MUSA - Murphy USA: A Solid Q3 With Ongoing Share Count Reduction

2023-11-01 21:01:34 ET

Summary

• Murphy USA shares have performed well, rising 15% in the past year and 350% in the past five years.
• Despite a decrease in earnings per share, the company exceeded expectations due to strong merchandise sales and a lower share count.
• The company's cash flow remains strong, allowing for share repurchases and steady new store growth, as it gains share from single-store operators.

Shares of Murphy USA ( MUSA ) have been a solid performer, rising about 15% over the past year, adding to its history of strong performance with shares up 350% and 750% over the past five and ten years, respectively. While gas stations and convenience stores may not seem like the most exciting businesses, they generate consistent and strong cash flow, which has rewarded shareholders handsomely. As such, I see continued upside for shares.

In the company’s third quarter , Murphy earned $7.69 a share, which was down from $9.68 last year. Still, this blew past estimates of $6.52 as merchandise sales were strong, defying concerns of a consumer spending slowdown. Revenue fell to $5.8 from $6.2 billion due primarily to lower gasoline prices. The absolute level of gasoline prices does not matter dramatically for Murphy’s business as it primarily passes on prices to customers. These impact the top line far more than the bottom line. A $400 million drop in revenue led to just a $50 million drop in net income, which speaks to how much commodity prices pass through.

Still, fuel margins did narrow somewhat. Fuel margins came in at 34.5 cents/gallons from 37.6 last year, which is still a solid level. Last year, crude oil prices were falling during the quarter, and because oil prices fell before gasoline prices started to, Murphy was able to retain a couple extra cents of margin, which I why last year was so strong. The world was still working through sanctions on Russian oil and refined products, which kept product markets tight and supported extremely wide margins.

We are now seeing margins return to a more normalized footing. With last year also benefiting from the tail-end of post-COVID “revenge travel,” we saw retail gallons sold fall 2.5% systemwide and 4.7% on a same-store basis. Due primarily to lower fuel margins, fuel segment profits of $419 million were down 10.5% from $469 million last year. With fuel margins having normalized, we are on a more sustainable run-rate footing now.

While there was some normalization on the fuel side of the business, I would note that Murphy gets about 30-35% of profits over time from its convenience stores and their merchandise sales. The margins on this business are also about twice as high as at the pump. Merchandise contributed $212 million of operating income, up 3% from last year as margins expanded 10bp to 20.1% Same-store monthly sales were up 1.4% to $41.9k with total sales up 3% to $1.056 billion. Given fuel volumes were down, this was a solid merchandise performance, aided in part by price increases, as well as its “raze and rebuild” efforts to gradually upgrade the quality of its locations to get more shoppers to go into the store while filling up their tank. Importantly, this momentum is continuing with management saying that October has been strong with record food and beverage profits at QuickChek convenience stores.

Critically, the business remains highly cash-generative. It generated $110 million of free cash flow during the quarter; $145 million net of working capital. Free cash flow is $289 million year to date and $386 million net of working capital. With this free cash flow, it has done $173 million of stock repurchases this year, reducing its share count by 8%. I will discuss capital returns further below.

Murphy’s store count is up 1.5% to 1,724 from last year. This is the one major negative area from the earnings release, management cut guidance to 27-30 new stores from “up to 45” previously after only opening 8 in the quarter. Slow permitting has lengthened project times, pushing some store growth into 2024. As a consequence, MUSA was able to reduce cap-ex guidance by $50 million to $375-$425 million. One plus is that it expects to complete about 33 raze-and-rebuild improvements from 27-30 previously.

Over the past decade, it added over 500 new stores , and it aims for 40-50 annual store growth over the next decade. This year MUSA will come up short of that goal, but I view it as a “growth delayed” rather than “growth denied” issue as permits will eventually clear. Plus, the lower cap-ex needs will provide more cash for buybacks. Even if somewhat slower, I also think it is important to emphasize that MUSA is a growing business, even as some, at a high level, may see gas stations in terminal decline.

I understand some may worry about the long-term viability of this business given the goals to shift to more renewable fuels. I would suggest this is a very long-term concern. Gasoline demand is about 3% lower than in October 2019—less than a 1% annual decline. I would agree that the gas station industry, as a whole, is not likely to be a growth one, but aggregate declines are likely to be quite small. Moreover, automakers have slowed their EV expansion plans as customer adoption has been slower than anticipated, meaning these declines should not materially accelerate. Plus, EV drivers still need to take bathroom breaks or get a snack at a convenience store. MUSA may not generate as much revenue from EV drivers, but in the very long run, if there is a post-gasoline world, it is unlikely to be a post-convenience store world, in my view.

Further, even conceding the “pie” of gas station sales is not growing, MUSA can continue to grow its share of the pie as it has in the past decade. Over 60% of stores are owned by a single-store operator. These are cost-disadvantaged businesses that lack the scale of a Murphy to negotiate better prices with gasoline and convenience store suppliers as they do not have significant volume. The extent to which this industry remains fragmented provides MUSA plenty of opportunity for bolt-on acquisitions or organic growth as it pushes out high-cost sellers. Murphy is a proven market-share gainer, and I expect this trend to continue

MUSA has been able to grow its store count during the past decade, and it should be able to do so again in the coming years. Moreover, even if the theoretical addressable market is shrinking by 1-2%/year, MUSA’s strong cash flow is enabling it to reduce its share count far more quickly. MUSA has focused its capital returns on share repurchases, and it has bought back over half of the company in the past decade, which has played a significant role in its EPS growth and strong long-term share appreciation. Share repurchases continue to be the top priority, given the muted growth outlook for the industry.

If a business has 1% declining cash flow, but it buys back 5% of shares per year, each remaining share still has a ~4% higher per share cash flow. If a business is sufficiently cash-generative, valued appropriately, and declining only modestly, a “melting ice cube” can generate positive returns for investors. I would also note this is an overly bearish framework for viewing Murphy as it should be able to grow more quickly than the overall industry as it gains share at the expense of higher-cost operators.

On October 26, Murphy’s board approved a 5% sequential increase in the quarterly dividend to $0.41. Shares yield only about 0.5%. This payout is 17% higher than a year ago. This dividend is functionally more of a token payout; share repurchases are the primary value creator. I do expect ongoing dividend increases, but it will take years for this payout to be a meaningful contributor to returns

For the year, I expect MUSA to generate about $500 million in free cash flow. Given the relative inelastic demand for fuel and its low-cost profile, with this cash flow, I view its $1.78 billion of debt and capitalized leases as very sustainable. MUSA has a strong balance sheet with debt to EBITDA below 3x. At its current share price, the stock has a 6.5% free cash flow yield, enabling it to continue to reduce the share count in a meaningful way.

Over time, if it can deliver on 40-50 new stores, it will grow its footprint by 2.5-3% per year. Assuming ongoing 1% declines in fuel margins as volumes slowly decline and 3% growth in merchandise cash flow due to inflation and benefits from modernizing its store plant, same-store sale growth should be 1-1.5% over the medium term. That makes MUSA about a 4%/year growth business.

That may not seem dramatic, but with free cash flow that enables 5+%/year share count reduction, it is a recipe for 10% EPS growth over the medium term. MUSA may not be the most exciting business, but it is a steady grower with a value-accretive capital allocation formula that should generate solid ~10% compound returns for investors. If the slower store growth causes any weakness in shares, I would use that as an opportunity to be a buyer as I see them moving towards $400 over the next year as free cash flow is used to further reduce the share count and store growth re-accelerates.

For further details see: