Alimentation Couche-Tard - An Appealing Valuation

As a long-term investor seeking to invest in undervalued/fairly valued high-quality companies, investment opportunities that meet my investment criteria are currently few and far between. Following Alimentation Couche-Tard's (ATD-a.TO and ATD-b.TO) recent $1B private debt offering Press Release, however, I now revisit this existing holding to determine if I should increase my ATD exposure. Based on my analysis, I conclude that Alimentation Couche-Tard has an appealing valuation and justifies the purchase of additional shares.

In late 2017, before initiating an ATD position in early 2018, I purchased Daring to Succeed - How Alain Bouchard Built the Couche-Tard & Circle K Convenience Store Empire. At the time, the company's website had a link from which this book could be purchased. This link no longer exists but the book is available through Amazon. It is an amazing story of how someone from a very humble beginning successfully built a company that generated just under $60B in annual revenue in FY2020!

Previous ATD articles can be accessed from The FFJ Archives.

NOTE:

  1. ATD's shares are publicly traded on the TSX in Canada and trade over the counter in the US.
  2. Class A shares are owned primarily by insiders and are thinly traded and there are 10 voting rights to every 1 voting right for Class B shares.
  3. Shares currently trade at ~$43 CDN. Operating results are in USD and a USD $1 = CDN $1.212 conversion rate is used for this article.

Industry Overview

The convenience store industry is highly fragmented and is undergoing consolidation. For example, in the US where ATD has its largest presence, we see an extensive list of industry participants. This list was compiled as of December 31, 2019. After this date, 7-Eleven Inc. (#1) completed its ~$21B acquisition of Speedway LLC (#3) from Marathon Petroleum Corporation mainly under the Speedway brand.

 

Business Overview

ATD is the leader in the Canadian convenience store industry. In the United States, it is the largest independent convenience store operator in terms of the number of company-operated stores. It is a leader in the convenience store and road transportation fuel retail industry in the Scandinavian countries (Norway, Sweden and Denmark), in the Baltic countries (Estonia, Latvia and Lithuania), as well as in Ireland and Poland. In Asia, ATD operates a network of company-operated convenience stores in Hong Kong.

ATD successfully grows organically and through acquisition.

In fact, ATD sees ample opportunity to expand its global presence.

Recent Acquisition Activity

In February 2020, ATD announced a revised non-binding, indicative offer to the Board of Caltex to acquire 100% of Caltex in Australia. EG Group, owned by private equity firm TDR Capital, also battled for Caltex.

Caltex, a Sydney-based refiner-marketer had rejected an initial bid from ATD and EG’s counterbid.

Following these bids, COVID-19 hit and the flurry of merger-and-acquisition (M&A) activity evaporated under the crushing weight of mandatory business closures and orders for everyone to stay at home. While ATD kept up negotiations with Caltex, the oil price war between Saudi Arabia and Russia sent crude prices plummeting. This created a disastrous selling position for Caltex.

ATD and Caltex agreed to terminate negotiations but not the possibility of a future deal. In April 2020, ATD informed the investment community that despite having secured the necessary financing commitments for the Caltex acquisition, it was not in a position to make a revised proposal.

In late December 2020, ATD completed its ~$0.36B bolt-on acquisition of Convenience Retail Asia (BVI) Limited; this company has 340 company-operated sites in Hong Kong and 33 franchised sites in Macau. ATD regards this important acquisition as a platform in Asia from which to launch its regional growth ambitions.

On January 12, 2021, ATD confirmed it initiated exploratory discussions with Carrefour SA regarding a potential friendly transaction. Extensive pushback from the French government resulted in both parties quickly terminating any further discussions.

A comprehensive overview of the company is found in the March 2021 Investor Presentation, page 3 of 33 in ATD's Q3 2021 report,  the 2020 Annual Information Form for the fiscal year ending April 26, 2020.

The EV Future

Some investors are concerned about ATD's future given the transition from fuel to electric vehicle adoption. This is a valid concern considering ATD's product mix.

However, management is well aware of this risk. The company's 2020 Sustainability Report and overview of its Focus Areas provides a high-level overview of its comprehensive strategy to adapt to this change.

Furthermore, on May 13, 2021, ATD announced the closing of a $1B private debt offering consisting of two tranches of notes of which $0.35B is Green Bonds. These bonds are the first of their kind by a convenience and fuel retailer. Deployment of these proceeds will be toward driving a more responsible future.

