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Is CST in a 'Strategic Quandary'?

Shareholder demands performance improvement, calls for possible sale

NEW YORK -- Calling convenience-store company CST Brands Inc. “significantly undervalued," and insisting that opportunities exist "readily within the control of the board of directors to substantially increase shareholder value,” Engine Capital LP, a 1% shareholder, delivered a letter to the CST’s board expressing its concerns about the company's strategy.

CST Brands

New York City-based Engine Capital describes itself as "a value-oriented special situations fund that invests both actively and passively in companies undergoing change."

As reported in a 21st Century Smoke/CSP Daily News Flash, Engine Capital cites what it describes as “the poor stock performance of CST since its spinoff from Valero Energy Corp., the significant operational underperformance of the company, executive compensation, capital allocation, real-estate monetization, corporate governance matters, investor communication and board composition.”

Representatives of CST Brands did not respond to CSP Daily News requests for comment by posting time.

Acknowledging that CST has a collection of valuable assets--its large retail portfolio of Corner Store convenience stores and others acquired in the last few years from the likes of Nice N Easy and Flash Foods, as well as its real-estate, its capital structure and its master limited partnership (MLP) relationship--Engine Capital said, "CST is in a strategic quandary. The board and senior management view the company as one of the industry consolidators, yet [they are] unable to articulate how it improves operations at its target companies. … CST must quickly demonstrate it can increase its merchandising and operating productivity if it is to be one of the enduring consolidators in the industry."

It continued, "The public market is not currently ascribing appropriate value for these substantial assets. CST trades at a significant discount to its public peers with Alimentation Couche-Tard and Casey's General Stores Inc. trading at approximately 13x and 10x EBITDA, respectively versus approximately 8x for CST. … Based on recent M&A transactions, we estimate that CST would sell for between $50 and $55 per share, implying a premium of around 43% to the current stock price."

CST competes with Marathon Petroleum Corp.'s Speedway, Sunoco LP and Couche-Tard, said the letter. "These three companies are top-tier operators that significantly improve the operations of their targets and that can therefore afford to pay more than CST for their acquisitions," it said.

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Engine Capital also cited the recent purchases of Hess Retail by Marathon and The Pantry by Couche-Tard. "These better operators can squeeze more profits from their targets and can therefore afford to pay more, which make them the natural consolidators in this space. … CST must become a best-in-class operator if it wants to pursue a successful consolidation strategy given the competitiveness of the M&A market."

"As an alternative to the standalone option, we believe the company could also create significant value through a comprehensive review of its strategic alternatives. CST has already publicly announced that it is conducting a strategic review of its California assets, and senior management has publicly commented that it is looking for ways to unlock the value of its real-estate assets. Given that the California assets, as well as the real-estate holdings, represent a significant component of the company's entire value and these assets may have strategic value for potential acquirers of CST, the board should not consider these transactions in a vacuum," said the letter.

"Based on prior transactions, we believe a sale of CST today would take place at between 11x and 12x EBITDA," the letter said. "At this point, Engine has certainly not reached the conclusion that the company should be sold. We have raised it as a value-maximizing alternative given our uncertainty at this stage as to whether senior management and the board would commit to executing on" the initiatives it has suggested.

Engine Capital concluded, “There are many levers for management and the board to significantly enhance shareholder value. In order to justify remaining a standalone public company and not taking advantage of this unprecedented period of M&A, CST must act quickly and make the necessary changes to improve its operations. … Alternatively, CST could evaluate all strategic alternatives to maximize shareholder value and explore what one of the large consolidators would pay for the company's valuable assets. The one thing that is certain is that the status quo is unworkable and the board needs to act with a sense of urgency.”

To view the full letter, click here.

Assessing the fund's argument, Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo Securities LLC, New York, said, "[We] can't say we don't agree."

"After reviewing Engine Capital's letter, we broadly believe their thesis is sound, and their arguments should be seriously considered. We share Engine Capital's bullish outlook for CST, but equally share investors' frustrations at the lack of performance," she wrote in a research note. "Management could do a better job communicating its strategy and the ways in which it can enhance value. Bottom line: We continue to see substantial upside potential for CST, and believe that with an activist shareholder outlining what we have long believed to be true, this might be the catalyst needed to get the stock to finally reflect more of CST's inherent value."

San Antonio-based CST Brands has approximately 1,900 convenience stores and gas stations throughout the southwestern United States, New York and eastern Canada. CST also owns the general partner of Allentown, Pa.-based CrossAmerica Partners LP, an MLP and wholesale distributor of fuels.

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