Interview Transcript

This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Can you give a brief introduction to your role at GPM?

I am the regional operations manager and have eight direct district managers who report directly to me over a four-state area.

How does GPM’s network compare to Circle K in your districts?

We are an acquisition company who grew 1,800 stores last year and we have a group of 80 stores we will probably announce next week. We currently have over 3,200 sites. Circle K are in the 11,000 range, so we have a lot of room to grow. It is such a unique space; the majority of our sites have a 24-hour customer flow, so it lends itself to a variety of customer demographics based on the individual area.

How does evening traffic differ from the traffic at other times of the day for a typical c-store?

Our peak periods are 5:00 AM to 9:00 AM when people are going to work and from 3:30 PM to 7:30 PM when they return home. We have an additional surge as people are out getting gas for the next day, but the two peak periods are consistent. On Saturday and Sunday, it varies over the whole day, with midday being busier on weekends.

How will the amount and flow of traffic change as we see more electric vehicles and less gas?

All competitors in the C-store space have over 70% of their volume based on tobacco products. Customers are forced to shop at our sites because other vendors have been eliminated. 18,000 CVS stores and 5,000 Walmart sites no longer carry tobacco. You will never stop people from smoking, vaping or utilizing tobacco, so that bodes well for C-stores.

Wow. Is tobacco really such a high percentage of merchandising volume in your stores?

On the inside, yes.

How has that changed over the past three to four years?

It has been relatively consistent, but the percentage grows as the big box larger chains eliminate tobacco from their portfolios. It is super important to the C-store.

What is the ratio between customers refueling and those just entering to buy tobacco?

Each site differs but the goal is to get fuel customers inside the C-store, regardless of whether they purchase a tobacco product or any grab and go convenience. They could use their lunch hour to refuel versus waiting in line. Covid has caused staffing issues where they could sit in line at a McDonald's for half an hour, because they will not allow you to enter the building, so C-stores are a quicker option for customers.

If, by 2030, the gallons per store is down 30% to 50%, do you expect to keep that tobacco revenue from customers who are no longer refueling or charging EVs?

The short answer is yes because many retailers will push the “healthy option” and by eliminating that, we control the space on the C-store side.

Why is everyone leaving tobacco but C-stores are picking up the leftovers?

It has always been a large portion of our revenue. These larger companies want to give customers the impression they care about long term health issues, so it is a PR play but it has substantially helped maintain volume at the C-store.

Is there a risk C-stores could lose some of that business in future?

There is always risk in the business and we always have to continue evolving. Our federal government continues to regulate flavored vapes and the space is always changing. It has been for the good as it has supported other ways for customers to use tobacco products.

Why would customers stop buying tobacco from C-stores by 2030?

As the government continues to regulate, there is a risk the tax is so high that customers can no longer afford to purchase tobacco. During my lifetime, we used to spend 70 cents for a pack of cigarettes where they now average over $12. Depending on which state you live in and how it is regulated, the government could continue to tax tobacco users.

Are these c-stores effectively captive mini tobacco stores?

You could summarize it like that to someone outside the C-store business, who would not know it was such a high percentage of our overall volume, excluding fuel.

What is that merch revenue split for a typical C-store in your districts?

The overall average is over 70% on tobacco products. Other items include grab and go snacks, soda fountains and the 270° wall of refrigeration and frozen. It is all about convenience to customers, grabbing a bottle of water, beer or wine. A large portion of the refrigerator space is energy drinks, where customers want that extra jolt of caffeine. They start or end their day with Red Bull, Start or Bang. That space is getting crowded but it is very innovative.

How have gross margins on tobacco changed over the past three years?

It is definitely not increasing, and a portion of our revenue is based on big companies paying for the space, which helps our annual margins on the back end.

Do you mean an effective slotting fee?

Philip Morris or Altria buy a certain square footage at a corporate level which helps us maintain close to the margin we are looking for in this space. We will also get slightly higher margins with vape products.

How do you think gross margins will change for tobacco over the next five years?

We would be thankful to maintain at the current level. They are always squeezing the space, but advertising dollars should help pump up margins because the space no longer advertises like they used to. Most of that is done federally, by regulating the space.

If Philip Morris want their products on your shelf, what pricing structure would you offer them?

