Earnings Call Transcript - MUSA Q2 2023

Operator, Operator

Good morning, and welcome to the Murphy USA Second Quarter 2023 Earnings Conference Call. My name is Brianna, and I will be your conference operator today. I will now turn the call over to Christian Pikul, Vice President of Investor Relations. Please go ahead.

Christian Pikul, Vice President of Investor Relations

Yes. Thanks, Briana. Good morning, everyone. Thank you for joining us all today. With me are Andrew Clyde, President and Chief Executive Officer; Mindy West, Executive Vice President and Chief Financial Officer; and Donnie Smith, Vice President and Controller. After some opening comments from Andrew, Mindy will provide an overview of the financial results and then we will open up the call to Q&A. Please keep in mind that some of the comments made during this call, including the Q&A portion will be considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. As such, no assurances can be given that these events will occur or that the projections will be attained. A variety of factors exist that may cause actual results to differ. For further discussion of risk factors, please see the latest Murphy USA Forms 10-K, 10-Q, 8-K and other relevant SEC filings. Murphy USA takes no duty to publicly update or revise any forward-looking statements. During today's call, we may also provide certain performance measures that do not conform to generally accepted accounting principles, or GAAP. We have provided schedules to reconcile these non-GAAP measures with the reported results on a GAAP basis as part of our earnings press release, which can be found on the Investor section of our website. With that, I'll turn the call over to Andrew.

