CHICAGO -- A slowing economy, continued benefits to convenience stores and challenges to industry mergers and acquisitions: These are some of the trends we see hitting the c-store channel in 2019.
Here’s a look at some predictions …
The U.S. economy will slow each quarter. At a minimum, it will feel like a recession, as demand softens. We are late in the business cycle as 1) market dislocations increase, 2) housing and car sales soften, and 3) capital spending slows despite incentives. These factors are only partly offset by increased government spending. Political confusion and uncertainty over tariffs and government policies do not help the U.S. or the rest of the world to grow. Politics are affecting world economies much more than normal. Over time, the world economies usually grow or recede in unison. Low U.S. unemployment, an economic indicator that usually lags the real economy, will keep upward pressure on wage rates and limit productivity gains but will keep the consumer spending.
Short-term interest rates will remain tame from moderate inflation and a slowing economy. Increasing federal deficits keep some steady upward pressure on long-term bond rates and especially the so-called junk-bond high-yield market, whose market weakness often precedes recessions. Reductions in corporate stock buybacks and the difficulty of predicting earnings, especially for international companies, will keep stock markets volatile and on edge, especially if the company's debt levels are high.
Oil prices should be in the $40-$60 WTI range, which I have been predicting for several years. There is too much oil in the world to maintain high oil prices even though demand is strong. Oil is cheap right now, but Russia and the Saudis must cut production enough to raise the price for their own revenue requirements; however, weakening demand from slowing large economies, namely Europe, China and Japan, will be a constant pressure. Oil demand grows faster in smaller emerging economies, but their high debt levels, usually denominated in the strong U.S. dollar, will limit their economic gains.
Big-picture mergers and acquisitions
Overall merger-and-acquisition activity will remain comparatively strong. Interest rates will not increase enough to eliminate the important gains from mergers for technological and strategic reasons. As the economy softens, expense savings and other efficiencies will drive merger activity as well. High federal deficits, combined with political uncertainties may leave some of the very favorable Trump tax cuts in doubt, which will dampen selling multiples.
I anticipate major oil and refiners will keep seeking secure outlets for their products through outright acquisitions or joint ventures, as well as other creative methods. This could mean more acquisitions and partnerships by big oil companies.
Also, because of changing world political events, there will be more uncertainty about foreign investors in our space. Foreign investors plus integrated oil companies have been probably the most important forces pushing up acquisition prices the past two years. The larger convenience-store chains are important participants, but they usually have not pushed multiples to recent levels.
Other M&A observations:
- Fundamental overhead and efficiency savings will always be important incentives for consolidation in this industry. A slowing economy usually benefits larger companies. Let's face it, size and industry scale bring overhead efficiencies, cost buying power and, very important for the future, technology savings to compete.
- Site procurement and new-build construction costs will remain high and tedious for companies wanting to grow rapidly.
- On balance, 2018 earnings will be at a peak for the industry. Given a more cautious economic environment, buyers will not pay up as aggressively as in the past and will take more time for due diligence. They will be more careful about buying units that can become obsolete overnight by new-to-industry outlets built by market disruptors.
- Despite reduced immigration, low-cost operators will continue to be important purchasers, as they have a lower-cost model and can survive even at lower volumes than new-to-industry players. More companies will supply unwanted or even marginal units to these buyers.
- Management succession issues will remain important, as some companies are perhaps better off to liquify their investments for the family benefits, as challenges increase.
On balance, the c-store industry will continue to benefit from 1) low crude prices helping fuel margins and demand, 2) relative brick-and-mortar insulation from the internet and 3) increasingly "convenient lives" in which consumers demand easier and faster access to products. New markets could be very important, much as how vaping has overcome reduced cigarette sales. In addition, growth will materialize from expanding use of now legal cannabidiol (CBD) hemp products without THC, a product that produces no “high” from its use. Eventually, growth will also come from regular marijuana products that will become more mainstream. The public will demand it. My advice: Think convenience!
Thrifty consumers, however, will shop more intelligently toward discount marketers both in and out of the industry. As a result, c-store unit sales may shrink, limiting gains to inflation and foodservice, which will remain challenged due to labor issues, which I believe will continue even if there is a recession, eroding profitability. Slowing construction and reduced immigration also slow our key customer counts.
Overall, with all that is happening in the world, we should count our blessings to be a part of this industry. Valuations will fluctuate, but strong companies and most areas of the country should be more stable than most brick-and-mortar industries.
Jeff Kramer is managing director for NRC Realty & Capital Advisors LLC, Chicago. He may be reached at [email protected]