Tuesday, January 5, 2010

The Pantry, Inc. (PTRY): With a P/B of 0.65, Are They a Vision in Value?

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The Pantry, Inc. (PTRY) came up in one of my recent stock screens, and upon further review I decided to dig a little deeper to see if it was as good as it looked just based on the Price to Book (P/B). As a note, my screen is for companies trading below 1 P/B, market cap below $10 billion, average volume above 100,000, stock price above $1, and that they be turning a profit.

Here's some basic info on PTRY, just so you get an idea:

Market Cap : 297.66 MM
Enterprise Value: 1.40 B
P/E : 4.98
Forward P/E : 7.99
PEG Ratio : 0.69
P/S : 0.05
P/B : 0.65

And Yahoo! Finance description: "The Pantry, Inc. operates a convenience store chain in the southeastern United States. Its stores offer a selection of merchandise, gasoline, and ancillary products and services. As of September 24, 2009, it operated 1,673 convenience stores in 11 states under various select banners, including the Kangaroo Express, its primary operating banner. The company also operated 229 quick service restaurants that offer Subway, Quiznos, Hardee’s, Krystal, Church’s, Dairy Queen, Baskin-Robbins, and Bojangles branded food products. The Pantry was founded in 1967 and is headquartered in Cary, North Carolina."

So what piqued my interest about PTRY?

Considering that a P/B of less than one is a condition that I look at a stock, the degree to which it is below one is important. Also, I tend to prefer companies that operate on a simple business model and are relatively asset intensive. The Pantry seems to pass both qualifications, so it's on to the next step.

Let's Break it Down

Before I talk about the operational fundamentals of the company, I'll speak to it from a strictly asset perspective. PTRY owns the real property at 396 of their stores and leases the property at their remaining 1,277 stores. Looking at their balance sheet, assets primarily fall under cash (6.7%), receivables (3.6%), inventory (4.9%) and property plant and equipment (PPE) (55.8%). Goodwill (24.9%) and intangibles (1.2%) from acquiring other chains and stores also make up a large chunk of total assets.

When looking at the raw assets, I think it's important to remember that GAAP requires assets be stated at the lower of cost or market, so unless there is/was an impairment charge or the asset is exchange traded, the book value is the cost at which it was acquired netted of depreciation. I look at goodwill and intangibles as the least reliable assets on the balance sheet, mainly because these (a) aren't tangible assets and (b) could be dramatically overvalued if PTRY paid too much for a particular company (imagine the goodwill that Time Warner recorded when they purchased AOL).

The ideal investment for me is one where you can completely write off the book value of intangibles and goodwill and still have a P/B of less than 1. Unfortunately, PTRY doesn't pose as such an instance, so the next step is how much of an impairment on goodwill and intangibles that they can record and still be at a P/B of 1. I calculated this to be 31.35%, which if you ask me is a pretty safe error margin.

But What About the Company

One of the reasons that I restrict my screen to companies posting a profit is that I don't want to deal with growth companies or to speculate on whether a company can eventually make a profit. I should mention that in this P/B less than 1 environment, I feel that the scruples that need to be placed on the company are less strenuous. I don't feel the need to find a convenience store that's going to outperform other convenience stores. Rather, I simply want to find a company that is going to make all of their debt payments and perform at an adequate level until the market can re-evaluate it at a more favorable value.

In their 10-K, PTRY noted that 35% of their stores are "located in coastal/resort or tourist destinations, areas such as Jacksonville, Orlando/Disney World, Myrtle Beach, Charleston, St. Augustine, Hilton Head and Gulfport/Biloxi", and that 25% are "situated along major interstates and highways". While there's probably some overlap between those two numbers, I was impressed by a cogent and well articulated investing thesis that management presented.

This strong tourism exposure gives PTRY more "cyclicality" (e.g. more tourists during the summer) and helps explain why the stock has been beaten up in a down economy as people have shunned extracurricular spending. While I wasn't a big fan of the "Kangaroo" logo and brand, the company emphasized that they had "re-imaged" 80% of their stores in the past four years to make them well lit, clean and better looking, and that in 2009 they spent $14.8 MM to remodel 110 stores.

