Caseys General Stores Inc Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Casey's General Stores' Third Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Bill Walljasper, Chief Financial Officer. Please go ahead.

Good morning and thank you for joining us to discuss Casey's results for the quarter ended January 31st. I am Bill Walljasper, Chief Financial Officer. Darren Rebelez, Chief Executive Officer is also here. Before we begin, I'll remind you that certain statements made by us during this investor call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include any statements relating to our possible or assumed future results of operations, business strategies, growth opportunities and performance improvements at our stores. There are a number of known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from any future results expressed or implied by those forward-looking statements, including our ability to execute on the strategic plan or to realize benefits from that value creation plan as well as other risks, uncertainties and factors, which are described in our most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q as filed with the SEC and are available on our website. Any forward-looking statements made during this call reflect our current views as of today with respect to future events, and Casey's disclaims any intention or obligation to update or revise forward-looking statements whether as a result of new information, future events or otherwise. This morning, we’ll first take a few minutes to summarize the results of the third quarter and then open for questions about those results. I would now like to turn the call over to Darren to discuss those results.

Thanks, Bill, and good morning, everyone. As you've seen in the press release, diluted earnings per share for the third quarter were up $0.91 per share compared with $1.13 per share a year ago. The results were impacted by lower fuel margin versus the third quarter last year and higher operating expenses as we cycled over significant operating expense reductions in the prior year. We also experienced a timing shift in the approval of a performance target for equity compensation from the first quarter to the third quarter. Year-to-date, diluted earnings per share were $5.43, up over 12% from the same period a year ago. We continue to execute on key elements of our long-term plan this past quarter positioning us well for future growth. I would now like to go over our results and some of the details in each of the categories. During the quarter in the fuel category, we experienced a challenging demand environment while at the same time we were comparing against our strongest margin period from a year ago. We were pleased with our ability to leverage our current price optimization and procurement programs to navigate through this. These factors enable us to achieve an average fuel margin of $0.217 per gallon. Same-store gallons sold were down 2% in the quarter. The average retail price of fuel during this period was $2.40 a gallon, compared to $2.22 per gallon a year ago. Despite the decline in same-store gallons, total gallons sold for the quarter were up 3.3% to 573 million gallons, due to the strong contribution from our new stores opened in the last 12 months. As a result, gross profit dollars increased 1.4% in the quarter in the fuel category. Same-store gallons sold year-to-date were down 2% with an average fuel margin of $0.23 per gallon. Through the first nine months, gross profit dollars in the fuel category are up over 14% compared to the same period a year ago. Our effort and price optimization continues to have a positive effect on our overall profitability in the fuel category. During the quarter, we completed the full integration of this tool with our point of sale system. In addition to this, we also converted over 300 stores to digital price signage. We'll be fully converted to digital price signage by the end of the fiscal year. This integration and sign conversion will provide us increased flexibility in adjusting retail prices to react more quickly to the rapidly changing fuel environment. We're also pleased with the progress we made in fuel procurement in the third quarter. Currently, our contracted fuel volume represents about 43% of our total fuel volume. We're on pace to have approximately half of our fuel volume under contract by the end of the fiscal year. Lastly in the fuel category, we continue to gain traction in our fleet card program. Over the course of the third quarter, we continued to add new card holders. Today, we now have over 3,100 accounts and approximately 20,000 card holders. This combined with our additional efforts and other types of fleet cards has driven the universal fleet card program up 9% in the third quarter. We remain optimistic about the potential of all these initiatives going forward. Same-store gallons for February trended above our current annual guidance range, excluding the benefit from the extra day in the month. Moving to inside the store, total sales in the grocery and other merchandise category were up 7.1% to $582.4 million in the third quarter. Same-store sales were up 3.5% during the quarter towards the upper end of our annual guidance. Excluding cigarettes, same-store sales were up 5.2%. The average margin in the quarter was 32.9%, up 100 basis points from a year ago in the same period due primarily to a favorable product mix shift to higher margin items. Gross profit dollars for the quarter in the category were up 10.5% to $191.7 million. For the first nine months, same-store sales were up 3.2% with an average margin of 32.5%. As you may recall, the year-to-date margin was adversely impacted by a $6.6 million one-time adjustment that occurred in the first quarter. Without that adjustment, the margin was 32.8% and gross profit dollars for the first nine months were up nearly 9% to $633.9 million. Same-store sales for February trended within the range of our annual guidance, excluding the benefit from the extra day in the month. During the third quarter, we continued to integrate our price optimization platform inside our stores. We completed the rollout of the beer and alcohol categories to this platform and are currently working on the integration of promotion forecasting.

