Content Published Last Week

1. Circle K: US C-Store Asset Quality & Unit Growth

2. IP ANALYSIS: Circle K's US Unit Growth and Fuel Margin Outlook

3. Cogent Communications, Microsoft, & Dark Fiber Networks

4. Old Dominion, Saia, & US LTL Competition

5. Maravai Lifesciences: Trilink Customer

6. Fever Tree: Sourcing, Bottling, & Demand Planning

Circle K: US C-Store Asset Quality & Unit Growth

Couche-Tard's investment thesis is built around market consolidation as smaller players are pressured by higher cost and regulation. Consolidation will drive higher fuel margins to rational players, even in the face of declining market volumes due to growth in electric vehicles.

The free cash flow generated whilst EV penetration increases can be used to upgrade stores and buyback stock. In short, it’s squeezing FCF from a steadily declining asset in a favourable market structure.

Part of this thesis is playing out nicely: since 2019, fuel margin per gallon (CPG) has doubled to ~49c and fuel volumes are down ~17%. In 4 years, US fuel and merchandise gross profit per store has grown 59% and 34%, respectively. The stock has trebled.

But what happens when Circle K has upgraded its existing store base? Can it return to unit growth to capture more fuel volumes in a shrinking market?

We interviewed a Former M&A executive at Circle K, who reported to Alain Bouchard for over 20 years, to explore the quality of ATD’s network and the outlook on unit growth and profitability.

We also published our analysis on ATD’s US store growth and gross profit. Members can access the full write-up here. We’ve shared a few snippets below.

ATD splits its store base into 4 categories of quality. Around 35% of the US store base are C and D stores, the lowest quality. This can be a problem:

There is nothing wrong with a C-format store if you are in those type of markets where it’s very difficult and competition can’t come in on you. But if you are sitting there with a C asset, in a Tampa, Florida or a Phoenix, Arizona, where you can get permits within a year or 18 months, and you can go and build a large-format store right down the street, that C store then gets destroyed. - Former VP M&A, Circle K

This has led ATD to reinvest ~40% of annual EBITDA to upgrade its network. The steady disposal of lower quality assets has pressured unit growth. Even with ~80 greenfield openings and the fact small operators are challenged from SG&A inflation and increased regulation, ATD’s US net unit growth is negative.

This hasn’t impacted the stock as EPS has compounded ~14% since 2019 from higher fuel and merchandise margins, even in the face of declining fuel volumes.

Source: ATD, IP estimates
Source: ATD, IP estimates

ATD is selling more fuel per store at higher margins. This seems to be due to more rational competitive behavior:

What I think, fundamentally, happened is, when fuel volumes started declining, EVs started entering the market, and all of these discounters woke up and said, there’s enough margin for all of us to make; we don’t necessarily have to keep things so aggressive and everybody can make money. - Former VP M&A, Circle K

There are real structural competitive advantages for scaled c-stores. Vertically integrated fuel and food supply chains drive sustainable, lower procurement costs. Most players also own the land the station sits on. Mom-and-pops typically lease the land from jobbers who can take up to 5 CPG on fuel sales.

As SG&A costs have increased, the cost-breakeven for a small operator is incrementally higher. Mom-and-pops need the higher fuel gross profits to cover the increased costs of running the station. As smaller owners recently increased fuel prices, the large public operators followed. This led to record fuel CPG for the listed players.

But questions remain: what is the CPG in the terminal year? How many gallons per store can be sold? And how many stores does ATD need to sell this volume? And at what price may jobbers sell the assets?

In our analysis, we explore such questions and work through some back of the envelope math to estimate ATD's US FCF generation until 2030. Members can read the full analysis here.

The combination of steady but low organic growth, consolidation, increased profitability and consistent buybacks is attractive. But this is not O’Reilly; ATD’s bear case is that c-stores will be killed by electric vehicles that are charged at home. In the coming weeks, we will explore the terminal risk to ATD through our study of Circle K’s Norway Lab.

Cogent Communications, Microsoft, & Dark Fiber Networks

Cogent Communications is closing a deal to acquire Sprint's dark fiber network. This Former MSFT VP, responsible of building out MSFT’s dark fiber assets, helps us understand how hyperscalers are thinking about network infrastructure and Cogent’s opportunity.

