It was a new beginning, the ushering in of a fresh era. Respected in the supplier community, Terry Marks took the helm of The Pantry and realized its unmet opportunities and untapped leverage, much like a lion that had not yet realized its roar.
Marks brought in his A-team, former colleagues from Coca-Cola Enterprises, to head up marketing, and hired a new CFO, CIO and human resources executive. Together, the new company leadership shed some assets, curbed the company’s notorious M&A appetite, invigorated its portfolio with a fresh foodservice theme, and attempted to seed a company culture based on individual empowerment.
Most important, the Marks team sought to streamline a disparate set of stores collected over a 15-year run into a single retail brand, Kangaroo, and a brand-focused forecourt presence propelled by Marathon.
That was two years ago. Since then, much has changed. Marks is gone. So are the marketing execs, the CFO, the CIO and Pantry veteran and former operations leader Brad Williams. And with the old executive team, gone is talk of “lifting all boats” by meeting core operational metrics.
In place is another new team that, much like Marks and his crew, come from outside the c-store channel, raising questions of whether their results for the company will be any different.
Steering The Pantry is former supermarket executive Dennis Hatchell, with a new CFO and senior vice president of operations bringing more CPG experience to the company’s c-suite. Hatchell’s team has been busy making its own mark, producing the first ground-up in five years, rolling out a new demographics-based marketing initiative, entering into a multiyear fuel branding deal, and investing in new software to enhance margins on the forecourt and sales per square foot on the backcourt.
It is all part of an effort to strike a balance between the simple but wildly ambitious goals of the previous Marks administration and an even earlier legacy that favored store-count growth over operational excellence—and whose decisions still beleaguer the chain. Instead, the Hatchell team is banking on the powers of localization and that consumers will reward it for meeting their specific needs.
At the same time, the Cary, N.C.-based chain faces an invasion of its Carolina beachhead. QuikTrip [CSP—March ’13,p. 38], that standard bearer of consistency, and Sheetz, widely acknowledged among the top 10 U.S. c-store operators, are spreading stores throughout the Carolinas and speak confidently of expanding their presence and market share in the Southeast at The Pantry’s expense. 7-Eleven, as part of its nationwide expansion, is also pouring fresh dollars into cementing its presence [CSP—January ’13, p. 38].
Those are the external threats; now let’s look at the internal ones. The Pantry’s margins continue to stumble. Over the 12 months through January, the company’s gross margin was 11.1% and operating margin was only 1.3%, with a net margin of 0%. Those figures represent a significant dip from the company’s five year average, during which gross margins peaked at 16.4% and averaged 12.5%.
Also, the company faces a $500-million hole and owns only about 20% of its properties, undercutting its ability to leverage capital. Depending on whom you ask, The Pantry is either up the creek without a paddle, or riding a slow but steady current toward its goal.
“They’re in a tough position,” says Ben Brownlow, equity research analyst for Raymond James, St. Petersburg, Fla.“They’re facing increasingly tougher competition. It’s already pretty competitive in the Carolinas, and you have QuikTrip and Sheetz opening more sites there. You don’t have the population growth as you do in Texas. So if there’s going to be growth for someone, it’s going to be taking market share from someone—and that someone could easily be The Pantry, as well as independents.”
That said, Brownlow offers modest hope for the chain: “They’re trying to take on a lot and make positive changes. They’re moving at a slow, methodical pace. That’s why I’m not bullish on their stock.”
But some analysts are. “The Pantry is in a very early evolutionary state,” says BryanC. Hunt, senior analyst for food, food retailing and restaurants for Wells Fargo Securities LLC, New York, who maintains an “outperform” rating on the stock. He cites the latest merchandising initiatives, new technology and Hatchell’s grocery background as reasons to hope. And then there is the chain’s size: more than 1,500 sites in 13 states.
“They definitely have critical mass, and it will give them time,” he says.“Dennis will have analytical tools at his disposal that the previous teams did not, which will hopefully allow him to execute a much better merchandising and marketing strategy going forward.”
Talking to Hatchell, you wouldn’t sense that any of this debate about The Pantry’s future—new competition, executive turnover, lackluster margins—is weighing on him. Instead, he has embraced a self-help philosophy.
“I was taught by an old retailer a longtime ago that you need to walk out into the parking lot, turn around and face the store. This is the only store you can do something about,” he says. “Pay attention to this one, and we’ll be OK.”