Thanks, Darren. We continue to stay focused on controlling operating expenses. For the quarter, total operating expenses increased 10.5% to $377.3 million. This was mainly driven by operating 70 more stores this quarter than a year ago, as well as an increase in technology costs with the implementation of our digital systems. In addition, operating expenses were impacted by a rise in credit card fees from the higher retail fuel prices. Same-store operating expenses for the quarter, excluding credit card fees, were up 5.4%. On a two-year stacked basis, they were up 3.3%. This was in line with our expectations as we cycle over significant expense reduction initiatives from a year ago. Last year in the third quarter, we had a reduction in store labor hours of nearly 6% as we made refinements to our labor scheduling process. We look to continue to refine this process with the completion of our time-motion study later this fiscal year. Year-to-date operating expenses were up 8.2% in line for annual guidance.

Thanks, Bill. For our target coming into this fiscal year was to build 60 stores and acquire approximately 25 additional stores. Through the third quarter, we have opened 50 new stores, acquired 10 stores, and have 11 additional stores under agreement to purchase. Currently, we have 88 sites in our pipeline, including 15 under construction, which positions us well for future growth. We anticipate meeting our new store opening target by the end of the fiscal year but will fall slightly short of our acquisition target due to timing considerations that are common in this area. We believe we have a strong opportunity to accelerate our acquisition activity as we stand up our dedicated M&A team as part of our new long-term strategic plan. Before we open for questions, I'd be remiss if I did not take a few moments to speak about coronavirus. Casey's is committed to the health and well-being of our team members, our guests, and the communities in which we operate our stores. Even though we may be more insulated from this exposure due to our rural geographic presence than others, we are taking recent developments very seriously and are monitoring the situation continuously. With this in mind, we created a cross-functional response team to oversee this issue to ensure the safe and stable continuation of our business operations.

Our first question comes from the line of Christopher Mandeville with Jefferies.

Can I ask you guys just given the last 48 hours, if you will, of significant crude pricing declines and now today's kind of subsequent bounce back to some degree, how are you thinking about the pace of converting gallons to short-term contracts and for what has now been kind of contracted out, how should we be thinking about your ability to remain competitive in terms of pricing and still capturing a healthy margin on those gallons?

Yes. Chris, this is Darren. I think, obviously, this is a very volatile environment we're experiencing right now with respect to fuel. And it does afford us some opportunity to capture margin, at the same time it affords us some opportunity to grow gallons. So every day is a new day right now with respect to how that's working. With our contracts right now, we, like I mentioned, we have about 43% of our volume under contract and because we don't have 100% of our volume under contract, it does give us latitude to toggle between spot and contract volume to maximize that opportunity. So that's kind of how we're managing it right now.

I appreciate the comment about February gallon comparisons being above guidance. However, did you provide information about your February fuel margin? I'm trying to understand how the recent volatility might lead to a more pronounced margin compared to February.

Yes, Chris, this is Bill. Regarding the February margins, they are currently within the annual guidance. However, as you mentioned, recent developments have led us to experience margins significantly above this range. While we can't predict how long this will last, the margin environment is very strong right now, allowing us to capture margins and possibly use some of that to drive volume elsewhere. As Darren noted, we are trending well above our same-store gallon expectations.

A couple of the questions were about guidance. The implied range for the fourth quarter was quite broad across all categories and line items. I understand that February benefits from an extra day, but could you provide a bit more detail? For Fuel, we're looking at a range of 1.8% to 7.8% on comparable sales and margins, and each category seems to have a very wide range.

Yes. No. And so, to your point, so we made the decision not to narrow the categories. So maybe that's a way I would reference for the investment community. If we believe the annual guidance, keep in mind this is in annual guidance, not quarterly. If we believe the annual guidance we still are going to be within that range we make the decision not to adjust the range; and so that was kind of the mantra that we took here in the fourth quarter. So the only range that we did adjust was depreciation because we were going to fall outside of that range on the low side. So we felt we had to make that adjustment.

Yes. Karen, this is Darren. With respect to the time-motion study we're still working through that process. We'll wrap that study up by the end of this quarter, aiming to implement it in the first quarter of next fiscal year. We still have yet to determine what the overall impact of that is going to be. But the way I would think about it is, this is focused more on putting the right amount of labor against the right stores, not necessarily taking labor out of stores. And what I fully anticipate happening is that some stores, we will see a reduction in labor hours. In other stores, we may see an increase in labor hours. In virtually all stores, we think we'll get much sharper at putting hours during the right parts of the day to make sure we're satisfying the guest needs. So this isn't necessarily a cost-cutting exercise as much as it is, a labor deployment effectiveness exercise.

