had some demand destruction, and so those margins expanded. Now we've kind of compass that. And now we're in this inflationary environment where you have labor shortages, supply chain challenges, EMV compliance costs. Those costs are rising. And still, the industry composition is still largely the same, and so we're seeing those margins be a little more persistent than they probably would have otherwise. Now what would cause that to unravel? A reduction in the industry-wide cost to operate convenience stores. Could that happen? I suppose it could. Is it likely to happen? Probably not. So my guess is that these margins will be somewhat persistent for a period of time.

Yes. Yes, it makes sense. And if those costs unwind, that's another benefit that would simply just be offset. So yes, it doesn't sound like it could necessarily be as bad as some maybe feared a few months ago. But I think we're right at time. Darren, thank you very much for your time today and for everybody tuning in. I hope to see everybody in person real soon. Take care.

Thanks a lot, Matt. I appreciate your interest in Casey's.