They often help the space with quarterly promotions where they offer incentives on five of their top 20 items, which we pass on to customers. It is typically centered around a twofer where customers save $3 if they buy two packs, which helps increase volumes.

How could the growth in vaping change the mix?

The vape space continues to grow and is simply an alternative for customers. JUUL used to rule the space but are now only a quarter of what they used to be five years ago. Most of that is due to government involvement on how they advertise to “young consumers”.

What is your target gross margin in the tobacco category?

It varies, but we are excited if we can get to 25 points.

How can you increase the 27% merchandise gross margin from last year?

The easiest way is to continue growing the vape side where margins are higher and it is not as tightly regulated from a tax standpoint. That will also improve our product mix.

What about food?

Food is a differentiator and the goal of GPM and many big players is to provide customers with fresh meal options. The company is focused on converting as many stores as possible. An example of a fresh option is hand breading chicken. We want to provide meal options during our peak times, including breakfast in the morning. Casey's, one of our biggest competitors, have almost 2,800 sites who make their own pizza dough and bake their pizzas, which gives them a competitive advantage.

Our goal is different and we are continuing to evolve that space. During Covid, customers have been very receptive to the C-store grab and go, which used to be hot dogs and soda. As we continue to provide healthy options like grab and go salads and sandwiches or hand breading and putting the labor back there to provide six to 10 items, that creates a destination for customers, either during their lunch hour or as a dinner option.

Does that drive a higher gross margin?

The margin there is extremely high. It is very labor intensive so you need the staff in those individual sites to support the food programs.

Is there any reason you cannot replicate what Casey's have done?

You learn from your competitor and their focus is on the pizza side, whereas we are trying different programs at our sites. 17% of my sites have a Subway inside, so those are the kind of things that are destination but also a differentiator to our competitors.

Is that gross margin in addition to the 27% you get, historically?

Yes, we would run that under a different umbrella and would not be part of the overall margin inside the C-store. It is run as a separate business within a business so to speak, and it gives customers another meal option.

Does the gross profit per store change with a Subway or other QSR on site?

It adds a revenue stream to the company but also provides additional traffic. The goal is, while they are in Subway, they also pick up a tobacco product or other meal solution.

Circle K's gross margin on the merchandise side is upwards of 33% which is a six-point difference between what ARKO achieve. How is it possible to close that gap?

It is possible by changing the merchandising mix to higher margin products. ARKO make quarterly adjustments looking to improve margins and drive the number of turns, to ensure we get our share inside the C-store when we get that customer in.

What is the long-term target merchandise mix in your stores?

The goal is to improve the overall turns and we also look for new items. Many times, we will lean on our vendor support to ensure we have the newest item mix out there. This is at a local level, because certain cheeses are important in Wisconsin but not nearly as important in rural Southern Illinois. We base it on individual locale and customer preferences.

What turns per year do you target?

Targets differ per category, but I would prefer not to throw that number out there. We improve our turns by having the right merchandise mix and ensuring we have stock for customers.

What are the biggest challenges improving the fresh food offering? You mentioned labor but are there operational challenges such as capex requirements?

There is a finite amount of room inside a C-store building, so when we refurbish or put a fresh food program in, it requires us to eliminate something. We are very careful and diligent to ensure we eliminate the right categories to implement new ones within the space allotted. At the same time, adding a fresh program requires a large cash allocation. There are always delays on the construction side, and Covid has put additional pressure there.

How do you source the fuel for your stores?

That is done by a corporate buying team who we have call three times a week. They keeping us abreast from both a global standpoint and what is going on in the US. For example, a hurricane will sometimes disrupt our flow which increases the cost, but the same holds true for all our competitors. The fuel side is very competitive with three others on a corner or intersection, so customers have a choice. We never want to be priced lower than Circle K or Speedway. We monitor on an hourly basis corporately and we have the ability to react as specific locale change the fuel price throughout the day.

Would you compete with a company like Circle K, given their scale on fuel? How could you have a cheaper price if they acquire ten times the volume?

Our volume is getting up there now; we are almost at 4,000 sites.

Two billion gallons?

