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Tuesday, January 18, 2022

One Disruption That Will Not Be Transitory After Covid - Qualified Labor

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

Everyone remains hopeful that we are seeing the last vestiges of the Covid 19 virus and pandemic. Perhaps it will soon start to show its decline, at least in the U.S., as evidenced most recently by fewer hospitalizations and deaths. Spreading further to other key countries like China will exacerbate shortages and extend inflation. Regardless of Covid at this point, very large changes are impacting financial markets, which in turn will impact the economy, interest rates, and certainly M&A, even including convenience store cash flows and all-important purchase price multiples. Key material shortages will also persist, most notably computer chips, which are starting to remind me of oil's historic importance. But one change likely to persist in the U.S. for quite a while is that of finding a qualified labor force with the skills needed for both old industry positions and New Age technology-oriented job requirements. Think of finding truck drivers with truck computerization and automation skills as one example.

Some of Covid's changes are transitory in nature and some are not. Technology has allowed a huge amount of the workforce to work from home, allowing employees to work from or move to smaller towns. In our industry, multiples have always been stronger in urban markets versus rural because of property values. If rural store cash flows improve relative to urban, that might cause a big shift over time. The U.S. generally competes well in the world in technology, including Artificial Intelligence, cloud storage, robotics, and perhaps less polluting electric and driverless vehicles. Internal Combustion Engines (ICEs) are not going away overnight, but the automotive industry is having perhaps a transformation not seen since World War II, and it will be interesting to see how the economics of alternative engine economics will compare with ICEs on cost, maintenance and net energy savings. Regardless of how we feel about the subject, the worldwide race is on.

At this time, the U.S. economy remains fairly strong, helped by business and consumer savings. Both federal government fiscal spending and especially the Federal Reserve pumping in huge reserves and reducing interest rates near zero for a long time now have more than been able to offset the slowing effects of Covid. However, the Fed pumped far more money into the economy than it could absorb for long term productive uses like retraining the workforce, education, and climate change. Instead, the huge excess 'stimulus' wound up increasing asset values beyond any peacetime norms, most notably stock prices, home prices, and some commercial values. The Fed is clearly behind the curve, as they are still adding $40 billion per month to their record $9 trillion overall deficit.

Convenience stores and fueling stations benefited by being deemed 'essential businesses' early on in the Covid period, helping provide record fuel margins and overall profitability, which ultimately impact asset value and generating sizable M&A demand. Overall total U.S. retail sales were incredibly 11% higher in 4Q 2021 than in 4Q 2020. Perhaps this is related to worries over Covid-induced shortages largely in China where they have many very serious economic issues of their own and has caused the consumer to buy early. Remember the U.S. consumer comprises 70% of our economy.

The net result is an inflation rate in most world countries that is the highest in 40 years and led by food and energy, still critical items whether the Fed economists consider them to be 'core items' or not. Some items may be transitory, perhaps $100/day car rentals, and high ocean freight shipping rates as carriers catch up. Most important, so-called 'free money' interest rates may be a thing of the past, as the Fed tries to calm the markets while praying inflation cools down. Unfortunately, 2022 is an important Congressional election year at a time when the politically appointed Federal Reserve has decided not to act until the historic inflation has shown up in delayed and sometimes flawed government statistics. If this inflation slows spending at the same time businesses and consumers react to normalizing interest rates at higher levels, the combination is not good. The U.S. federal deficit is now $29 trillion compared to a $21 trillion GDP, a ratio that implies higher interest rates that may cause business to compete with government for funds. Over the past 30 years, the benchmark 10 Year U.S. Treasury rate has averaged over 3.5% compared to 1.7% currently with inflation at over 7% by any measure, compared to much lower normal inflation rates.

So, with interest rates rising and inflation strong, what's next for employment prospects in our labor-intensive convenience store industry? The U.S. unemployment rate is already at an extremely low 3.9%, and November 2021 statistics showed job openings at 10.6 million positions, compared to November hires of 6.7 million jobs. Also, many workers are quitting and changing jobs at very high numbers, a sign of a still healthy economy. More and more economists now believe the scales have tipped towards labor after many years of ample labor supply at reasonable costs.

The profit challenge is on for the fuel/c-store/foodservice industry. During Covid, less volume in many categories for many retailers such as fuel, cigarettes, beer, and CSDs has led to higher prices and margins, which so far often exceed high labor costs to again lead to record industry profits. Will this continue in the post-Covid era? Capital will be needed for automated checkout counters, robotics, solar power, and maybe rapid electronic fueling chargers, if desired at fuel outlets and economically justified. There will be a great deal of competition for fast and convenient electric fueling, and as we know, our customer base often fuels and buys convenience items at one stop. And if the consumer gets more price conscious, our industry is not always perceived as price competitive, not necessarily fair depending on the competition. Convenience for sure will always be an important customer need and shoppers will always shop with their eyes as well as their wallets.

Regardless of any of the above, consolidation and convenience store M&A will remain active. Chain and store profitability may vary more than normal. Fuel pricing differentials of 30 cents or more per gallon between stores may not be as common as seen recently. Internet providers will continue improving market share. Sellers will see more market multiple variation. Cost cutting will hopefully continue. Many dynamics.

Recent selling multiples for quality c-store chains with owned stores have been as high as 14X store cash flow before synergistic savings and compares to 5X after the 2009 recession through 2014 when they started to improve. The good news is that despite 2022 challenges as always, quality well financed buyers remain active in an overall very profitable business. Maintaining record multiples may be more challenging, but more important could be multiples and business confidence as buyers are constantly reminded about New Age vehicle and autonomous vehicle rollouts. Key to electric vehicle fueling will be whether our stores handle 10% of that new business, or will they handle 70%? Through it all, 'you gotta fuel and you gotta eat', and historically this industry has done an excellent job of keeping up with both.


Managing Director
(303) 619-0611