Mergers & Acquisitions

The Pantry Stops M&A for 2008

Decision spurred by $5.1 million second-quarter loss; also halts hedging

SANFORD, N.C. -- A soft retail marketing underbelly coupled with brutal crude oil prices and lingering poor weather in the Southeast contributed to The Pantry's underwhelming second quarter, a performance marked by modest declines in same-store revenue and fuel volume from similar-period 2007. As a result, the retailer said it is curtailing spending and ceasing hedging.

On Tuesday, Sanford, N.C.-based The Pantry reported it incurred a net loss of ($5.1) million—23 cents per share—compared with net income of $8.4 million—36 cents per share—during the year-ago second [image-nocss] quarter. The results, however, outpaced analysts' forecasts, spurring shares of the publicly-traded company to jump $1.20, or 11.7%, to $11.42 in afternoon trading.

In reporting quarterly results, company chairman and CEO Pete Sodini attributed much of the financial challenges to still-soaring crude oil prices and the existing soft economy. To counter such obstacles, Sodini said, "We have continued to focus on improving our productivity, as evidenced by our expense management performance, and plan to keep a tight rein on the business until market conditions improve."

Specifically, the company is reining in capital spending and halting all hedge activities on fuel. In further testament to its efforts to regain solid financial footing, The Pantry, which has built much of its 1,600-store portfolio through acquisition, said it's putting away its wallet for awhile.

Sodini said that The Pantry has reduced its fiscal 2008 net capital expenditure target "by another $20 million, to approximately $90 million, and are suspending any additional acquisition activity for the remainder of this calendar year. We also do not have any plans to repurchase stock at this time.

"We expect these actions to contribute significant additional free cash flow in the second half of the year as our business ramps up during the peak summer season," he said.

Not surprisingly, analysts on yesterday's call were eager to know more about The Pantry's acquisition strategy post-2008. About the possibility of entertaining the notion of adding more stores perhaps in 2009, Sodini said that many smaller convenience retailers are unleveraged, since many own their properties. He said this enables them to "ride out this [market situation]." However, when asked if smaller retailers are interested in selling their stores, the executive said: "I think they clearly are."

Financials & Fuel

Total revenues for the quarter rose 39.9% from like-period period '07, to approximately $2 billion, with in-store revenues jumping 5.4%. The caveat, however, was that in-store revenues fell 3.4% on a comparable-store basis, the company said. The same condition applied to retail gasoline as gallons sold in the quarter increased 9.4% overall, but declined 3.4% from a comparable-store perspective.

Bolstering The Pantry's aggregate revenue position was the addition of 19 new retail locations to the network over the past year, including 16 stores added in a deal with Charleston, Miss.-based Sayle Oil Co.

Sodini, who has been widely praised for transitioning The Pantry over the past decade from a roll-up company to a solid retail chain, discussed the poor gasoline performance and its plans to cease its gasoline hedging program, citing significant volatility. "Clearly, our gasoline hedging program did not perform as we had expected. We are now out of all of our positions and expect to take an additional after-tax charge of approximately $900,000 (4 cents per share) in the third quarter."

During a question and answer period, a financial analyst asked Sodini whether, in examining the company's business model, the CEO anticipated a "change in its fuel paradigm." Sodini replied that, as it relates to gasoline hedging, "volatility has been modulated upward over last couple months. We are trying to deal with this volatility as it comes through. This is further magnified with the rapid run up in crude costs" which hit another all-time high Monday at more than $120 per barrel.

Merchandising Opportunities

While gross in-store merchandising margins registered at 37.5% (which compared favorably to the 37.7% gross margin recorded in like period '07), same-store merchandise sales were dogged by high fuel prices, as consumers opted to suppress their purchases of in-store items to compensate for high gas prices. The company cited only lottery ticket sales as the most brisk mover inside the store.

Poor weather in March and April—particularly on most all weekends—had a profound drag on in-store sales, Sodini said. This factor was compounded by the fact that consumers were more conservative with their "discretionary driving," he said.

As Memorial Day approaches, Sodini said, The Pantry is eager to capitalize on an opportunity to drive inside merchandising sales higher thanks to holiday and summer-oriented promotional programs. He cited a "mutual interest" with The Pantry's vendor partners to share the costs on what was termed "across-the-board" promotions to support store categories.

In responding to a query from a financial analyst about that topic, Sodini said that in-store promotions, coupled with the tax rebate checks from the U.S. treasury, could put consumers on a path to greater spending in the coming weeks.

Total merchandise gross profit for the quarter was $142.5 million, a 4.6% increase from the corresponding period a year ago. Sodini said the company continued to shoulder high credit card fees, which rose 1 cent a gallon from a year ago.

On the fuel side, increased ethanol marketing could help improve margins going ahead. To date, 873 of The Pantry's 1,643 stores offer ethanol blends. By end of the year, two-thirds of all locations should be offering ethanol, said Sodini. He said the chain will be better able to answer by October when the entire retail network will be marketing ethanol—a timetable that is contingent on major oil blending facilities and their online blending schedules.

The average retail price per gallon of $3.10 reflected a 35.4% increase from the $2.29 a gallon price a year ago. At 9 cents per gallon, the retail gross margin on fuel was relatively lower compared with 11.5 cents a year ago. Excluding the hedging loss, the retail fuel margin in the quarter was 10.6 cents per gallon—higher than its second quarter retail gas margin in four of the last six years, despite the significant rise in crude oil prices this year.

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