The U.S. is currently facing stubborn inflation of approximately 6%, presently largely blamed on low unemployment and wage pressures of about 5% in a mature service-oriented economy. Still, post-pandemic consumers are spending fairly freely on service-related businesses and restaurants, and home repairs and upgrades, especially as they are being priced out of the market on new housing and new car purchases due to the fast rise in interest rates.
Lower- and middle-income wage earners are struggling as the savings they built up—or didn’t—during the pandemic are being depleted and their debts, often through credit cards, are increasing rapidly. Unfortunately, most of the industry’s gas and convenience-store customers, as well as our in-store employees, are in these groups.
Push and Pull
The U.S. government response has been to keep raising interest rates to market levels reflecting the latest thoughts on how to slow inflation. The Federal Reserve has been largely financing the government deficits by almost $5 trillion over the last five years, and now the Fed recently began to try withdrawing those funds from the banking system through quantitative tightening (QT), which has never been tried to the extent being used right now.
Unfortunately, our government continues to spend with new legislation that continues to add to the deficit and keep the economy going, which could add to less credit available for businesses and consumers. Some spending programs have been termed “inflation reducing,” but I believe that is only true over time, such as those relating to de-globalization and climate control—however badly needed. So, monetary policy is pushing in one direction at the same time that fiscal policy is pushing in the opposite direction.
And the same is true in many other countries. These policies get even more complicated when unexpected events, such as war, cryptocurrency collapses, bankruptcies, pension funding problems and COVID recurrences in China, bring unexpected liquidity problems. Think of the world economy as turning a big battleship, which takes time, and ours is the biggest battleship of all.
End in Sight?
I do believe inflation is decreasing, ironically perhaps with oil as one of many important leading indicators. Granted, some of the price decreases in oil and at the pump have been helped by sales of strategic oil reserves, but the demand decreases for gasoline and now even diesel fuel are stunning, at least for now.
Still, the U.S. gasoline and c-store industry is perhaps the strongest it has ever been, if profitability and asset appreciation are the benchmarks. The large volatility in crude oil prices and recent important oil refining capacity tightness have generally helped retailers for now. They’ve also benefited from industry consolidation in the recent low interest-rate environment, giving pricing power even with lower demand. C-store and foodservice demand also remain strong as convenience and full employment allow the consumer to pay a premium.
Time to Buy?
Merger-and-acquisition activity may continue to be slowed by antitrust pressures going forward. But M&A interest should remain robust, as synergies in purchasing power, overhead savings, and the difficulties of keeping up with automation will keep M&A incentives in play. And the aging demographics of the U.S. population affecting our economy are certainly evident in our industry ownership and the management of this not-so-easy business.
In recent deals aided by NRC Realty and Capital Advisors, second- and third-tier buyers took center stage, after having been effectively shut out of the market by the largest operators over the past several years, and they have been able to take advantage of still-low interest rates, historically.
Also, fortunately, our industry remains considered unique by banks and Wall Street, largely because of its historical flexibility from good retail traffic placements. Over time, the industry has evolved from retail gas stations dependent on 15-cent-per-gallon fuel margins to full convenience stores, to now in many cases quick-serve restaurants with more complementary items than any pure fast-food operators will ever have. And more recently, some c-stores have added gaming machines, CBD dispensaries, interstate highway rest and shopping sites, and who knows what is next? How many retail industries can offer that much potential growth if you can be an innovator?
So, regarding future industry M&A, the first question is how much do you feel profitability could be affected by a recession over the next two years? Most economists expect overall economic profitability declines can be as much as 25%-50%, the key being the depth and length of the decline in the economy and the industry position. Fed Chairman Jerome Powell may believe he needs that result in order to stabilize inflation at lower long-term levels.
The 2009-2010 recession brought oil-price reductions that helped buffer our industry’s profit declines. Regardless, the real and psychological changes of tight credit from the banking industry, and uncertain demand and profitability decreased store cash-flow selling multiples (i.e., before non-store overhead, interest and depreciation) from about eight times (8x) to 5x for owned and operated properties and chains. The 5x level lasted for about four years until the rise in the economy and industry-improved confidence, while interest rates continued their decade-long decline.
Our industry selling multiple levels climbed as high as 12x-14x during the height of the recent so-called “free money” era for larger chains, and before allowing for synergies even including refining and distribution savings. Publicly traded companies frequently stated that these synergies were expected to bring their effective purchase multiples to nearer 8x. Current selling multiples are more in the 7x-10x range before some non-overhead synergies.
The other good news is that buying activity remains robust. In addition to the usual industry buyers and consolidators, we still see activity from private-equity buyers, and even several oil refining companies who seem to prefer to diversify their cash flow sources, plus benefit from having secure volumes for their refinery output. Some may be thinking about outlets for electric-vehicle charging.
It has been an incredible period for our industry with record profits and valuations. Normally that money will be spent on acquisitions and/or new-to-industry (NTI) site construction. Despite excellent tax incentives to continue in those directions, buyers realize that with multiples high and new construction costs remaining expensive, the interest rate and economic outlook may continue the trend toward more buyer caution.
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