The following is a guest post from Tsachy Mishal of TAM Capital Management, who presents a look at a gas station pair trade, if you will. Tsachy also runs the blog Capital Observer.



Market Folly readers will recall that hedge fund Scout Capital recently disclosed a position in CST Brands and this write-up presents a different viewpoint.





A Tale of Two Gas Stations: Susser Holdings & CST Brands





Susser Holdings (SUSS) and CST Brands (CST) both operate gas stations with convenience stores attached. Susser Holdings came public in 2006 with private equity backing, while CST Brands is a recent spin-off from Valero (VLO). On the surface a spin-off would seem far more attractive than a private equity backed IPO, but looks can be deceiving.





Business



Over 80% of Susser’s gas stations are located in Texas, the second fastest growing state in the US. CST’s gas stations are located across the southern US and Canada, with about a third being in Texas. CST mentions Texas numerous times in their Form-10 as a stand out economy and a driver of growth From the CST Form 10:



"The economy in Texas has fared better than many other parts of the U.S., partly supported by a solid economy, a relatively stable housing market and strong population growth and job creation. We have also benefited from the significant increase in economic activity in Texas that has resulted from the increased oil and gas drilling activity in Texas. We have a large number of convenience stores in Texas, and these operations have benefited from the increase in population resulting from employees of the oil and gas industry who have moved to Texas to support that industry."



On the basis of location, Susser has a clear advantage over CST with a much greater percentage of its gas stations being in Texas.



Susser earns the majority of its profits from convenience store sales while CST Brands is more heavily dependent on fuel sales. In 2012 59.7% of Susser’s gross profits came from merchandise sales, while 40% of CST Brands’ gross profits came from merchandise. The reason for this is that Susser’s average convenience store footprint is 3,600 square feet, while CST’s average footprint is 2,200 square feet.



Susser’s larger footprint allows it to sell fresh food and earn more from its convenience stores. CST Brands realizes that it is preferable to have a larger convenience store footprint and is planning larger footprints for its new stores but that doesn’t help its existing store base.



CST’s heavy dependence on fuel sales is a negative for a number of reasons. As Americans have been driving less and driving more fuel efficient cars, fuel usage in the US has been declining. By contrast, convenience store sales have been steadily increasing. Additionally, 2012 was an abnormally profitable year for fuel sales that is unlikely to be repeated.



As oil prices decline, gas stations are slow to lower prices. The $35 oil price decline in the second quarter of 2012 was a bonanza for gas station owners. In 2012 fuel gross margin for CST brands increased by 2 cents a gallon or $40 million, primarily as a result of this extreme downside volatility in fuel prices.



It is very unlikely that we see such an extreme move in oil prices this year. As a result, year over year fuel gross margin should decrease by close to 2 cents a gallon resulting in lower year over year earnings and EBITDA for all gas stations with a disproportionate effect on CST Brands due to its reliance on fuel sales.





Operation Performance



In 2012, Susser had same store merchandise sales growth of 6.6% and per store fuel gallon growth of 5.8%. CST does not provide historical same store sales numbers but does provide “per store” figures. In 2012 “per store” merchandise sales actually showed a slight decrease while per store fuel gallon sales showed a less than 1% increase.



In the first quarter of 2013 CST provided SSS figures for the first time and showed US SSS down 1.6% compared to Susser growing 4.2%. This is likely attributable to CST’s older stores and larger dependence on cigarette sales, which have been in secular decline. Cigarettes make up 40% of merchandise sales for CST compared to 19% for Susser. Dollar stores have recently moved into this category, which will increase pressure. Susser has clearly enjoyed superior operating performance to CST Brands.





Management



The Susser family has been in the gas station business since the 1930’s. Sam L. Susser, the CEO, joined the company in 1988, when Susser operated five stores and had revenues of $8.4 million. Sam Susser grew up in the gas station business, has 25 years of experience and a proven track record.



Kimberly S. Bowlers is the CEO of CST Brands. Below is her bio from the CST Form 10:



"Ms. Bowers was elected Chief Executive Officer and President of CST effective January 1, 2013. Ms. Bowers served as Executive Vice President and General Counsel of Valero from October 2008, and previously served as Senior Vice President and General Counsel of Valero since April 2006. Before that, she was Valero’s Vice President–Legal Services from 2003 to 2006. Ms. Bowers joined Valero’s legal department in 1997. Ms. Bowers was elected to the board of directors of WPX Energy, Inc. on December 30, 2011."



In other words Ms. Bowers, the CEO of CST Brands, has been a lawyer her entire career and has little operating experience. I’m certain she was a very capable lawyer but that does not make her a capable CEO. If experience counts for anything, then Susser has the superior management.





Valuation



Considering that Susser has the superior store locations, a superior business mix, superior performance and superior management one might conclude that Susser should trade at a premium to CST Brands. One would be wrong. Susser Holdings trades for less than 6.3 times EV/LTM EBITDA, adjusting for their ownership in SUSP (slide 21).



CST Trades for roughly 8 times EV/LTM EBITDA. Instead of trading at a premium Susser trades at a greater than 20% discount to CST Brands. This does not take into account that had CST been a public company they would have incurred additional expenses. Additionally, on a forward basis I believe Susser trades at a greater than 30% discount to CST Brands.





Conclusion



CST Brands is a case of “You Can Be A Stock Market Genius” gone awry. In investors haste to buy a “spin- off” they have valued a poorly performing company at an undeserved premium to one if its closest, better performing peers. There are too many geniuses out there right now.





Catalyst



CST Brands has not given any forward guidance so investors have had to create their own earnings models. Many investors seem to have simply extrapolated forward an increase in earnings and EBITDA from 2012 to 2013 for CST. This ignores the one time bonanza in fuel margins in 2012 ($40 million) and the increased costs of being a public company ($20 million). When CST reports second quarter earnings it should become clear that estimates are pie in the sky.





Full disclosure: TAM Capital Management is long Susser Holdings (SUSS) and short CST Brands (CST).



Embedded below is a .pdf copy of TAM Capital's thesis:









We've posted some other investment theses from TAM Capital here.