Andrew Clyde, President and CEO

Thank you, Christian. Good morning, and welcome to everyone joining us today. We are excited to discuss our exceptional second quarter performance, which reaffirms the strength of our strategy and business model and our enduring commitment to driving sustainable value for all our stakeholders. Murphy USA reported another impressive quarter of financial results in Q2 underpinned by continued strength across all major categories. Beginning with fuel, we achieved nearly flat APSM volumes in Q2, including positive volumes in May and June, as we held market share gains achieved last year and continued to outperform the OPUS volume survey in our geographies. We built on merchandise sales and margin momentum, led by total volume and market share gains in tobacco, and sales and contribution growth in non-tobacco categories. Tobacco share grew across all subcategories as we continued to promote and provide affordability to our customers, while our non-tobacco category saw broad-based strength led by energy sales up 21% in units, up over 13%. Food and beverage across the enterprise also accelerated in Q2 with sales and margins up 6% and 3%, respectively. Despite some of the traffic challenges that continued to impact the Northeast, our QuickChek stores posted record food and beverage sales in Q2 with record margin months in May and June. On the cost side, our already low-cost model saw per store operating expense growth of less than 4% in Q2 as we continued to leverage our scale, reduce overtime, and lap targeted wage increases from the prior year. Notably, as inflation eases, associate engagement remains high as together we focus on our mission to help customers affordably meet their non-discretionary needs. If I take a step back and consider the relatively benign external operating environment of the second quarter with nothing extraordinary taking place and then think about the high bar we are lapping from the prior year period, I view our results as even more exceptional. Turning specifically to fuel margins, the past three years can be characterized by exogenous events, including pandemic-driven demand destruction, geopolitical instability, severe volatility, steeply rising prices, and precipitous price fall-offs. Each and every quarter was distinct in its own way. The one constant has been significantly higher fuel margins as the industry supply curve steepened due to cost and traffic headwinds for marginal retailers. Some investors and even analysts have been reticent to believe that higher margins are sustainable, and they wanted to see the results in a more normal period. Well, following three years of macro uncertainty and one-time events, there was absolutely nothing remarkable about the environment in Q2. In fact, the only thing you may find remarkable about the quarter is that we are once again reporting all-in fuel margins on the high end of our range at $0.295 per gallon. In recent months, more investors and analysts have asked me, 'Are we really still debating higher fuel margins?' My answer, of course, is no, we are not. There is no internal debate at Murphy USA. The answer to us appears quite clear. Looking ahead, while we do not know the market dynamics that will define the rest of Q3, we do not expect a quarter as remarkable as the third quarter of 2022. During Q3 2022, we achieved significant share gains, growing total gallons over 13% and all-in margins of $0.38 per gallon, while peers reported flat or declining volumes. As we have stated previously, these exceptional prior-year gains and high margins are not repeatable in a normal quarter, but were instead the result of a prolonged period of rapidly falling prices that we only witness every six to eight years. I don't particularly like talking about two-year stack, but we know that Q3 will be a difficult comparison and want to set expectations accordingly. As a hypothetical, flat same-store gallons in Q3 this year would result in an industry-leading two-year stack of 9%, while declines as high as 4% would still likely lead peers with a two-year stack of 5%. Internally, we are focused on sustaining last year share gains while continuing to drive traffic to our stores through our loyalty program, in-store promotions, and overall pricing strategy. And while fully maintaining Q3 share gains would be an ambitious goal, where we would need some help from the macro environment, I do believe that any two-year stack for fuel volumes greater than 5% would demonstrate strong execution against our long-term strategy. Turning to merchandise. As I mentioned at the beginning of this call, we are really pleased with the second quarter performance and seeing that momentum continue into the second half of the year. I believe the strong results speak for themselves. So I want to spend a little bit more time today talking about the exciting aspects of the QuickChek integration and how synergies and other benefits are manifesting across the enterprise. We are in the early stages of recognizing significant benefits from product and menu innovation as well as enhanced promotional and marketing activities to help improve store performance, particularly in the food and beverage category. The combined learnings of both companies are coalescing into sustainable and material performance drivers of the business, and so I want to share some examples on this call. Starting with branded products and promotions. We are creating new opportunities to engage with our customers outside of fuel and tobacco. We think this is a significant building block upon which we can implement further improvements in store traffic and profitability. As an example, we saw strong sales from a limited-time made-to-order watermelon smoothie of QuickChek, which was subsequently reimagined and introduced as a limited-time offer Sour Patch Kids branded frozen slushy product at Murphy USA stores. Similarly, edible cookie dough and brownie bites cups first introduced in the QuickChek open coolers were quickly followed up at Murphy stores. Having successfully increased the level of promotional awareness of QC's 2 for $5 breakfast sandwiches, where we grew both sales and margins by 11% in the quarter, we have introduced similar 2 for promotions for Murphy grab-and-go items across multiple categories in day parts. We expect to accelerate the use of promotions and limited-time offers across the enterprise in the second half of 2023, giving customers even more reason to come inside our stores. Turning to innovation. The QuickChek format is the perfect test and learn environment to identify high-potential products that have strong overlap with Murphy USA customers, and the QuickChek team has been leading these innovation efforts. For instance, we've developed products with well-known national brands, including a new and exclusive sugar-free frozen energy drink with Prime and partnered with Red Bull on both iced and exclusive to QC frozen flavored infusions, creating a new traffic-driving and basket-building category in-store at QC. In addition to the introduction of nitro coffee at QC, these innovations are expected to lead to new dispense beverage options at Murphy branded stores. We also continued to innovate in our growing core categories, where the made-to-order menu at QC is being realigned with consumer insights and fresh product preferences. This will lead to some exciting new signature sandwiches to be introduced in the second half of 2023. Maintaining a differentiated offer is vital not only to customer engagement but to encourage customer retention. We need to give customers more reason to come into our stores and even more reasons to want to come back. As we incubate and unleash this innovative mindset across the enterprise, we are increasingly excited about the future opportunities to impact store performance. Turning to marketing and other customer-facing improvements. With the right products and the right amount of innovation, clearly communicating and presenting our improved and distinctive offer to customers is becoming increasingly important for both QuickChek and Murphy USA. From a visual marketing perspective, through the insights learned from our in-store experience campaign, we recently kicked off a series of retrofits on existing 2,800 square foot stores, featuring a new layout based on learnings from QuickChek. Selling spaces optimized, allowing for easier traffic flow. Queuing lanes have been added that promote impulse sales and reduce congestion around the register. While at the same time, we improved lighting and signage. This layout is specifically designed around driving food and beverage sales at Murphy stores, enabling access to a more desirable assortment of high-quality grab-and-go, grab-and-reheat-and-go, and self-serve dispense beverages that are more accessible, visually appealing, and relevant to our customers. With the right assets and the right places, selling the right products, managed by the right people, we are in a unique position as a company to fully realize benefits and more intentionally drive food and beverage sales through targeted marketing strategies that go beyond our most effective marketing tool of everyday low prices. We are in the early stages of further leveraging our digital assets to unlock significant value inside the store through machine learning tests, and we are more and more excited about the potential of the combined business. I'm now going to hand the call over to Mindy to briefly review the financial results, and then we will wrap up and open up the call to Q&A.

