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Tuesday, December 31, 2019

2020 Convenience Store Predictions Affecting Profitability and M&A:
Is this the Year the Industry is Impacted by the Internet?

Source: Observations from the Executive Suite
By Jeff Kramer, Managing Director, NRC Realty & Capital Advisors

U.S. ECONOMY

Most forecasts are in the 2% real GDP growth range, led by strong consumer spending and increasing government spending in the 11th year of a record expansion while the rest of the world tries to catch up. So far, 2019’s Federal Reserve easing policies have benefited the stock market much more than economic growth. Politics will remain an unknown, exacerbating issues in key large economies, notably China, India and the European Union, whose economies rely more on trade.

INTEREST RATES

Interestingly, economists are split evenly on whether the key 10 Year U.S. Treasury rate will rise or fall. Those looking for an increase in rates expect strong growth and possible inflation, with those expecting lower rates concerned about the economy slowing and possible deflation. Competition for funds from growing Federal deficits complicate the outlook.

OIL PRICES

OPEC seems to be trying hard to restrain supply and increase prices. The problem is that higher prices bring new competitors to the market, increasing supply. Regardless, oil prices always decline when the world economy declines, so the anticipated economic growth is very important. IMO 2020, whereby all world ships are “required” by an international agreement to switch from high sulfur fuel to low sulfur diesel, starts in January. No one knows yet how this will work out, and making a required amount of diesel also could overproduce gasoline and unwanted heavy oil at the same time.

C-STORE TRAFFIC AND PROFITS

Four straight years of record fuel margins and overall profitability may be a hard act to follow. Potential headwinds are:

  • Industry actual store surveys have shown gasoline demand down about 2% through October 2019, but with the decline versus 2018 accelerating in November and December. To be sure, weather conditions in most of the U.S. were near perfect over the key seasonal months for c-store traffic and sales. But with more jobs being service and internet oriented, it is likely that “work from home” alternatives may reduce work-related commuting.
  • If soft fuel volumes persist, retail fuel margins are likely to shrink as “loss leadership” could return to help draw traffic for more profitable food service and store sales.
  • 2020 could see the first year where Internet sales start to impact c-store sales. Amazon is rolling out a chain of 30,000 square foot Grab and Go “frictionless” mini supermarkets at the same time that Wal-Mart and competing supermarkets are forced to increase their online presence through both store pickup and home deliveries. The higher volumes will decrease their distribution costs due to economies of scale, much as Wal-Mart did in their huge growth stage. There will be increased competition for “convenience”, fresh food and produce, and the consumer dollar.
  • Strong c-store chains with solid food service operations should do well, but even they may face competition from home delivery. When you have the chance, Google “Cloud Kitchen” for a successful home delivery concept working well in China that has potential here and could include some c-store chains as well because of our broad complementary product offerings.
  • Labor issues will persist--namely quality of the work force and cost. Technology and automation will help over time, but they will be capital intensive and can add overhead.
  • ESG, or Environmental, Social and Governance issues will remain important. Some trends directly affect some of our key sales categories.

INDUSTRY CONSOLIDATION

It will continue under almost any economic circumstances due to increasing complexity of the business and economies of scale. Also, it is hard to predict how long favorable tax laws and rates, especially for capital gains and inheritance taxes, will remain low, prompting some long-time operators to sell. Astute operators will sell off marginal sites or business units while the market is strong. Some units may have more value to other companies.

IPOs

Despite excellent industry profitability, there are few publicly traded companies. Low interest rates, solid and reliable profitability and huge amounts of private equity capital have driven multiples to record levels. Regardless, Wall Street is cautious, and consolidation without a clear business plan for brick and mortar businesses may not be sufficient.

DEALERS AND FRANCHISEES

They will remain very important as an alternate method of distribution, especially if suppliers can offer real estate ownership to their customers.

COMMERCIAL FUEL AND DISTRIBUTION

Very economically sensitive with margins at record levels. Our economy has been spoiled by low fuel costs.

SUMMARY

2020 could see a reversal of strong industry profitability. It’s going to be harder to rely on high fuel and store sales margins to offset lower volumes. Industry consolidation lessens the competition, and certainly some areas of the country are less subject to competition. But overall softening of volumes will also adversely affect record purchase price multiples at some point. The combination of lower profits and lower multiples creates a double whammy on company valuations.

JEFF KRAMER

Managing Director
[email protected]
(303) 619-0611

To see a list of convenience stores and gas stations for sale, click here.