In preparation for the EV future, ATD is using Norway as a real-world EV laboratory. Under the Circle K brand, ATD offers its own brand of fast chargers plus others in partnership with Green Kontakt, Tesla and Ionity.

An Impressive Financial Record

Several companies that grow through acquisition generate less than ideal investment returns. Oftentimes, companies depend on acquisitions to mask weak operations. ATD is not such a company. It has a lengthy track record of highly successful acquisitions because it follows a very strict M&A strategy. In fact, ATD's CEO states:

'We are not a group of Harvard MBAs, we’ve developed a unique culture. When we do M&A, we don’t do hockey-stick charts. A lot of companies would hire an investment bank to look at M&A; we don’t do that, we do it ourselves. We know the business, we know what we can do, and we know what we can’t do. And we don’t grow crazy with valuations.'

 

Interestingly, ATD has ~$10B of incremental Balance Sheet capacity. Its leverage ratio at the end of Q3 2021 is 1.36 versus a target of 2.25 or lower. This is the lowest degree of leverage in almost 2 decades! I envision a major acquisition will occur in the not too distant future if management can negotiate terms and conditions that meet its strict acquisition criteria.

Furthermore, in an August 2020 interview with Forbes magazine, the company's CEO discloses plans to make the convenience-store giant even bigger.

How Does ATD Fare In A Recession?

Looking at how the industry has fared between 1999 - 2019, we see convenience sales grew during the last two recessions.

The COVID-19 pandemic, however, presents unique challenges never before experienced by the industry. For the most part, the major industry participants are proving resilient. In many regions, authorities deem the convenience channel essential.

While the pandemic and subsequent stay-at-home restrictions immediately slowed M&A activity, industry operators were fortunate to have entered the COVID-19 downturn from a position of strength; many industry participants entered the COVID-19 crisis experiencing record profitability, healthy leverage and ample liquidity.

Despite the industry’s 'essential' status, the pandemic has hit industry participants hard...especially their fuel business.

The number of gallons purchased immediately after the March 2020 'lockdown' resulted in a drop in fuel volumes of as much as 44% and a drop in inside sales of as much as 20% in the days following shelter-in-place orders in various States.

Although people in the stores are your basic convenience-store customers who go into work every day, the soccer moms and people dressed in suits are not frequenting the stores.

It is also evident that industry participants that do not keep up with the modern evolution of food service are being left in the dust. ATD, fortunately, is one of the industry leaders when it comes to the modernization of foodservice.

Don't Bogart That Joint

On August 7, 2019, ATD invested CDN $26.0 million (USD $19.5 million) in Fire & Flower Holdings Corp., a leading independent cannabis retailer listed on the TSX. The investment was in the form of unsecured convertible debentures which would result, as at FYE2020 (April 26, 2020) and on a fully-diluted basis, in an 11.3% ownership interest in Fire & Flower upon conversion.

ATD's CEO indicates the rationale behind this investment is to understand the market, how to run the stores, and to learn consumer behaviour. One-third of Americans are in states where the purchase and use of cannabis are legal. ATD, however, can not enter these markets because it is still illegal at the federal level. Management, however, is confident the U.S. will eventually legalize it.

ATD also received common share purchase warrants, that, if exercised under the terms of the investment, would subsequently increase its ownership interest in Fire & Flower up to 51.6% as of April 26, 2020 on a fully diluted basis. As of April 26, 2020, the unsecured convertible debentures were not converted, and no common share purchase warrants were exercised.

On December 21, 2020, ATD exercised common share purchase warrants in Fire & Flower for a cash consideration of CDN $8.7 million (USD $6.8 million), which fulfilled ATD's commitment to exercise a portion of the common share purchase warrants for an amount of CDN $19.0 million by December 31, 2020.

After the end of Q3 2021, ~CDN $26.0 million (USD 20.3 million) of convertible debentures was converted into common shares of Fire & Flower. These conversions stem from the realization of certain events which allowed Fire & Flower to require ATD to convert all or part of its convertible debentures. Following these conversions, ATD's ownership interest in Fire & Flower is 19.9%.

Credit Ratings

ATD's unsecured long-term debt is rated Baa2 (Moody’s) and BBB (S&P Global). Both are identical ratings and are the middle tier of the lower medium grade investment-grade category.

These ratings define ATD as having ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity in which ATD can meet its financial commitments.

These ratings are satisfactory for my purposes.

Dividends and Dividend Yield

While ATD distributes a quarterly dividend, the priority is to retain funds for further growth.