All Hail ‘Chief Roo’
In February 2012, The Pantry announced Hatchell’s hiring, replacing the marketing focused Marks, who left in October 2011. While Marks drew plaudits for shifting the company’s focus from acquisitions to in store operations and working to win Wall Street support, some criticized him for hatching an overly simplified strategy that ignored market and regional differences.
According to Hunt of Wells Fargo, it could simply reflect the struggle that many management teams fresh from investment-grade CPG companies with deep pockets suffer when arriving at a high yield company with limited resources.
“At big organizations, a lot of infrastructure is typically in place, and you move into someplace like The Pantry, and it’s just not there,” says Hunt. “It wasn’t there when Terry came to The Pantry, and it makes big decisions in terms of spending and strategic movements more difficult to accomplish.”
“The wrong thing for the current management team would be to focus on the short-range results. I think that was a mistake by Terry,” says Brownlow of Raymond James. He cites The Pantry’s earlier practice of pricing fuel above the market for over a year, losing volume and sales—which Hatchell is now trying to address by taking less fuel margin.
Inside the store, the approach was somewhat short-sighted as well, he says.
“Terry Marks’ focus was trying to take one model and apply it across the entire chain—coffee, beverages,” says Brownlow.“The big difference with Dennis Hatchell is he’s looking at this much more strategically, on a market-by-market basis. What is the local market? Who is the competition? He’s looking at all these factors.”
Described by one colleague as “what you see is what you get,” the 63-year-old Hatchell has a low-key, down-to-earth charm, complete with a “Chief Roo” nametag—and Twitter handle—and is fond of passing out Chief Roo pens to store employees on site visits. Indeed, rather than meet with CSP in an executive boardroom or office suite, Hatchell conducted his interview on the sales floor of a local Kangaroo store, next to the coffee counter.
In Hatchell, The Pantry is not embracing a youth movement or next-generation leader. Rather, it is banking its immediate future on a well-respected executive with four decades of grocery experience, including a 16-year run as president and COO, and later vice chairman, of Alex LeeInc., Hickory, N.C., a holding company for Lowes Foods Stores Inc. Before that, he served as president of Lowes Foods Stores, and in the late 1980s he was group vice president of merchandising and store operations for H.E. Butt Grocery Co.
Though he is richly experienced in the grocery channel and its complex supplychainsystem, it’s the lack of direct c-store experience that worries some observers, especially considering The Pantry’s past struggles to master the fuel business, which represents nearly 80% of the company’s annual revenues.
“Many of us were surprised they went with someone outside the c-store channel, “says a financial expert who spoke on condition of anonymity due to his relationship with the company. “Hatchel has a solid name on the grocery side, but he has no gasoline background, and I haven’t seen anybody come in there with a gasoline background.”
On the other hand, Hunt of Wells Fargo—among the more enthusiastic analysts who track The Pantry—sees Hatchell’s grocery background as a positive that outweighs any unfamiliarity with fuel.
“Even though they didn’t directly sell gasoline at Lowes Foods, and [Hatchell]doesn’t have direct experience managing that merchandise category, he understands the power of it at the end of the day,” Hunt says. “It’s just like the merchandising of consumer goods—they’ve had a merchandising issue with gas because they didn’t have the proper analytical tools that large-scale chains in the industry had at their disposal.” The company planned to have KSS Fuels fuel-pricing optimization software implemented at all sites in March.
And Hunt already observes a clear grocery influence in The Pantry’s new build in Charlotte: a 4,900-square-foot store with 12 MPDs that is its first ground-up in five years. “There are steps taken here by Dennis and his team reflected in his store in terms of LED lighting and enclosed cooler cases; those are things that the grocery industry is doing,” he says, also citing the addition of frozen yogurt and iced coffee in foodservice, as well as a build-your own-six-pack program for craft beer.
Granted, none of these are bleeding edge improvements. Many of the convenience industry’s best and brightest have had similar features and offers in place for the past decade. But for The Pantry, it is positive change. There is also the fact that Hatchell has spent the past three decades in North Carolina, not an insignificant point considering the entry of QuikTrip and 7-Eleven into the local retail scene.
The analyst who critiqued the lack of fuel savvy within the executive suite expects an adjustment period for the near-term as Hatchell gets assimilated with that side of the business and its core customer. That said, he also sees Hatchell’s long-term potential: “I believe he possesses the experience The Pantry needed—a background in foodservice, merchandising, retailing and operations, all of which are core attributes to leading the turnaround.”
A Lifestyle Change
Back in 2010, the Marks team was all about four key metrics: mystery-shop scores, cups of coffee per store, cartons of cigarettes per day per store, and bundles per store, with specific numbers for all stores to reach. “If we do these four things, the boat will rise,” said John Fisher, then senior vice president of marketing and a former colleague of Marks from Coca-Cola Enterprises, who left The Pantry at the end of March [CSP—Jan. ’11, p. 36].
