ANALYSIS: Can The Pantry Be Saved?

You know the challenges; what are some potential solutions?

Mitch Morrison, Vice President of Retailer Relations

Dennis Hatchell, The Pantry

Dennis Hatchell

CARY, N.C. -- One senior executive announced his resignation last week and another, according to sources, stepped down effective immediately.

Insurgent shareholders are fighting for fresh faces on a board of directors they charge has failed its governance and fiduciary obligations.

The company recently announced quarterly returns that showed continued declines in earnings and erosion of gallons.

This is The Pantry, one of the country's largest and one of the few publicly traded convenience-store chains. With four new leaders at the chain over the past five years, financial observers are wondering whether The Pantry may soon undergo another leadership change as CEO Dennis Hatchell enters the final year of his three-year contract and struggles to convert his supermarket success into a c-store strategy.

More important than any singular individual, though, are the daunting challenges: Burdensome debt, challenging credit terms, lack of prime dirt as the retailer owns relatively little of the real estate that holds its more than 1,500 Kangaroo Express c-stores.

Andrew Henckler, a consultant in risk and capital markets, earlier this month may have written the most authoritative piece that further validates CSP magazine's cover feature last spring and my editorial in that issue.

That is, basically, that The Pantry is overvalued and overleveraged and is in very serious trouble. It's a view that vehemently challenges a recent report from a prominent analyst that suggests The Pantry's ongoing store-by-store upgrades is delivering steady improvement.

Simply put, renovating less than 10% of the concern's portfolio is basically putting cosmetics on a comatose patient and saying he looks good.

The problems are much more profound.

From 2011 to 2013, the Cary, N.C.-based company's adjusted EBIDTA has slumped from $231.7 million to $202.4 million, while its portfolio has fallen from 1,649 to 1,548 units. Exacerbating its woes, The Pantry's business model, from the late 1990s under the leadership of Pete Sodini and M&A bankroller Freeman Spogli to the current era, has centered on strong fuel margins and high inside margins. And while inside sales have inched northward, gallon sales have fallen five consecutive years with no signs of reversal.

Pointing to 2014, The Pantry's management, I believe, is being fair and possibly optimistic in painting a picture that portrays further concerns. The operator's forecast suggests The Pantry will generate barely enough revenue to cover its interest and capital expenditures.

Meanwhile, in much of The Pantry's core terrain, top-scale operators are ramping up new retail models and offerings. RaceTrac is plowing through more of the South, Sheetz and QuikTrip are expanding smartly in the Southeast. Wawa and Thorntons are investing in Florida.

Henckler's analysis is sobering--The Pantry's weak financial condition has not gone unnoticed.

"The company's major vendors (including Marathon Oil, BP, and McLane) have required significant letters of credit be posted by The Pantry in order to do business with the company."

He elaborates, "As of the first quarter of fiscal 2014, The Pantry had $83.6 million of letters of credit outstanding. Although some of these letters of credit are related to self-insurance programs and regulatory requirements (the company does not break out letter of credit usage), the need for letters of credit in such volume means that if The Pantry ran into trouble with its bank group over covenant violations the loss of letter of credit availability would likely be devastating to the company in a short period of time."

So, What Can Be Done

Is The Pantry in an irrevocable tailspin?

There are some who say yes and believe the company will ultimately file for Chapter 11 bankruptcy protection. Others are suggesting The Pantry downsize to its regional strengths, to withdraw from markets where it is No. 3, 4 or 5 in consumer choice and shift capital into the Carolinas and Florida and a handful of other select markets.

The dissident group of stakeholders, calling themselves Concerned Pantry Shareholders (CPS) and nominating three candidates with seemingly solid retail backgrounds to The Pantry's board, has accurately identified the many problems plaguing The Pantry.

I believe if The Pantry is to have a chance it will require radical steps to restore trust with creditors and vendors, including the following:

  • New Management Team and Board: It is critical The Pantry install a team that includes the brightest minds in the c-store channel. Not just retailing, but convenience specifically. Currently, there is not a single c-store member on the executive team. That must change.
  • Debt: I agree with those who believe The Pantry should cull its network, withdraw from weaker markets and significantly attack its debt.
  • C-Store Retail Strategy: To its credit, The Pantry has undertaken some important initiatives, ramping up its coffee program and freshening its foodservice offering. Yet, when compared to leading chains in The Pantry's markets, the company pales much in the way coffee consumers strongly prefer Dunkin Donuts over McDonald's for their morning java. There is little in the food or coffee offering that would pull a consumer from Sheetz, Wawa, QuikTrip or RaceTrac.
  • Fuel: The company is using the KSS fuel software system and has been tooling with pricing strategies and profit projections. What is most challenging, though, is the national decline in fuel consumption and that The Pantry's street prices are neither the lowest, nor is its inside offering robust enough to generate enough dual users--those who both fuel up and shop inside.

There is a fundamental flaw to my prescription, however, one for which I admittedly don't have a perfect solution. Stockholders.

If it could, it would be great for The Pantry to go private, but that is as unlikely as the New York Knicks winning an NBA title.

The Pantry is publicly traded and the prescriptions I and others propose will not yield the necessary short-term miracle shareholders too often demand. In short, there is no magic bullet to curing problems born more than two decades ago.

The Pantry must shrink before it can grow again. The question is: Will anyone buy such a stock?

Mitch Morrison Winsight CSP By Mitch Morrison, Vice President of Retailer Relations
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