The company does not maintain a dividend history on its website but rather, directs investors to the TMX Group's website.

ATD quarterly dividend distribution commenced in March 2006. Looking at the dividend history on TMX's website, it appears ATD has cut its dividend a few times. This is not the case. TMX just does not adjust the dividend history to account for stock splits.

Despite this drawback, investors typically invest in ATD for its growth potential and not for dividend income. The current $0.087/quarter/share dividend provides investors with a ~0.8% annual dividend yield based on the current ~CDN $43 share price.

Share Structure

As of March 12, 2021, the company had 253,803,100 Class A multiple-voting shares and 830,852,446 Class B subordinate voting shares issued and outstanding. In addition, it had 3,267,501 outstanding stock options for the purchase of Class B subordinate voting shares.

ATD has Class A and B shares.

  • Class A multiple voting and participating shares have 10 votes per share except for certain situations which provide for only one vote per share. They are convertible into Class B subordinate voting shares on a share-for-share basis at the holder’s option. Under the articles of amendment, no new Class A multiple voting shares may be issued.
  • Class B subordinate voting and participating shares are convertible automatically into Class A multiple voting shares on a share-for-share basis on the earlier of the following:
  1. When all 4 of the Corporation’s co-founders reach the age of 65 years old; or
  2. When all 4 of the Corporation’s co-founders will hold, directly or indirectly, less than 50% of the voting rights attached to all of the Corporation’s outstanding Class A multiple voting shares and Class B subordinate voting shares.

The Class A shares are illiquid with the daily trading volume typically under 35,000.

Share Repurchases

ATD maintains a share repurchase program that allows it to repurchase up to a specific percentage of the public float of the Class B subordinate voting shares. All shares repurchased under the share repurchase program are cancelled upon their repurchase.

On April 21, 2021, ATD announced the termination of the early share repurchase program it had commenced on November 27, 2020. In conjunction with this announcement, ATD also announced the commencement of a new share repurchase program.

The repurchased shares are roughly equivalent to the number of shares issued under the company's compensation structure. In FY2011 - FY2020, there were 1,129, 1,101, 1,121, 1,136, 1,137, 1,138, 1,139, 1,134, 1,130, and 1,125 million shares outstanding.

Valuation

In late June 2021, we can expect ATD to release Q4 and FY2021 results. The following valuation estimate is based on Q3 results released January 31, 2021 and FY2021 and FY2022 adjusted earnings estimates from brokers.

In the first 3 quarters of FY2021, ATD generated $1.92 ($2.33 CDN) in diluted net EPS and $1.93 ($2.34 CDN) in adjusted diluted net EPS.  Full-year diluted EPS guidance from the 14 brokers is $2.13 - $2.43 and a mean of $2.28 ($2.58 - $2.95 and $2.76 CDN). Based on the current ~$43 share price, the forward adjusted diluted PE range is ~14.6 - ~16.7.

FY2022 guidance from 15 brokers is $1.81 to $2.17 with a mean of $1.98 ($2.19 - $2.63 and $2.40 CDN). Using the ~$43 share price the FY2022 forward adjusted diluted PE range is ~16.35 - ~19.6.

By comparison, ATD's FY2011 - FY2020 diluted PE is 14.93, 18.63, 18.34, 26.89, 22.98, 22.81, 21.75, 15.63, 17.58, and 13.72.

Alimentation Couche-Tard - An Appealing Valuation - Final Thoughts

For the sake of full disclosure, I acquired ATD shares through one of the 'Side' accounts within the FFJ Portfolio on March 23, 2018. Additional shares were acquired on October 24, 2019, and January 7, 2021 for our daughter's Tax-Free Savings Account (TFSA).

In an environment where I have difficulty in finding undervalued or fairly valued high-quality companies, Alimentation Couche-Tard's appealing valuation is greatly welcome.

Growth by acquisition is in this company's DNA which does present risks. However, ATD consistently demonstrates its ability to successfully integrate its acquisitions.

In my opinion, ATD is well aware of and understands the risks associated with the displacement of fuel-powered vehicles by electric vehicles. It is very proactive when it comes to positioning itself for the evolution that will impact the industry (ie. 'test lab' in Norway).

With ~$10B of incremental Balance Sheet capacity and a 1.36 leverage ratio at the end of Q3 2021 versus a target of 2.25 or lower, I envision a very bright future. I intend to add to my existing ATD position within the next 72 hours.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long ATD-b.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.