At the same time, the leadership team heralded the company’s Fresh Initiative, which opened up the stores’ sight lines and introduced salads, cut fruit, packaged sandwiches and baked goods to The Pantry’s offer.
Hatchell believes metrics are still important—sales per square foot, sales per linear foot, gross profit, gross margin—though when asked to identify a central driving metric, he is not specific. As for game-changing retail initiatives, unlike the Marks team, Hatchell has a decidedly more holistic approach when it comes to which categories deserve the most attention.
“It isn’t just fresh,” he says. “We’ve got to sell everything inside these four walls as efficiently as we can. … It’s more important we have what the customers want, and that will take care of the performance.”
Enter the Lifestyles Initiative, a merchandising program that aims to tailor a store’s assortment to local demographics. Ultimately, three-quarters of Pantry sites will be sorted into one of nine segments: Hispanic, college, beach, urban, rural, military, interstate, interstate/truck stop and affluent. The remaining quarter would be reserved as a traditional store. As of press time, the chain was still in the initial stages of the rollout, with 187 Hispanic stores, 120 college locations and 47 beach sites.
As Hatchell sees it, the Lifestyles Initiative is one way to deal with the hodgepodge of store sizes and locations that The Pantry collected during its M&A heydays. “We have all these different stores in all of these different cities, different situations—on the highway, near the beach, etc.—so if you homogenize that, you’re going to miss the boat,” he says.
“If you put in what everyone who shops this store really likes to see, and they feel like it’s a good offer, then they’re going to buy it and keep coming back, and the store will prosper.”
The strategy’s premise contrasts markedly with QuikTrip same-box, same assortment approach, Sheetz’s intense proprietary foodservice offering that leverages its family name, and 7-Eleven’s empowerment of franchisees.
The Pantry is approaching localization from a few directions, pulling demographic data from Spectra Data Group while also relying on feedback from store management.
“Spectra will tell you who is living around the store, but that doesn’t tell you who’s walking through the front door,” says Jon Bratta, vice president ofmerchandising, packaged goods. “But when you look at the customers in the store, we saw a big need for that product. We brought that product in to try to be relevant to this particular store for the customers coming through.”
So, for example, a beach location would stock general merchandise such as sun care and body boards, while an affluent site might have an expanded selection of craft beer and wine.“It’s about being local and relevant for the customers in our store,” Brattasays.
“It’s about taking store-level feedback, combining it with Spectra and saying, ‘OK, how can we optimize the assortment and be more relevant to the customers at every store?’ It evolves and gets better every day.”To help on the analysis side, The Pantry recently purchased space-planning software from JDA Software Group to handle space allocation. “We’re just putting that whole thing into Jon and his team’s hands so they’ve got some tools to do this with,” says Hatchell. “We’re doing it fi ne; we can just be doing it in a more productive and accurate way.”
While the localization has been mostly on the packaging side, The Pantry is incorporating it into the fresh side as well, such as Mexican pastries in the baked goodscase in a Hispanic site.
This introduces a personal crusade for Hatchell: maximizing the foodservice supply chain. “To do fresh well, we have to have the right supply chain; you can’t really get along with traditional delivery, “he says. “So what we’ll be working on hard is either how we’re sourcing the product or the frequency of deliveries.”Hatchell plans to lean on his familiarity with Southeastern foodservice distributors to make this happen.
A visit to a recently remodeled site in the Raleigh market suggests noticeable improvement from previous concepts, yet also a need to further clarify the basket of retail concepts.
The site is aimed at Hispanics and a line of popular ethnic salty snacks is headlined with botanas que conoces yamas (which translates as “snacks you know and love”). Yet the ethic flavorings subtle and sporadic, found in the snacks and fresh-baked section but largely absent in the cold vault, general merchandise, tobacco and prepackaged foodservice. The store also features a large general-merchandise section that hints at a beach store, with everything from sunglasses to remote-controlled helicopters.
The thematic concepts, still in their infancy, are likely to be furthered developed and distinguished. A veteran c-store expert, who spoke on condition of anonymity, described the demographic focus and technology investment as “category management 101.” But they are important steps for the chain to take to keep up with the industry.
The Pantry has also introduced new hot and cold dispensed offerings into its remodels and new sites, including a“Mixology station” where customers can add sweeteners, flavor shots and toppings to their coffee, as well as f ’real milkshakes and smoothies, iced tea and iced coffee.