"If you look at the Sprint network, it’s a direct burial network. It's not in conduit, it’s old. The quality of the glass isn't there. If you're telling me that you're going to invest in the T-Mobile or Sprint network, and then turn around and sell dark fibers, that both Amazon and Microsoft will look at and say, that stuff is junk. It's so old. Consider the generation of fiber; if I’m using leaf fiber and then I'm going to SMF 28 fibers, it’s a different quality of fiber and it’s a different type of glass. If I’m using the older leaf fiber, I may have to put more amplification in it to perform. - Former VP, MSFT

This interview also explores how hyperscalers approach network infrastructure:

When I'm an operator as an OTT hyperscaler, I'm not operating the network. I am hiring Lumen to operate these assets on my behalf. If I buy a subsea cable between two points, Lumen comes in and lights it for me once I have acquired the asset. For example, in 2013, I bought three fiber pairs, 16,000 route miles, 335 repeater huts, because I had to buy a colocation for every repeater hut because I have to amplify that fiber to work. It cost me $140 million for a 20-year IRU. Today, Lumen won't sell that dark fiber to anybody but the OTTs, and neither will Verizon. AT&T doesn't even know what to do with their dark fiber. There’s Zayo, who have a half-assed network, and then Lumen, who bought Level 3 and many other acquisitions over the years. Lumen realized they threw the baby out with the bath water when they sold dark fiber to the OTTs. - Former VP, MSFT

Old Dominion, Saia, & US LTL Competition

A Former Saia executive with 20 years LTL experience explores how the market is developing. This one interesting data stood out:

I know if we can keep the rates up high and it remains a lucrative job where you can make $70,000 to $100,000 driving a truck, people will still join. If we can get the younger generation away from the phobia of being a truck driver then it’ll continue to grow. I think there is always going to be a truck driver out there to move freight, someone is going to do it. Whether or not they get the right training or how they go about getting their training is another point. It is definitely a skill and is something I know I couldn’t do; there’s a reason I’m on this side. When I rode with my drivers, I used to praise them about how amazing they are at what they do; it is a difficult job and you have to have a great mindset. It is a tough job. They definitely deserve all the accolades anybody can bestow on them. - Former Saia VP

Maybe ever-increasing labour costs for LTL providers could pressure operating ratios?

Maravai Lifesciences: Trilink Customer

This interview explores how a customer of TriLink Biotechnologies uses the CleanCap technology from R&D to commercialization.

"We've gone from 1 ml to 100 ml to 1 liter and up to 10 liters for phase one and two, then it depends on the indication you're going after. If it's a vaccine space, it could be hundreds of liters. It depends on the population, what the indication is at that point in terms of what your ultimate scale is going to be. You're probably going to be 1 to 5 liters for a phase one and two, for most indications people are currently looking at." - TriLink Customer

Customers need to scale multiple hundreds of times between just the R&D phase to Phase 1/2. This presents an opportunity for TriLink to significantly expand revenues as biotechnology companies often prefer to use existing solutions early on in order to move faster.

Fever Tree: Sourcing, Bottling, & Demand Planning

This interview explores Fever Tree's operations from a demand planning, sourcing, and bottling perspective given the recent challenges in the US. We have the sense FEVR is at trough margins, but it may take longer than expected to reach the magical mix of 50% gross and 30% EBITDA margins. If ever.

We walk through how Fever sources ingredients and materials to align with demand. And, more importantly, why the company faced challenges in the US bottling plants more recently.

Entrepreneurial people think they can make money setting up a factory. Some are better than others with quality, but run as much volume as possible, because that makes the most money. That makes it hard to find a co-packer who is interested in the quality of your product and is as invested as you are...It's quite complex, but they chucked it in the blender, it comes out and goes in a bottle, so what are you complaining about, we followed the rules? That investment and ownership is hard to drive. That factory in Somerset grew together so they are more invested because they're so intertwined. If you go to a new partner because there is a shortage of production lines, they will simply choose to bottle someone else because your method is too complex and they cannot be bothered. - Former Manager at FEVR