We are one third the size if you compare the total number of sites. We have 1,800 sites in South Texas. When we acquired Empire, we started supplying fuel to those sites, even though they are independent. They are now called Empire GPM but we do not operate those C-stores. We supply 1,800 sites with fuel, so our scale continues to help.

As a store manager, do you set prices or are they set at HQ level?

On the fuel I will be directly involved, multiple times throughout the day. During this call I have been asked to go up or down at this particular site. We will typically match the competitor; very seldom would we make a decision not to follow the geographic locale. We might have three sites on one road within a mile of each other, and we try to keep those sites the same so we have consistency to our customers. A large part of our day is ensuring we are strategically priced in an individual market, district or town.

How does a station strategically purchase fuel from GPM?

We offer sites the best possible price because it is a commodity, similar to gold. The price of fuel goes up and down based on the barrel price, which is currently $70 and will hopefully get back down to a regular price of $35.

The growth in consignment for ARKO is potentially improving the margin; do you optimize gross profit on the fuel side by offering more or less consignment?

Whether they are company-operated or independent, we off the same price because they are all part of the ARKO umbrella. When we acquired Empire Fuel, they were able to leverage GPM’s scale to improve their overall margin on fuel, while leveraging the brand when dealing with big players like Pepsi, Coke and Frito-Lay. They can get the same deals a corporate store would, simply because they are now part of the Empire family.

So the gross profit on fuel from Empire or formerly owned stores is the same?

Yes; at the end of the day, it's a win-win for the independent and the company.

How do you see your gross profit per gallon in cents changing?

We continue to grow through acquisition, which improves our overall scale which we are able to leverage to our benefit. We have a great corporate team in Richmond who work 24 hours a day for our sites, ensuring we are optimally priced in each market and that we never have fuel shortages at any site.

Circle K have a two to three cent premium in the margin they earn; is that purely due to their scale that Couche-Tard is able to earn a higher gross profit in fuel?

The simple answer would be scale but, at the end of the day, we all buy fuel instead of making it.

Are you all buying from the same sources?

There are a finite number, so ultimately, when you come to the table with your scale as the largest, you should probably be able to command a benefit for that. It is critical to our business to be priced competitively. Each of our sites are required to trust and verify a group of sites at our competitors. Some sites will input that in three or four times a day.

What are the core drivers when looking at same store sales growth?

If you get a customer converted to a rewards program, they will typically spend three times more than they would have, which tells you the importance of the reward program and our ability to send promotions to customers based on their purchasing history. Every time purchases a cup of coffee, his reward email will be tailored with an offer like, if you purchase enough gallons, you will receive a free cup of coffee.

Are those all incremental profit opportunities in existing stores?

The first goal is to get customers to sign up for our rewards program in store as we tailor our promotions based on their buying habits. On the first day working for GPM, staff are trained on the rewards program and we aim to sign up a customer within 22 seconds. Fresh food meal solutions also drive loyalty to the space because customers do not want wait for 30 minutes at McDonald's. They would rather get a grab and go meal and be on their way.

How do you see the potential incremental return on invested capital in existing stores changing over time?

It is probably increasing. We know we have to improve our meal solutions so the focus of the company is to refurbish or remodel sites which have no meal solutions. It is important to our overall growth so we are trying different programs and optimizing per locale. At many sites, customers have no other meal solution options for a five-mile radius, which gives us an advantage for multiple reasons.

How do you look at the impacts of electrification?

Everyone in the space is faced with that. Prior to GPM I was at Meyer, who had 220,000 square foot sites with the C-store out front. They embraced that early on in 2013 by teaming up with Tesla to provide four parking spaces which they build into charging sites. There are always opportunities to team up with big players, and the government also helps. The world is changing and we will have to change with it.

If electrification leads to a 20% to 30% decline in gas consumption, how will C-stores adapt?

You will no longer have the same overall fuel volume, but we are all operating in the same space. One way to adapt is to change your overall merchandising mix to effectively give customers other reasons to visit that site, such as the only place offering tobacco or meal solutions. The C-store industry has seen success because they adapt and give customers other reasons to come into the store.

If 50% of gross profit comes from fuel and you sell 20% to 30% less by 2030, how will the gross profit for fuel change as it moves to electric?

If we could agree on that, we would probably be able to pick a lottery number. We know we have to evolve and offset that because our investors will expect the same profit.