Critical to these programs’ success will be the store employees. The Pantry is emphasizing greater training for suggestive selling, and incenting employees through regular sales contests between different stores and districts. It is a sale stool that even the most accomplished chains find tough to implement 100%.
“What we’ve tried to improve on right away was giving them the training to handle foodservice right, how to sell it, treat it safely, food safety—all those things that I think they’re pretty excited about having, “says Hatchell. “And then convincing them not just to do the work but sell it. It’s a lot more fun if you’re talking and interacting with customers. Retail’s hard work, so why not have some fun with it?”
Building an empowerment culture was a cornerstone of Marks’ turnaround strategy for The Pantry. It’s one that Hatchell—who has never met Marks and admittedly has not studied his executive decisions—seems to agree with in theory. “I think we were better at fi xturesand product than we were at developing people,” he says.
And yet, while Marks approached culture building as if it were a slow, evolutionary process, Hatchell believes that the hard work has already been done. Or as he sees the suggestive-selling push, “This balances it out—we’ve caught them up now.”
Hedging Nightmare
While The Pantry continues to feel out new growth opportunities inside the store, on the forecourt it is finally, it hopes, gaining traction after a rough stretch. Only five years ago, The Pantry broke from the shackles of terms and fixed contracts, embracing an aggressive hedging strategy that sought to capitalize on volatility and deliver to the company extra pennies of pure profit for every gallon sold. And for a company pumping millions of gallons monthly, pennies quickly translated into thousands of dollars and, over time, into seven-digit profits.
But in 2008, The Pantry reported a net loss of $5.1 million for its second quarter. It blamed the flood of red ink on gasoline hedging positions. In somber tones, the company said it would halt acquisitions and close out its gasoline hedges.
“Sodini had such an unpleasant experience in hedging that they’ve never overcome it,” an oil expert says of then-CEO Pete Sodini, who took a modest local chain and turned it into the largest independent convenience retailer in the Southeast.“They’ve been much more traditional ever since, buying rack, entering contracts.”
This conservative approach, he says, has its drawbacks. “What’s challenging for them today is that companies like QuikTrip and RaceTrac have traders on their staffs,” said the expert, who spoke on condition of anonymity. “Those companies are aggressive and trying to gain every cent of profit they can. The Pantry isn’t doing that; they’re not leveraging the buying power they have to take advantage of volatility in the market.”
Another oil expert familiar with The Pantry agrees: “I’ve watched the Pantry since they really started sprouting and growing. For a while I thought they were cutting their teeth and trying to figure out fuels. But the last few years have been a real struggle for them.”This source estimates that 98% of The Pantry’s business is on a fixed contract.“They may have upper and lower ceilings with Marathon and Valero, but in this day and age you cannot commit 98% to contract,” the source says. “It would have to be one flippin’ sweet deal.”
Why are such contracts undercutting The Pantry? What’s wrong with predictability?“If they got a chunk of stores and this chunk of volume is tied to one index, they’re stuck,” the source says. “Their competition, like QuikTrip and Sheetz, are very aggressive and very flexible. It leaves The Pantry with no margin for error.”
Hatchell confirms that hedging is not in The Pantry’s future—“Not as long as I’m breathing,” he quips—but says there are opportunities in streamlining supply logistics. “If we sell from in-ground out to the tank, what do we do about in-ground back to supply? It’s more than just pick it up and deliver it all of the time. There airtimes to pick up more and times to pick up less. There are things to be done there that don’t have anything to do with hedging.”
For the past few years, The Pantry has-been gathering data from its KSS fuel price optimization software, which has helped it begin to understand how the markets are flexing and where it’s moving, and to get cents per gallon stabilized. The company is just beginning to realize the potential of that technology.
“Now we’ve got to track over what we got in prior years,” says Hatchell. “We have good weeks and bad weeks, depending on what happened in prior years, and we’re just holding our nose and getting past that.”
On the brand side, The Pantry now sells Marathon, Valero, BP and its own private label, which puts fuel in sync with the localization push inside the stores, he says. The next step will be encouraging customers drawn to the pump to also walk inside.
“We’ve got to grow the inside of outbox and reduce our reliance on fuel margins, so we can just enjoy them as they are, and manage those as best we can with price optimization,” says Hatchell. “We don’t want the pendulum swinging really wide back and forth on prices, so we want to move it a little bit and make fuel be attractive ... and get customers in here.”
Seeking Leverage
Back in late 2010, then-senior vice president Fisher told CSP, “Quite frankly, we’re not sure what the Kangaroo is yet.”That is, what did the brand mean?
