MLPs: Sign of the Times

CornerStoreMore convenience store chains like CST Brands are banking on master limited partnerships to improve their position in a widely-fragmented industry.

By David Bennett, Senior Editor

Acquisitions have always played a strategic role in the convenience store industry. Take for example CST Brands Inc., which last month entered into an agreement to acquire the convenience store assets, franchisor rights and associated trademarks of Nice N Easy Grocery Shoppes Inc., allowing the San Antonio-based retailer a substantial foothold in the northeastern U.S. market.

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Arguably, a bigger company coup came earlier this summer when CST agreed two months ago with Lehigh Gas Corp. to acquire the general partner of Lehigh Gas Partners LP (LGP), thus gaining operational control of the partnership. Aside from gaining access to capital through LGP’s growth-oriented master limited partnership (MLP) vehicle, the $85 million deal provides CST Brands with a platform for a long-term, drop-down strategy for its U.S. wholesale fuel supply business in the same geographic region that Nice N Easy operates.

Formed in 2012, LGP of Allentown, Pa. distributes a wide variety of fuel brands to more than 1,050 locations, and owns or leases more than 625 sites in 16 states. A quarter of those states—Massachusetts, New Jersey, New York and Pennsylvania—are among the top 10 consumers of gasoline in the U.S., and three of the top 10 for diesel.

LGP distributed 235.5 million gallons of fuel for the quarter ended June 30, 2014.

Kim Bowers, chair and CEO of CST Brands, explained that while the Nice N Easy deal is an important component to the company’s expansion footprint, extending throughout the greater Syracuse area into the North Country, Mohawk Valley and Finger Lakes, the versatility of LGP’s operating network—especially its sustainable fuel distribution platform—puts CST in an ideal position to examine new acquisition targets.

“We are very excited to have such a strong fuel distribution footprint in the Northeast,” Bowers told CSD. “It really opens up new markets for expansion of our Corner Store operations. In addition, we believe we will be able to leverage our Canadian operations/Montreal service center expertise, since it is just a few hours away.”

CST has more than 840 Dépanneur du Coin retail sites across six provinces, led by the CST Service Center in Montreal.
Bowers explained that the Nice N Easy deal was struck independently of LPG, “that said, given Lehigh’s attractive capital structure, the Lehigh Gas transaction has the opportunity to add even greater value to an already accretive acquisition.”

Strategic Darlings
C-store companies attempt to build flexibility into their logistical operations, enabling them to respond more nimbly to changing market conditions, often outperforming competitors with less supple footprints. More and more expansion, accomplished through mergers and acquisitions, is a successful strategy in the highly fragmented world of convenience retail.

Because MLPs are classified as partnerships, they avoid corporate income tax at both state and federal levels. Unlike a corporation, which pays taxes on its own income, the income earned by an MLP is passed through to its owners—the public investors. These public investors, in turn, pay the income tax at their individual rates.

MLPs aren’t a new concept. MLP tax benefits can be traced to the Tax Reform Act of 1986, which was designed to encourage investment in energy-related infrastructure projects, such as oil pipelines. Most MLPs today generate income from the production, processing, transportation and storage of oil, natural gas, coal and refined products.

They have become strategic darlings in the convenience industry because they offer streamlined corporate structure at a lower cost of capital—for starters.