Okay. Just one last question from me regarding same-store SG&A. If you mentioned the dollar amount for credit card fees, I apologize if I missed it. When I compare the growth in gross profit dollars to SG&A growth, excluding credit card fees, that gap seems to be widening. I'm looking at it on an absolute basis rather than a same-store basis. Can you provide any insight on when you think those two might align more closely?

Yes. In the first part, about $36 million was the credit card fee expense for the quarter. To address your question regarding the apparent disconnect between operating expense growth and gross profit growth, there are several factors to consider from both quarterly and year-to-date perspectives. This year, we experienced some of the highest cheese costs I’ve seen in a long time, but I do not expect these prices to continue rising as they are currently declining. Specifically, in the third quarter, we faced a difficult comparison due to a favorable fuel margin in the previous year, particularly in November, which impacted Q3. Additionally, in the first quarter, there was a $6.6 million inventory adjustment that affected our EBITDA and gross profit lines. All these factors contributed to the disconnect, but we anticipate that by the end of the year, our year-to-date figures will be more balanced.

Thank you. Our next question comes from the line of Paul Trussell with Deutsche Bank.

So, maybe just to circle back on what's happening kind of near-term, maybe just give a bit more detail about the Rewards Program being such an early success. Maybe give some examples of how you're finding your customers, engaging with the app and the behavior that is driving? And then also just on coronavirus, I mean, like you say, you mentioned you might be a little bit more insulated than others, but just is there anything that you would attribute to coronavirus in terms of any impact to your business so far that you can see? Thank you.

We're really pleased with the progress of the Rewards Program. We've seen significant enrollment growth, reaching nearly 1.8 million members, which exceeds our annual goal. Consequently, we're resetting our targets and noticing strong engagement. Almost 20% of our transactions now involve rewards participation, which is also ahead of our expectations. The enrolled members are actively engaging with the program, providing us with new opportunities to connect with our guests. Regarding the impact of coronavirus, it's challenging to predict. Before the recent drop in crude oil prices due to OPEC issues, gasoline prices were already declining, driven by some demand concerns in the market. We haven't experienced a drop in demand, but we've noted a reduction in costs that allows us to grow volumes while capturing some margin. That's the most significant impact we've observed so far, and we're closely monitoring the situation for any further developments.

Yes. Hey, Paul, this is Bill. I want to revisit the rewards comment that Darren mentioned. One thing I see as a potential long-term or mid-term benefit is that our activity is exceeding expectations. From a long-term perspective, we aim to capture customer data to enhance our engagement and service. The faster we gather this data, the better we'll be able to target our marketing efforts, potentially at a higher or quicker rate than anticipated. This could lead to an accelerated opportunity for targeted marketing in the upcoming fiscal year.

I want to ask about price optimization. You talked about the Beer category. I'd be curious to hear kind of where we are on the runway for the rest of the Grocery and Other Merchandise category and then the Prepared Food and Fountain category? How contributive should that initiative be to improve results as we move forward and kind of what are some of the elements we should be considering with respect to that?

Yes, Ben, this is Bill. From a timeline perspective, we began introducing categories to the platform in the second quarter. By the end of the calendar year, we expect to have most of the central store on the platform and are working towards adding packaged beverages in the third quarter. As we mentioned, Beer and Alcohol will also be added during the third quarter. To put it in baseball terms, we're probably in the mid-innings of this rollout. We chose to postpone the roll out of cigarettes given the current circumstances. Looking at the results so far, although it's very preliminary, we have less than two quarters of information at this stage, and even less in some categories. However, we are already seeing an acceleration in same-store sales in the Grocery and General Merchandise category while also improving our margins. Some of our efforts are reflected in these results, although there is some noise making it hard to draw clear conclusions. Specifically, we observed immediate traction in the Beer and Alcohol categories after they were rolled out in the third quarter, which led to a margin increase. We believe there are additional opportunities as we introduce the remaining categories. The rollout of Prepared Foods is not yet complete, and one significant area I believe will be the promotion forecasting aspect. This will allow us to take a more detailed look at the promotions we run across our network.

My first question was just to circle back Bill on your comments about the Grocery business. Is the favorable product mix that you're seeing, is that the results of the pricing optimization or is that just ebbs and flows in what the consumer is purchasing? Just trying to get an understanding of what exactly pricing is driving? Is it driving the 100 basis points of margin improvement? Or is that just the mix that we're seeing from consumers buying a different product offering right now?

