Peter Lynch loved to visit malls to seek out investment ideas. When you see convenience stores popping up in your neighborhood, Core-Mark Holding Company, Inc. (NASDAQ:CORE), one of the largest distributors of fresh products to convenience stores in the U.S., might come up as an interesting investment candidate. Core-Mark Holding Company, Inc. (NASDAQ:CORE) is benefiting from the growth in single convenience stores and the increased focus on fresh food. Furthermore, it is undervalued relative to its peers with a forward P/E of 13.
Growth in single stores positive for Core-Mark
An owner of a single convenience store is more likely to do business with wholesale distributors like Core-Mark Holding Company, Inc. (NASDAQ:CORE), compared with large convenience store retail chains. Larger convenience store retail chains might handle their own distribution to achieve cost savings resulting from economies of scale. According to a presentation by The National Association of Convenience Stores (NACS), the number of single convenience stores grew twice as fast as the entire convenience retail industry. The total number of convenience stores in the U.S. grew by a 12 year CAGR of 1.9%, from 119,751 stores in 2000 to 149,220 stores in 2012, compared with a CAGR of 3.8% for single convenience stores. Single convenience stores also now make up 62% of all U.S. convenience stores, compared with 50% in 2010.
The owner and operator of a single convenience store will not have advanced inventory management systems, big advertising budgets, or sufficient working capital. This is where a wholesale distributor like Core-Mark Holding Company, Inc. (NASDAQ:CORE) leverages its scale to provide support to small convenience store operators with such services. Moreover, direct sourcing is not an option, given that most suppliers will not want to deal with such small orders.
Gaining market share from direct-store-delivery (DSD)
Convenience stores typically source their products from wholesale distributors like Core-Mark Holding Company, Inc. (NASDAQ:CORE), beverage companies like Miller-Coors and The Coca-Cola Company (NYSE:KO), and DSD vendors. The beverage companies are out of bounds for Core-Mark, but grabbing a bigger slice of the pie from DSD vendors is a real possibility. Core-Mark mentioned that it has taken close to one-fifth of the market share of DSD vendors from 2008 to 2012, according to management comments at the 4Q12 earnings conference call.
If you’ve ever witnessed convenience store staff excusing themselves halfway through an inquiry or purchase to sign for the receipt of goods, you will appreciate the issue with multiple DSD vendors serving smaller convenience store operators. Smaller convenience store operators have to assign more staff to handle multiple deliverymen and check for stock, if they chose not to consolidate purchases with a fewer number of wholesale distributors.
Fresh (food) opportunities
At a meeting a few weeks ago, a manager of an Asian supermarket chain shared with me that margins for fresh food are much higher than both national brands and private labels. He explained that the fragmented nature of fresh food suppliers and consumers’ emphasis on the quality of fresh food account for that. Core-Mark shared similar views of the U.S. market in its most recent 10-K, adding that it has invested in its refrigerated infrastructure in recent years to increased refrigerated capacity.
Unlike Core-Mark, which mainly supplies to convenience stores, SYSCO Corporation (NYSE:SYY) distributes over half of its food products to restaurants, with hospitals, schools, and hotels making up the rest of its customer base. Not content with having one-fifth of the market share of the fragmented food service industry, Sysco recently rolled out its new Solutions and Services business last week, which provides services such as cost management and customer relationship management to restaurant operators. This is a step in the right direction, as value-added services will position Sysco as a trusted advisor in the mind of restaurateurs, as opposed to just being a supplier.
United Natural Foods, Inc. (NASDAQ:UNFI) is differentiated from both Sysco and Core-Mark, in that it mainly distributes natural and specialty products. The competitive landscape is highly fragmented, with a large number of local and regional players. United Natural Foods has been a primary supplier to Whole Foods Market, Inc. (NASDAQ:WFM) for more than a decade, with its current contract running until 2020. It is also expanding its customer base by targeting supermarkets, food service producers, and gourmet stores.
Core-Mark is valued at a discount to its peers with a forward P/E of 13, compared with forward P/E ratios of 17 and 22 for Sysco and United Natural Foods, respectively. According to estimates from Yahoo Finance, analysts expect Core-Mark and United Natural Foods to grow at a CAGR of 14% for the next five years, compared with a five-year CAGR of 6% for Sysco. Unfortunately, for those investors considering United Natural Foods, growth expectations have already been factored into its stock price at a PEG of 1.68. In contrast, Core-Mark is fairly valued on an absolute basis at a PEG of 1.06. In addition, Core-Mark has the strongest balance sheet of the three, with a net gearing below 10%.
The biggest risk facing wholesale distributors is that many customers decide to do their own distribution as they grow bigger and want to achieve more cost savings. I am more comfortable with Core-Mark in that aspect, as its core customer base of owners of singe-location convenience stores are more likely to stay put. Also, as more single convenience stores come on stream, and Core-Mark increases its market share at the expense of DSD vendors going forward, the market will be likely to have more confidence in Core-Mark’s growth prospects. I expect Core-Mark to be re-rated and catch up with peers, like United Natural Foods, in terms of valuation.
The article Will You Be On The Mark With This Core Stock Pick? originally appeared on Fool.com and is written by Mark Lin.
Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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