Mindy West, Executive Vice President and CFO

Thanks, Andrew, and good morning, everyone. Revenue for the second quarter of 2023 was $5.6 billion versus $6.8 billion in the year-ago period. Adjusted EBITDA was $257 million versus $317 million in the second quarter of 2022. And net income for the second quarter was $132.8 million or $6.02 per share versus $183.3 million or $7.53 per share in the prior period. Average retail gasoline prices were $3.21 per gallon versus $4.21 per gallon in the year-ago period. Total debt on the balance sheet as of June 30th was approximately $1.8 billion, of which approximately $15 million is captured in current liabilities, representing 1% per annum amortization of our term loan and the remainder a reduction in long-term lease obligations as they are paid through operating expenses. Our $350 million revolving credit facility had an $0 outstanding balance at quarter-end and is currently undrawn. And these figures result in gross adjusted leverage, which we report to our lenders, of approximately 1.7x. And finally, cash and cash equivalents totaled $93 million as of June 30, up about $30 million since year-end, net of $142 million of capital spend and $108 million of share repurchase, clearly demonstrating the accretive benefits of our positive free cash flow business. And with that, I will hand it back over to Andrew.

Andrew Clyde, President and CEO

Thanks, Mindy. In keeping with recent tradition, I'd like to close with some insights around preliminary July performance. As in any single month comparison, remember, performance is partially dictated by the price environment we encounter. In 2022, we witnessed steeply falling prices, which are very conducive to elevated margins, supporting our ability to create price separation versus competitors and take share. This July, prices were actually up around $0.50 per gallon, which historically suggests a more challenging volume and margin setup. However, despite that move in prices, I'm pleased to say that retail-only margins averaged around $0.25 per gallon in July, moving north of $0.30 towards the end of the month and into the first few days of August. And that is before the additional benefits we would expect to report from PS&W in a rising price environment. Per store volumes are approximately 96% of prior year and 104% of 2021, demonstrating sustained market share gains over the two-year period. While it is somewhat shocking to see our internal daily reports highlighting that margins on many days during July were only 50% of the same day a year ago, we're very comfortable with the persistent structural equilibrium in the industry and the margins we are realizing. As managers and owners of the business who are truly invested for the long term, while the exceptional 2022 results present a challenging comp, we are encouraged by the higher earnings power and cash flow generation of the business in a highly stable environment and the significant upside potential for outsized earnings and cash flow when volatility returns. With that, operator, we can open up the lines for questions.

Operator, Operator

Our first question comes from Anthony Bonadio with Wells Fargo.

Anthony Bonadio, Analyst

So I know we're still a couple quarters away from 2024 guidance, but as I look at the 2027 targets you've given, that seems to imply something like 7% to 8% compound EBITDA growth from that $900 million midpoint you talked about this year. Is that sort of the right way to think about the base case growth algo into next year? And then anything you can add as we think about possible benefit from strategic investments? And other puts and takes would be helpful as well.