Yes. Bobby, this is Darren. I would say that the mix shift has been more around the product assortment in the store and less around the pricing activity. Now, obviously with some of the pricing activity we've been able to gain some margin benefit. But some of that product mix shift, one, just the mix of cigarettes declining a bit relative to the overall product assortment is accretive to the margin rate. Then the second thing we saw was pretty significant growth in the energy drink category, which obviously carries higher margins with it as well. And so that was a direct result of doing some resets within the stores, expanding some assortment of some of the higher velocity items in that door we're seeing a really good contribution from that. Well, it is for the moment, right. And then as consumer preferences ebb and flow we'll adjust the product assortment accordingly. And that's something that we're really building out the capability of is being more nimble with the product assortment. So as guest preferences change, we're able to adapt that assortment to meet those needs. And it just so happens in this case that those needs come in the form of higher margin items. And so as we shift that mix around to those higher margin items that blends up the margin rate.

Yes. Hey, Bobby, this is Bill. One of the other considerations that is currently uncertain is how H '21 will impact the cigarette category. If cigarette demand starts to decline, it could contribute to the product mix shift that Darren mentioned. Combined with other activities, this may lead to continued margin expansion, just something to keep in mind.

Yes. This is Darren. I'd say that promotional activity that was more of a one-time event when we launched our new coffee platform. So we were aggressive and we did any size coffee for $1 knowing that that would be an investment in the margin to drive velocity and trial. So that's not something that we're going to do on a routine basis. But it is something we may do from time to time if we're launching a new product and we're pulsing in new items. So I wouldn't bake that into any expectation on a routine basis.

Thank you. Our next question comes from the line of Kelly Bania with BMO Capital Markets.

And a couple of questions, I guess, just can you clarify, just want to make sure I'm understanding the message on some of the comments on February. Are you seeing an underlying acceleration in some of the same-store sales and gallons or is that just the extra day impact? Maybe you could just go back to that and help us understand that. And then, can you tie-in what you're seeing in just customer traffic trends inside the store?

Yes. So, absolutely, we are seeing an underlying acceleration in the comps across all categories. And this has been going on probably for the last several months. We just want to try to make sure we're very clear that even with that acceleration on the underlying comps, we do have a roughly about a 4% impact from the extra day in the month of February. And so when you roll those two together, we are in the high single-digits across all those three categories. So, yes, definitely seen acceleration and I think that holds true with traffic as well. So, we have seen some traffic acceleration as well. And so, we're seeing basket ring elevation and starting to see some movement in traffic and we believe there are a number of things around that. Obviously, there is the Rewards Program that's helping the matter. But also we did have some favorable weather comparisons toward the end of the quarter as well. You might remember, we did compare against the polar vortex a year ago. And so just to be fair, there is a little bit of that. Yes. So it's a little bit early for us to give you any information. We just started just a few months ago in that regard. And so we'll be playing this out through the end of the fiscal year with more and more to come on that. So, not really any information at this point, we feel this is the direction for the company here as we look at trying to control a number of things ranging from out of stocks, but probably more significantly is the ability to bring more fresh product into the store on a timely basis.

Yes. Kelly, this is Darren. What we have seen in the overall category, obviously, cigarettes have been a little softer, but not as much as you might have thought given the age restriction. On the vaping side that has softened a little bit, but it's still growing. So just growing at a slower rate than it was previously. So from a margin standpoint, it's blending out about the same but has definitely softened. And then there has been a bit of a shift to the smokeless items as well.

Thank you. Our next question comes from the line of Chuck Cerankosky with Northcoast Research.

In looking at the most recent quarter in the negative 2% gallons and where the margin was, what lessons do you take away from that as you continue to move forward here and adjust price on an ongoing basis?

Chuck, this is Darren. There are definitely lessons to learn, but we are still working on finding the right balance between volume and margin. As you may recall, we began our price optimization process for fuel at the start of this year, so we are still in the early stages. However, I believe our team is developing a good understanding of the markets, becoming more familiar with them than before, and learning how our competitors react to our pricing strategies. Each day, we are becoming more adept at handling different situations. This improvement is starting to show in our recent performance, particularly with three quarters of data to analyze, and we're beginning to see growth in gallons. We are finding a better way to balance volume and margin across various regions, as each behaves differently. With time, as we build our knowledge, we are improving our approach. Yes. I think it'd be pretty small, Chuck. I don't know that that mix has really impacted our overall margin very materially. Okay. Well thank you very much for joining us this morning. And I'll close the call by reiterating our strategic plan is designed to maintain our strong growth in EBITDA, at the same time to drive return on invested capital. We think this is a well-balanced plan that we believe will continue our long-term track record of driving shareholder value. We're looking forward to updating you with our results as we progress through the next three years. Thank you.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.