Circle K in Norway have all electric stations and a completely different format with many more seats inside. You can make up some gross profit with more merchandise but what fuel gross profits are required to make the economics work?

The cost per site could vary from almost free to $180,000 to $250,000 per month. The C-store space will evolve as electric vehicles become more prevalent, and we may charge customers to charge their electric vehicles.

If you replace some gas pumps with charging units, where does the gross profit in the charge come from? How does that work between Tesla or IONITY?

To fill up with 20 gallons takes six minutes, whereas a complete charge on your vehicle will mean you are in that station for an hour. Our goal is for you to enjoy your hour inside and ensure you fuel your body. That will be an interesting mix, and many new sites are putting in seating because they want customers to feel safe and relaxed, without staying in their vehicles.

Let’s argue, hypothetically, there is $500k in gross profit for merchandising, per store, and the fuel is somewhat similar, if you lose half of the fuel gross profit because Tesla is coming in and putting the chargers there, or less people are charging in transit, preferring to charge at home, how will the economics change for a given property?

One of our solutions is to continue to grow the meal solution side. Instead of hot dogs, some sites are testing sushi, so the sky is the limit as to how we incentivize customers. We also have to maintain or increase our tobacco products which are dominated by C-stores.

Do you envisage C-store formats differing by location in future?

Love's, a big player in this space, have semi-truck washing stations on their sites. Most of them also have branded food like Hardee's, Kentucky Fried Chicken or Arby's. A third of their properties allow customers to sleep, which drives loyalty. Love's are now also building hotels on their sites. You can look to them for innovation because most of their new sites also have maintenance, where customers can put new tires on their trucks. Not many C-stores are as innovative as Love's, because of the size of their sites. Convenience stores can't compete with a Walmart 200 times their size.

Is the future of this industry becoming more retail without fuel?

Last week, in Chicago, I saw the innovation of self-checkouts at the NICS show. Home Depot, Lowe's, Walmart and Target all offer this, and Walmart announced last week that the majority of their sites will eliminate all but two cashiers checking customers out.

I saw Circle K in Norway are doing number plate recognition for payment.

When you travel through Chicago, they do plate recognition to charge for the toll.

I believe the transition to electric will be far slower than people think, but if gas gallons per store decrease by 30% to 40%, how will that change real estate values?

It depends; you could look at it two different ways.

Could it be more valuable?

22 years ago, the government required that metal underground fuel tanks were replaced with fiberglass, and many sites had to close because they could not afford $1 million to upgrade. 21 years later, those sites have been gobbled up and become something else. There is no additional real estate being created; only a finite amount of acres are available.

Circle K's new innovative stores are becoming more retail spacious facilities rather than purely fuel based with retail on the side; do you think that materially changes the value of these assets over time?

It is much easier to get a premium at a site which has been brought up to code. The new format will look different to a station which has not been touched for 30 years. That will improve the overall value and the ability to change, convert or sell that property.

What are the biggest challenges for C-stores over the next five to 10 years?

Labor has always been a challenge because there are a finite number of people who want to work, and big companies are offering $18 to $20 an hour to start. One solution could be to embrace self-checkout so customers have a choice. They might not want to wait for their lottery ticket, and the majority of our sites have contactless lottery vending machines, all 15,000 of which are supplied free of charge by the lottery.

Running the C-store today, how would you compare the challenges in driving same store sales growth, versus when you managed a chain of discount stores?

It is very different, because the majority of C-store staff are not required to do all the physical stocking which was required in a retail brick and mortar. We can supply similar if not better benefits on the C-store side, but do not require the same amount of physical work. We use that as a competitive advantage and recruit from Dollar General to staff our stores.

How do you look at the quality of a C-store business versus a discount store like Dollar General?

Once Covid hit, our sales decreased for six weeks, then suddenly customers decided C-stores were the safest place to shop. We ended the year 30% up in overall volume, which was simply due to the shopping habits of customers. It was primarily driven by the fact that the customer felt much safer inside a C-store, 24 hours a day, where they may have only one or two other customers in there at a time. Whereas in a Walmart, there may be 500 customers at a time. It has really been driven by a focus of a C-store being an option. Again, that bodes well on our focus for food and meal solutions.