Andrew Clyde, President and CEO

Yes. That's great. Anthony, we really break down that bridge in three steps. We have new stores and raise and rebuilds and a cadence for those and with a run rate expectation of 50 plus stores, 25 to 30 plus raise and rebuilds, there's incremental EBITDA growth at higher per store comps, whether it's fuel volume, merch sales, etc. And that's the single largest component of that growth. We do expect this industry supply curve breakeven equilibrium to continue to see fuel margins go up year-over-year. And we've built in, in that algorithm small increases that we would expect to capture going forward. And then the third component are the specific campaigns that we've launched for the business, whether it's around our in-store experience, whether it's around the digital transformation, the food and beverage innovation that we've talked about, the machine learning tests we're doing around promotion, the reimagined 2,800 square foot store and the retrofits we're doing, all of those things come together to complete the walk towards that $1.2 billion goal.

Anthony Bonadio, Analyst

Got it. That's very helpful. And then just quickly on volumes. APSM gallons were down, but clearly a lot less than some of us were modeling, and clearly improved from April. So I guess how should we think about the path of gallons from here now that we've lapped last year's price peak? And then can you talk about what you're seeing in terms of share retention? You seem to be hanging on to a lot of last year's shared gains. So any way you can frame that in more detail would certainly be helpful.

Andrew Clyde, President and CEO

Certainly. As we observed, the latter part of Q2 last year provided an exceptional opportunity for us to gain market share. We experienced margins exceeding $0.50 per gallon. With prices decreasing, we find ourselves in a unique position to thrive in a high-price environment. It's important to note that our customers consider fuel, tobacco, and many of the products they purchase from us as essential items. The value brand QuickChek, along with its excellent food and beverage offerings, also falls into this category. When prices rise at other retailers, whether they're generally high or low, we are still operating in a relatively high-price environment with crude prices at $80 a barrel and gasoline not dropping below $2 a gallon. Consumers are still feeling financial pressure, but we continue to attract new customers in both our fuel and tobacco sectors. Excluding rare events like those we saw in Q3 of 2022, as well as in 2014 and 2008, when crude oil prices plummeted, our everyday low price strategy will prevail as long as prices remain high and consumers face pressure. This success extends beyond fuel sales to other product categories, which also support one another.

Operator, Operator

Our next question comes from Ben Bienvenu, with Stephens.

Benjamin Bienvenu, Analyst

I want to drill in a bit, if we could, on the station and other operating expenses. Andrew, you noted in the quarter growth, excluding credit card fees, up 4%. That's certainly a trend of moderation. It sounds like we should expect continued moderation going forward. But maybe help us think about where the continued opportunities are there and what kind of the slope of that trend line might look like?

Andrew Clyde, President and CEO

Yes, certainly. We've talked over the last two, three years about some of the challenges that we faced, also some of the one-time things we did to support our associates, who make all the differences in the world. And that was the main reason for updating guidance over the last three years in Q2 was to call out exceptional things that we were seeing or intentionally doing around operating expenses. We didn't call out anything or update anything this year in Q2 on OpEx because we expect to stay within that guidance for the full year. We're lapping some of the wage increases. Staffing is improving. There are still challenges out there, to say the least. But we feel comfortable that some of those pressures are indeed moderating. As you could expect, Q3 absolute OpEx is higher because of the driver seasons, greater transactions, etc. But on a relative basis, we would expect to see these trends continue.

Benjamin Bienvenu, Analyst

My second question is on merchandise and in particular on merchandise margins. I know total merchandise margins were down year-over-year, but that really seems to be a function of mix with tobacco continuing to grow at a faster rate than certainly we were expecting. Maybe if you could talk about some of the opportunities and the growth path for margin expansion within each specific merchandise bucket versus the total? Because I know the top-line growth has a bearing on the total margin.