New MLPs that have made headlines in the last 12 months include:
• Energy Transfer Partners (ETP) which turned heads this spring with its $1.8 billion purchase of Susser Holdings, less than two years after it bought the Sunoco supply and station network. ETP is believed to be negotiating to acquire some other retail networks in the Northeast. Susser Holdings is majority owner and owns the general partner of Susser Petroleum Partners LP (SUSP), an MLP created in 2012 that is the largest independent wholesale fuel distributor in Texas.
SUSP distributes more than 1.6 billion gallons of motor fuel annually from major oil companies and independent refiners to Stripes convenience stores, independently-operated consignment locations, convenience stores and retail fuel outlets operated by independent operators and other commercial customers in Texas, New Mexico, Oklahoma and Louisiana.
• Coming on the heels of a number of initial public offerings (IPOs) in 2012 involving MLPs, several other industry players either commenced the IPO filing process or began an analysis of the merits of using the MLP structure during 2013. Western Refining Logistics LP, a subsidiary of Western Refining Inc., completed its IPO last October.
Western owns and operates more than 450 c-stores and gas stations located in Arizona, Colorado, Minnesota, New Mexico, Texas and Wisconsin. This past February, Western executives indicated they were looking at the feasibility of combining and spinning off their c-store network.
• Phillips 66 Partners LP, a subsidiary of Phillips 66, launched an IPO as well. The new entity (PSPX) owns, operates, develops and acquires primarily fee-based crude oil, refined petroleum product and natural gas liquid pipelines and terminals, and other transportation and midstream assets.
• The recent acquisition of Hess Retail Holdings LLC by Marathon Petroleum Corp.’s (MPC) subsidiary Speedway LLC, will have 2013 pro forma revenues of more than $27 billion, 6.2 billion gallons of annual fuel sales, and $4.8 billion in annual sales of merchandise.

While this was an outright acquisition by Speedway, the extensive real estate holdings of more than 2,700 stores in 23 states, as well as transport operations and shipper history on various pipelines are a source of long-term value to MPC. Moreover, Speedway’s growing footprint will likely capitalize from the operational flexibility offered by MPC’s subsidiary MPLX LP, a growing MLP. The addition of Hess’ stores to the Speedway network of sites positions Speedway strategically in the eastern U.S.

Means to an End
Ken Shriber, managing director of the Petroleum Equity Group, a Chappaqua, N.Y.-based advisory firm that provides consulting and financial expertise to the wholesale and retail fuels industry, said like ETP and MPC, CST can better focus on the wide c-store landscape, and has the MLP in its pocket to grow its business.

“One way to improve your spot performance and earnings per share is to make acquisitions. (CST) gets a much bigger footprint, more volume, higher store count, and a partner that is aggressive on the acquisition side, where CST has not been (before procuring Nice N Easy),” Shriber said.

While the c-store industry has been inundated with high-profile mergers and acquisitions where MLPs are concerned, Shriber estimates there are more MLPs and retailers that would be good marriages.

One retail entity rumored to be an attractive target is Providence, R.I.-based Warren Equities Inc., parent of Xtra Mart, c-store brand of Drake Petroleum Co., with locations in Connecticut, Maine, Maryland, Massachusetts, New Hampshire, New York, Pennsylvania and Rhode Island.

Shriber predicted there are other MLP deals to be had in the c-store industry—whether it’s a lucrative MLP looking for a healthy retail chain, or a c-store chain exploring partnerships with MLPs with capital assets or strong distribution resources as CST found with LGP. Though Shriber declined to speculate on what possible MLP partnerships might surface next, he sees more MLPs developing in the space over time, though there are fewer large-scale retail players available to participate in the process.

“There aren’t many left,” Shriber said.

Thinking Bigger
The c-store industry is largely populated with small, independent mom-and-pop operators. Almost 65% of U.S. convenience stores are owned by individuals that operate 10 or fewer stores. That provides very little in the way of purchasing power and marginal profitability.

Wells Fargo Securities analyst Bonnie Herzog said MLPs have become a more widely recognized tool for some c-store retailers to gain a competitive advantage, and better earnings over the long-term.

“It’s a very fragmented industry and it will continue to consolidate,” Herzog said. “This is one way retailers can take advantage of an MLP structure of unlocking some value for shareholders.”

Winning Combination
Looking at CST’s earnings last year, revenue in 2013 totaled $12.8 billion, down 2.3% from 2012. The company earned $139 million last year, down from $208 million in 2012. While the Nice N Easy acquisition is a solid cog in CST’s operation, LGP allows the operational flexibility to grow more robust, in part, because of its MLP means.