Part of my concern was what type of gas was sold at PTRY's stores, since from my personal experience the quality of the gasoline makes a big difference. In their 10-K, PTRY notes that of their stores, "68.9%, were branded under the BP, CITGO, Chevron, Shell, Texaco or ExxonMobil brand names". This assuaged my fears that they were selling mostly trashy gas.

I also was impressed by their IT commitment, which in the convenience store space I see as being useful, but not necessarily essential. PTRY notes in their 10-K: "In fiscal 2010 our technology focus will be on completing our point of sale upgrade and enhancing our ability to capture detailed merchandise movement data. We also anticipate upgrading our merchandise pricing system in fiscal 2010 to enable us to execute a greater number of pricing zones. In November, 2009 we established the position of Chief Information Officer and named Paul M. Lemerise to the role. These investments in information systems infrastructure are a key component of our strategy to optimize store level performance." I feel that this commitment to a "smarter" inventory management and pricing system will lead to better margins and potentially less spoilage of inventory.

Cash Flow Analysis

In FY 2009, PTRY had operating cash flows of $169 MM, CFs from investing of $(166) MM and CFs from financing of $(50.7) MM. This led to net CFs of $(47.7) MM.

Breaking down their operations, it's clear that the gross margins on gasoline are very little (6%), and are more to give you the margins you get from the convenience store (~35% gross margins). The Pantry spent $122.6 MM on additions to property and equipment and and $48.8 MM on acquisitions of businesses net of cash. If PTRY had cut off the acquisitions and toned down the PPE additions, which were still well above the FY 2009 depreciation charge of $109.6 MM, they would have had net positive CFs for 2009.

Looking forward to FY 2010, PTRY is going to have obligations of $129 MM coming due, which includes operating leases, financing leases and long term debt. Interest payments of $35 MM are also slated to be due, but since this is less than the $80 MM they experienced in FY 2009, I didn't think any additional amounts were needed to be taken out for consideration.

If The Pantry were to turn operating CFs in 2010 equal to those in 2009, this would unfortunately only leave $40 MM available for investing activities if PTRY hoped to turn a positive net CF in FY 2010. This seems unreasonable at best. However, if next summer yields a more favorable spending climate (in line with PTRY's seasonal cyclicality), and PTRY is able to grow revenue and/or increase margins, this might be possible.

This is of course presuming that PTRY has the exact same operating CFs for 2010 as they did for 2009, a less than realistic assumption (erring dramatically on the conservative end in my opinion). It does provide an interesting benchmark, and in the current economic climate, with the exception of a double dip recession, and unless they can't create positive value from their acquisitions from 2009, I think it is a very baseline assumption for operating cash flows. In addition, I feel that their cash reserves and untapped revolving credit line provide an additional cushion that should allow them to survive any temporary short term difficulties.


I would give PTRY a buy recommendation. I have a positive macroeconomic perspective for 2010, and I feel that this will positively effect the regions and industries that The Pantry is most exposed to. Management seems to have a very good handle on what must be done, and the excellent degree to which they were forthcoming about the leverage that they had taken on and the risks inherent in their business made me feel that they weren't trying to pull a fast one on investors. With 98% percent of their shares held by institutions, I feel like this is a very good bet.

That being said, I wouldn't say that this is a "buy of the decade". The volatility of crude prices and their exposure to interest rates through $419 MM of floating rate long term debt make them more exposed to risks that they don't have a competitive advantage in taking than I would like. While they noted that a hedging program is in place to protect from interest rate movements, it would be nice to see them develop some sort of program for protecting against sharp movements in crude oil prices.

As electric cars begin to be phased in and American demand for gasoline presumably decreases, I only see competition in this sphere getting more intense. From the best I can tell, their business model seems to be based on selling higher margin convenience items to customers while they're purchasing much lower margin gasoline. While I don't see this business model becoming ineffective in the next 3 to 5 years, I would be concerned about holding on to this investment for too long.

If you want to see the spreadsheet for the analysis that I did, check out the below
PTRY Analysis

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