Andrew Clyde, President and CEO

Sure. So as you rightly point out, strong tobacco performance and significant share gains versus industry declines drive that total unit margin down. Within tobacco, we continue to see improvement across all the categories as we think about the more innovative, lower-risk products. Those tend to come at much higher margins as well. So there's improvement in those categories. And certainly, with our leading market share position, we are best able to help with the transition towards those products at higher margins. On the non-tobacco side, if you start thinking about packaged beverage, energy drink performance is really, really strong, as we noted, up 13% in units, up 21% in sales for the quarter. And so again, at attractive margins relative to some of the historical packaged beverage items. With the reset of our stores as we think about the retrofits of the 2,800s, if we think about the queuing lanes and the impulse items, there's a lot of high-margin items in that space that we would expect to see improve. And importantly, food and beverage, not only at QuickChek and Murphy, posted really strong results. And I think the offer that we are moving towards on the Murphy side, where we've got a better position, a better setup for condiments, etc. for grab-and-go, grab-and-reheat-and-go, our dispensed beverage, our bean-to-cup coffee, all the self-serve items there versus the made-to-order or made-to-stock items at QC, we're really seeing that performance turnaround, and that's a source of higher margins as well. So I think then across the board we're going to continue to see sales gains, market share gains. And the intentionality behind the efforts should start leading to merchandise margin gains. If the tobacco team gets in a competition with a non-tobacco team and we see the same mix issue, as long as total margin dollars are going up I'm not going to get in the middle of that one.

Operator, Operator

Your next question comes from Bobby Griffin with Raymond James.

Bobby Griffin, Analyst

Andrew, I guess I just wanted to kind of maybe circle back there on the merchandise side of things. It does seem like that it's starting to kind of accelerate, especially the cross learnings between the two concepts. Is there any further capabilities that you guys need to build out between the two concepts now with QuickChek? Or is it really kind of now plug-and-play where you can move very fast and at a faster speed when you see something working in one area and move it to the other side of things?

Andrew Clyde, President and CEO

That's a great question. We're still in the early stages of this process. I visited the Dallas-Fort Worth store that underwent a 2,800 retrofit, and we had construction happening just over a week ago, but the new setup was implemented last Sunday. The store is visually appealing, with improved display of grab-and-go beverages prominently positioned on the back wall. The queuing lane is impressive, and the merchandise is attractively arranged. We've also initiated pilots in two other regions. Additionally, we're conceptualizing a new design for a 2,800 store, which we refer to as our store of tomorrow, set to debut in 2024. We have identified necessary changes, how they should be presented, and the items to include. The insights we've gained so far, like introducing limited-time frozen slushies at Murphy and the whole concept of limited-time offers, are fundamental. We are leveraging our marketing capabilities, both digitally and otherwise. Our digital transformation, which enhances Murphy Drive Rewards and redesigns the QuickChek loyalty program, also allows us to utilize transaction data for better promotional targeting and customer insights. The machine learning tests we are conducting on various promotions are in the early phases, but we've established a solid data foundation, analytical tools, and learning capabilities within our organization. We can apply this to an increasing number of categories and products. Furthermore, the performance of new stores and renovations significantly influences merchandise category performance. To address Anthony's question, a major portion of our anticipated EBITDA growth from $27 billion to $28 billion, totaling $1.2 billion, will stem from innovation and growth. Because we are expanding and improving on a solid cost base and business model, we expect to retain a larger share of the industry margin during this timeframe. Marginal players in the industry struggle to make similar investments due to their lack of scale and capabilities. I believe that all these elements will integrate in a beneficial way over the next few years to achieve that EBITDA growth.

Bobby Griffin, Analyst

That's helpful. My second question was about new store productivity, but based on your response, it seems that the productivity of the larger stores in the first 12 and 24 months is improving well.

Andrew Clyde, President and CEO

It absolutely is. And so we look at the ramp after 3 months. The 12-month, 24, and 36-month periods all look very good. And when you look at the build classes that have completed that 24 to 36-month ramp, they're all performing well above the same format. So it's a tribute to the better real estate locations that we've identified for those stores. Some of our new QuickChek stores are already in the top 5 of the best QuickChek stores in the network. And so we see the similar type of opportunities there.

Operator, Operator

Your next question comes from Bonnie Herzog with Goldman Sachs.

