Tuesday, January 26, 2010

The Pantry Has A Lot To Overcome

The Pantry (PTRY) operates 1600+ gas stations and convenience stores in the southern part of the US. The stock recently hit a 52-week low, and looks attractive across a number of metrics. Though gas prices have been extremely volatile over the last few years, consider the company's recent operating margins:

How are the margins so steady when it operates in such a volatile pricing environment? Contrary to what consumers may believe about gas retailers, they don't make a lot of money from sales of gas. Consider the The Pantry's gross margins from its two major operating segments, merchandise sales and gasoline sales:

After allocating depreciation, store operating costs, and SG&A expenses towards the minimal gas profits that exist, gas operations likely lose money for the company. Clearly, the company's business model is to lure in customers with a competitive gas price, and then get them to buy cigarettes (which represent 35% of convenience store sales). Counter-intuitively, this type of business actually makes more money when gas prices decline!

As a result of The Pantry's stable operating model, the company has been able to load up on debt. (For a discussion on why this is so, see here.) But its debt load is now of epic proportion: tangible equity is negative, and debt to equity levels near 80% when operating leases are taken into account. Nevertheless, the company generates positive cash flow, and appears focused on reducing its debt. As such, the potential for price appreciation is strong. At the same time, however, because of the high debt levels, there isn't a lot of room for error for the reasons discussed here, and therefore investors should tread carefully.

Disclosure: None


optionsnut said...

What about buying any of the debt instead of the common?

Saj Karsan said...

I haven't looked at it. Do you like it? I'll let you know if I find anything interesting.