Two and a half years later, a new team seems to have a better idea.
“I think they know who they want to be,” says Hunt of Wells Fargo. “There’s definitely the opportunity to raise the bar in terms of foodservice and margin capabilities throughout the chain because of initiatives that will be rolled out overtime. … We think that there’s a lot of upside to the business, and you’re just starting to see the initiatives in some of the stores play out.”
Despite the new competition, Hatchell and his team seem confident that if they trust in the customer, everything else will fall into place. “If we put well trained people who are energized in those stores, and give them products that pertain to their local neighborhoods, because the stores are there, I think that’s a really big competitive advantage for us,” Hatchell says. “We’re not sourcing sites. We’re deploying a lot of capital in remodeling these stores, replacing them or building new stores within the network we have, up to and including acquiring stores if they’re there. So the whole thing is laid out.”
The Pantry has a goal of remodeling 10% of its stores annually over the next five years, boasting the upgrading of 200 sites since Hatchell took the reins. What many consider a major impediment—The Pantry’s diverse portfolio—Hatchel sees as a strength.
But analysts and observers, from within the convenience channel and on Wall Street, aren’t certain. An industry respected financial expert cites The Pantry’s skewed debt-to-equity ratio, which is substantially higher than other publicly traded convenience chains, such as Casey’s and Alimentation Couche-Tard. The Pantry’s portfolio girth is undercut by its lack of capital ownership, he says.
“They only own about 300 of the sites, and the rest is leased. So there really isn’t much to leverage,” he says. “This company is crying to be taken out of public. There is no dominant shareholder to help right their course, and there is too much debt and not enough hard assets to support a takeover or [acquisition].”The veteran c-store expert quoted earlier wants to see more from The Pantry’s executive leadership before he’s convinced of a successful turnaround: “To say you’re going to remodel 10% of your stores a year? That’s what any respectable business does. How is that going to put them in a position to compete against better models like QuikTrip and Sheetz in the Carolinas, and Wawa and Thornton’s in Florida?”Hunt of Wells Fargo is less concerned. From his view, debt to cash flow or debt to EBITDA are the more critical numbers. And, as others point out, the company’s units are cash positive.
“If you look at their leverage ratio, while it is high relative to management’s desires, they still are in the position even with a heightened cap-ex number for remodels and other initiatives to generate fairly substantial free cash flow,” he says. He estimates the chain will generate free cash flow of $35 million in 2013, which is about 3.5% of debt—a good number, although “not extraordinarily healthy.”
That, added to what is already slated, would give the company the capability to build 10 to 15 new stores. Hunt expects The Pantry to accelerate its new store opening program after 2014, adding, “Going from zero, anything’s an acceleration.”
Hatchell accepts the hand he’s been dealt. He waxes philosophical when asked about the long-term debt and the company’s assets, citing that as property leases expire The Pantry is assessing whether to divest the site, remodel or raze and rebuild.
“I think the healthiest thing you can do is focus on what you’ve got,” he says. Any consideration of taking the company private—which experts suggest would be cost-prohibitive—is simply not part of the board’s plan, he says.
Rather, as observers debate and predict the future of the chain, Hatchell sees only one direction: forward.
“The Pantry is what The Pantry is, and let’s just run the fire out of it,” he says.“Private companies have their own issues, and public companies have their own issues. The Pantry is The Pantry: We’re just doing the best job we can.”
At a Glance: The Pantry
Headquarters: Cary, N.C.
Store Count: 1,571 (as of Feb. 5, 2013)in 13 states
Employees: About 6,000
Key Profi t Drivers: QSRs/Foodservice in more than 200 sites, car washes in more than 200 sites, fuel at all locations
Top Three Categories: Cigarettes packaged beverages, alcohol beverages
Hot Growth Categories: E-cigarettes, energy drinks, cold/frozen dispensed beverages,publications
Capital Investments: Remodeled more than 200 stores, investments in fresh foodservice and Lifestyles Initiative
The Pantry’s Key Financials
Total annual revenue (2012): $8.3 billion
Net loss: $3.1 million
Fuel gross profit: $48.9 million, up $5.1 million from a year ago
Cents-per-gallon margin: 11 CPG after credit-card fees
Comparable store merchandise revenue (including cigarettes):+2.2%
Comparable store merchandise revenue (excluding cigarettes):+4.6%
Long-term debt: Approximately $500 million (down $200 million since December 2011)
Cash on hand: $24.4 million, with nearly $130 million available via revolving credit facility
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