Bonnie Herzog, Analyst

All right. I was hoping for a little bit more color on a comment you made regarding some of the promotions you're doing in tobacco. Just trying to think through that and just kind of looking at margins, which might have been a little bit pressured and wondering if that's played a role there. So maybe you could talk through sort of your strategy with balancing profitability within your tobacco merchandise with the share gains that you've been realizing?

Andrew Clyde, President and CEO

Certainly. First, let's compare our results to the industry. Our total volume increased by almost 2%, while the industry reported an 8% decline. This mirrors what we experienced last year in Q2. In relative terms, we're up 4% while the industry is down 20%. It's similar to the fuel situation; while we've seen a 2% drop over the past four years, the industry has decreased nearly 19% during the same timeframe. Our objective is to keep expanding our market share and volume in a profitable manner. With others paying less attention to categories like fuel and tobacco, we see an opportunity to gain share. The margin rate can be influenced by various factors, such as the mix of cigarette, smokeless, and other tobacco products, where we are experiencing record market share and ongoing growth. Promotions within the quarter, like launching a new nicotine pouch, might be structured to enhance margins, but this could lead to different comparisons in the following year. The mix of gains across cigarettes, smokeless products, and other tobacco can also affect the overall margin rate. Our aim is to keep investing in and growing our category, engaging in its transition profitably and capturing market share along the way. As a value-focused retailer, we will not compromise our everyday low-price strategy for marginal gains in margin rate, similar to our approach with fuel where pricing fluctuations could significantly impact volume.

Bonnie Herzog, Analyst

That definitely makes sense. For my second question, could you discuss your capital allocation priorities? I believe you've mentioned previously a 50-50 split between share repurchases and reinvesting in your business. In this quarter, you've certainly bought back some of your stock and possibly increased that effort. I wanted to get your perspective on how we should view the outlook for both buybacks and reinvestments. Additionally, I would like to hear your views on the current M&A environment and your potential interest in future M&A.

Andrew Clyde, President and CEO

Our algorithm hasn't changed. A lot of people will look at last year. And I would remind folks of our comment that if we generated excess free cash flow from highly elevated margins, we would direct that towards share repurchase as our primary vehicle for returning capital to shareholders. And I would say we're maintaining that broadly 50-50 allocation and you would expect to see that over any kind of 12 to 24-month period. So really nothing has changed there. And look, if crude oil prices go from $80 to $100 to $120 a barrel and then fall sharply and we get a once in every six to eight year event every two years, we'll have the same answer, we'll direct the excess free cash flow to share repurchase. In terms of M&A, certainly with the QuickChek acquisition, we see a lot more deal flow than we did before. I would say there's a lot of chains out there that are selling at peak margins, but they're not everyday low-priced retailers. They are formats that are old. We look at things like the age of tanks and the need to replace them after 25 years. We're a chain that's highly concentrated in a market. You wouldn't be able to move those stores to our everyday low-price model. And so we're highly conscious, Bonnie, of looking at things that would have a fit, right, from a consumer value proposition standpoint. Is the entire enterprise going to be focused on the mission of delivering value? Having a high-priced and a low-priced retailer under the same roof with different mindsets around who the customer is and how you deliver value would be challenging. And so there's just not very many retailers out there that are in a position to sell that kind of fit that criteria. In fact, those that share that mindset are some of the best-run private retailers and they're growing and they're great competitors, and certainly I respect those organizations. And I don't think they're selling anytime soon.

Operator, Operator

There are no further questions at this time. With that, I will turn the call back to Andrew Clyde for closing remarks.

Andrew Clyde, President and CEO

Great. Well, thanks, everyone, for their questions today. I think as we noted last year and we've noted throughout this year, we're heading into a period of a difficult comparison. I would just encourage folks to take the three to five-year view of where this business is positioned to go, the earnings and free cash flow generation that is going to create and recognize the initiatives that we continue to demonstrate proof points around that will take us there. So again, thanks for joining today and your continued interest in Murphy USA.

Operator, Operator

This will conclude the conference call. Thank you for joining us today. You may now disconnect.