Corner Gas & Milk

Shareowner, Jul/Aug 2006

Couche-Tard sells convenience by the gallon

We first featured Couche-Tard as a Stock to Study in the Jan./Feb. 1996 issue. We did so again in Nov./Dec. 2000, and yet again in May/June 2002. Between the '96 and 2000 issues its shares rose from $0.75 (adjusted for stock splits) to $2.50, providing owners with a 25% compound rate of price appreciation. From the 2000 to '02 issues it rose from $2.50 to $8.50, for a 125% annual gain. Since the last study, it has provided a yearly gain of 34%, to the April 2006 high of nearly $28.

ALIMENTATION Couche-Tard, the leader in the Canadian convenience-store industry, has grown rapidly through Canadian and U.S. acquisitions. Excluding stores operated by oil companies, it is now the second-largest convenience-store operator in North America, behind privately owned 7-Eleven.

The company, with some 2,000 stores in Canada and almost 3,000 south of the border, employs over 36,000 people. Outside of Quebec, Couche-Tard operates principally under the Mac's banner in Canada, and Circle K brand in the United States.

Historical Growth

Couche-Tard reports its financial statements in U.S. dollars while its shares trade in our dollars on the Toronto Stock Exchange. For consistency with the share price, all dollar values are expressed in Canadian currency.

Revenues

As indicated by the profile in Chart 1 (see next page), between 1996 and 2006 revenue growth averaged about 50% per year, quite consistently. For the latest fiscal year, ending April 2006, revenues increased by an estimated 13%, to about $11.5 billion.

Relatively large, periodic acquisitions have been the principal driver of this high, long-term growth. The Circle K acquisition in 2003 added almost 2,300 stores to Couche-Tard's network.

EPS

Average growth in KPS (earnings before discontinued, extraordinary, and special items) has also been unusually high, at over 35% throughout the study period. However, since 2001, EPS growth has tracked revenue growth quite consistently at about 45% per year.

As Chart 1 indicates, EPS growth typically accelerates following Couche-Tard's acquisitions. Strong purchasing and operating capabilities have played a central role in converting revenues into fastgrowing profits.

For fiscal 2006, EPS growth is projected at about 18%, to $1.14.

Reasons for Historical Growth

Important Products

Couche-Tard's revenues are derived principally from the sale of gasoline and other merchandise as well as services (including franchise fees, royalties, etc.) at almost 5,000 locations.

Motor Fuel (57% of estimated 2006 revenues, vs. 73% in 2001)

Some 60% of Couche-Tard's locations sell gasoline. The company receives commissions as an agent for various petroleum distributors. Approximately 85% of gasoline revenues are generated in the United States.

Gas-bar traffic is crucial to driving Couche-Tard's in-store merchandise sales. Despite the increased fees charged on gasoline sales by credit card companies, Couche-Tard has been able to expand its gross margin. It uses pricing to increase fuel sales.

Merchandise and Services (43% of estimated 2006 revenues, vs. 27% in 2001)

Traditional convenience store items include: tobacco products (about 37% of total merchandise sales), groceries (24%), beer, wine and liquor (16%); candy and snacks (8%); food services (11%) and dairy products (4%).

Couche-Tard grows same-store sales by adding new products and services with high margins to its merchandise range (e.g. automatic teller machines, lottery ticket sales, cellphones, pre-paid phone cards, and home-office supplies).

As well, low-turnover products are quickly replaced with better-selling items to maximize utilization of a store's selling space and to ensure that local customers can rely on their stores for always having popular items available.

IMPACT Store Concept. In 1998 CoucheTard launched this program to upgrade its company-owned stores (72% of locations) to increase their customer appeal and to promote increased sales of highermargin products. Each selected store is redesigned by a multi-disciplinary team of experts, and stocked to reflect the socio-economic and cultural character of the community.

So far, 1,600 stores have had the treatment. Costing up to $200,000, it typically results in an expanded food-service operation, that may include a quick-service food outlet. A scaled-down treatment (up to $60,000) is used in smaller market areas. Certain Circle K stores are targeted for the treatment.

Among its upgraded stores, CoucheTard operates over 300 quick-service restaurants and other food outlets with well-known brand names, such as Subway, Quiznos, Dunkin' Donuts, M&M Meat Shops, A&W, and Blimpie. The company runs the branded operation and pays royalties, rather than renting out space to food-service operators for a fixed fee. Thus Couche-Tard benefits directly from the revenue growth of popular branded products, enjoys a relatively high profit margin, and ensures quality service.

Currently, the company is testing a quick-service restaurant format for its stores. Using the name Boca Cafe, the new format should provide high margins and more installations than are presently available from the national brand outlets.