Yes, the LPG deal provides CST access to new geographic wholesale markets and expands its customer base. Also, industry figures show CST owns the real estate for around 79% of its convenience stores and gas stations, compared to an average of 52% for its peer group.

That provides the company with the potential to participate in leaseback transactions in the future and reduce the company’s fixed costs in the present.

LGP this past April acquired PMI, which operates two primary lines of business: convenience stores and petroleum products distribution.

In its convenience store business, PMI operates 87 convenience stores and nine co-located branded quick-service restaurants (QSRs), located primarily along the Interstate 81 corridor in Virginia, with a heavy concentration in the Roanoke, Va. area.
LGP also brings to CST’s table 52 wholesale supply contracts, one sub-wholesaler contract, five fee sites, six leasehold sites and certain other assets from affiliates of Atlas Oil Co. The acquired assets are all located in the metro Chicago area and are all BP-branded locations.

LPG provides CST with a platform for a long-term drop down strategy for its U.S. wholesale fuel supply business, as well as synergies for retail acquisitions, such as the Nice N Easy venture.

“We’re just beginning to evaluate our opportunities to leverage LGP’s fuel distribution assets with the Nice N Easy acquisition,” Bowers said. “ At this stage, however, it is too early to say how we will do so.”

CST Brands Readies for the Future
Since Valero Energy Corp. spun off its retail operations in 2013, Kim Bowers, chair and CEO of CST Brands Inc., has been busy. CST transitioned last year from a wholly-owned subsidiary of Valero to a stand-alone, publicly-traded company. With the whirlwind involving Nice N Easy Grocery Shoppes Inc. and Lehigh Gas Partners LP still swirling, Bowers granted Convenience Store Decisions some time to explain what the partnership with LGP will mean to CST, going forward.

CSD: Can you characterize the importance of the master limited partnership component of this deal? Specifically, how will CST benefit from the MLP arrangement, besides accessibility to capital?
KB: It provides CST with a growth vehicle to fund future expansion both in terms of organic growth (building new stores) and growth through acquisitions. By teaming up with LGP, CST is able to avoid the market risk, expense and management time associated with a potential MLP IPO.

CSD: Specifically, how does the partnership with Lehigh Gas Partners allow CST to expand its new store-build program?
KB: Over time, as CST constructs new stores, once operational, those new stores will be “dropped down” (sold) to the partnership for fair market value, and the sales proceeds that CST receives from the drop down can be used to reinvest in additional new stores, etc.

CSD: How will the MLP component benefit CST in terms of the company’s real estate holdings?
KB: With the new store drop downs, the MLP will acquire the real estate and improvements and then CST will lease them back and operate the new stores. While CST will continue to hold a significant amount of real estate with our legacy stores on its books, the MLP’s real estate holdings will grow over time with the new store builds, as well as through acquisitions.

CSD: Lehigh Gas Partners is touted to have an experienced management team with long-term relationships with major integrated oil companies. How important is this track record of success in regards to CST’s long-term fuel distribution goals? Why?
KB: Fuel brand diversity is important, and, with LGP, we have access to a combined total of 11 different fuel brands. Valero is still a key and valued partner with us, particularly with our legacy stores in the southwest U.S., but as we expand our footprint, we have more options in terms of branded fuel offerings.

CSD: Regarding Lehigh Gas Partners, there are arguably limited assets to drop down to grow the MLP. In what ways does the merger with your company benefit LPG?
KB: By teaming up with CST, LGP is gaining a “sponsor” with a substantial amount of assets that can be dropped down over time to the partnership—both with CST’s new stores as well as its large wholesale fuel business that delivers fuel to CST stores every day.

CSD: How does this partnership allow CST Brands to better compete against entities such as ETP/Susser?
KB: With LGP, CST Brands will be better positioned to pursue third-party acquisitions as well as accelerate our new store build program, and, in doing so, continue to strengthen our operations.