COUNTDOWN to Pantry Board Meeting (3 Days)

Retailer defends capital allocation, store base strategy

The Pantry Kanagroo Express Convenience Store

Editor's Note: Leading up to The Pantry's annual meeting on March 13, CSP will continue to post regular reports on the ongoing proxy battle between executives at the convenience store chain and a "dissident" investor group that wants to shake up its board.

CARY, N.C. -- The Pantry Inc. last week sent another letter to stockholders in response to what it calls the "ill-informed arguments" made by Concerned Pantry Shareholders (CPS) and three proxy advisory services that support the "dissident" investors group. In the letter, the convenience store retailer also strives to make its case in favor of its current board and strategy.

The Pantry and CPS are painting very different portraits of the chain's financial history and management track record, as well as the potential for future performance, leading into the company's March 13, 2014, annual meeting of stockholders.

As reported in CSP Daily News last week, much of the contention involves the quick-service restaurant (QSR) component of the business. Also at issue are capital allocation and the disposition of the store base.

In its communications with shareholders, CPS pointed to what it described as "10 years of high-growth spending" by The Pantry management "which has produced negative value. … disturbingly high levels of debt. … [and] abysmal operating performance … despite the massive amount of investment spending."

CPS' plan for The Pantry includes delevering the balance sheet by slowing capital expenditures, increasing focus on return on invested capital (ROIC) and paying down debt with free cash flow; exploring real estate monetization in order to continue to deleverage the balance sheet through a full sale, partial sale or MLP [master limited partnership] or REIT [real-estate investment trust] formation; strengthen store base by repositioning or selling 300 to 500 stores in weak or nongrowth markets and focusing on great performing stores in growth markets; implement a successful QSR plan by tapping into our nominees' strong restaurant expertise and operational experience; and enhancing corporate governance through direct shareholder representation on the board.

Click here to view the full CPS plan.

The Pantry's response:

  • "[The] board and management team have taken an extremely disciplined approach to capital allocation, maintaining strict policies and procedures to approve expenditures, review the ongoing performance of investments and monitor returns. We are a return-focused company in which capital allocation decisions are heavily scrutinized on the basis of discounted cash flow and return on investment metrics. During the period before the appointment of CEO Dennis Hatchell in 2012, the company temporarily discontinued its acquisition program in the interest of streamlining expenses. Under the new management team, the company has implemented a plan to invest in store remodels, QSRs, new stores and acquisitions following an in-depth review of its business supported by a globally recognized consulting firm."
  • "The dissident group ignores the success that has been fueled by the company's recent investments in store remodels. For the 35 remodeled stores that have been open for six months or more, The Pantry has posted an uplift on merchandise sales of approximately 6%, including a 21% uplift on foodservice sales and positive sales results in both packaged goods and services. The company's investments in store remodels have also driven positive results in merchandise gross profit and comparable gallons sold. Furthermore, despite more competitive cigarette and fuel pricing to drive traffic and temporary expense increases to support new merchandise initiatives, our top third of remodeled stores are already performing above expectations within the first year, with a 10% [or more] merchandise uplift."
  • "[The] board and management team are already taking concerted action to reposition and rationalize the company's store base. Over the past two years, approximately 92% of The Pantry's growth capital has been directed toward leader and expand markets, while the company is maintaining its core markets with minimal investment. Since 2011, the company has divested or closed 157 stores with a positive impact on total profitability. The dissident plan simply reiterates the current strategy with respect to portfolio optimization and does not provide any new ideas."
  • "The Pantry's management team has considered the pros and cons of a possible real estate monetization or REIT formation, and has concluded that neither would be in the best interests of The Pantry's stockholders. Real estate monetization through a sale leaseback would potentially create tax leakage as well as limit our ability to modify properties to accommodate QSRs or divest/close underperforming stores. Furthermore, incremental rental expense associated with a sale leaseback would impact the company's margins, create additional exposure to rising rent rates, and have a negative cash flow impact due to the current differential between capitalization rates on sale leasebacks and interest expense on our bank debt. Formation of a REIT would be subject to similar considerations, as well as lead to potential breakage costs on our bonds. The single-tenant characteristics of a Pantry REIT, incremental ongoing SG&A costs of operating a second public company and other taxes upon REIT formation have also been considered. In light of these issues, selling a significant portion of our remaining real estate or forming a REIT is not in the best interests of stockholders at this time."

Click here for more details on The Pantry's other arguments countering CPS' claims.

CPS is led by JCP Investment Management LLC, Houston, and Lone Star Value Management LLC, Greenwich, Conn.

As of Jan. 30, 2014, The Pantry, based in Cary, N.C., operated 1,537 stores in 13 states under select banners, including its primary operating banner Kangaroo Express.

Part of CSP's 2014 Convenience Top 101 retailers