Can Casey's Ring Up Better Cash Flow?

By Stephen D. Simpson, CFA | September 13, 2012 AAA

Plenty of stocks work even though their models fly in the face of academic notions of how financial markets are supposed to work. Take the case of Casey's General Stores (Nasdaq:CASY). While this company has a business plan that makes ample sense (building stores in small Midwestern communities) and has delivered good growth and reasonable returns on capital, the free cash flow generation has not been so great. So although Casey's doesn't work so well from a discounted cash flow perspective, I don't think that's going to hurt the stock all that much.

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Getting It Done at the Bottom Line
Although Casey's posted a small miss on the top line, I don't think the magnitude of the miss is significant, nor more important than the solid margin performance. Revenue did fall slightly this quarter, largely due to a very small decrease in gasoline sales (which makes up more than 70% of revenue). Grocery/merchandise sales were up about 6% (or 2.6% on a same-store basis), while food sales rose more than 15% (with 10.6% comp growth).

Margins were a bit of a mixed bag. Gross margin improved more than a full point, as the company continues to see better-than-targeted margins in all of its reported segments. Gasoline margins were nearly one cent above plan ($0.149 versus 14 cents), while merchandise margins were more than a half-point above plan and food margins were more than two points above management's goal. Operating income did decline 2%, however, as the company absorbs the costs of new store openings, remodels and installations against a tough retailing environment.

A Tough Model to Match
Casey's has focused on serving small communities; about 60% of its stores are located in towns with fewer than 5,000 people. Although that means there are only so many people that each location can hope to serve, it also means that companies like Walmart (NYSE:WMT), Kroger (NYSE:KR) and Safeway (NYSE:SWY) are going to be less inclined to compete head-to-head. Consequently, a lot of Casey's targeted consumers will weigh the cost and convenience of going to a Casey's in town or driving some distance down the highway to get to one of those larger stores.

With that, Casey's has less competition on its pricing, less need for advertising, and so on. Likewise, while there may be room for quick-service restaurants like McDonald's (NYSE:MCD) or Yum Brands (NYSE:YUM) in the same markets, Casey's still has a good growth card up its sleeve in rolling out more high-margin food offerings.

But Still a Tough Business
Casey's focus on smaller communities gives it an advantage, but this is still a company with limited cash flow leverage. Casey's operating margins have bounced around between 2.7 and 4.2% for the last decade, and the company's free cash flow margin has averaged out to just a bit over 1% of revenue. That's still pretty good compared to Pantry (Nasdaq:PTRY) or TravelCenters of America (AMEX:TA), so context is important.

Investors can look to some improvement as the store base grows and the company's capex needs shrink as a percentage of sales. Don't overestimate this as a catalyst, however, as existing stores will still need to be renovated and the company will likely need to install additional equipment in the years to come.

The Bottom Line
As I said in the beginning, not all stocks perform according to plans laid out in academic journals and textbooks. To that end, so long as Casey's can continue to show positive momentum in same-store sales and margins, there's a meaningful segment of the investment community that won't notice or care about the company's free cash flow generation. All of that said, these shares still aren't all that cheap by standards like PEG or EBTIDA/EV. On a 10 or 15% pullback, I might be more interested in these shares, but for now Casey's looks more like a hold than a compelling buy.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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