Parkland Corporation: Cheaper Than Peers For A Reason (TSX:PKI:CA)

Investment Thesis

In my previous analyses of companies operating gas stations, I found the business model attractive, primarily due to the non-fuel revenue generated by convenience stores. However, Parkland (TSX:PKI:CA) (OTCPK:PKIUF) stands out as having a weaker aspect in this regard, with over 95% of its revenue tied to fuel sales. Additionally, it carries more debt, exhibits lower margins, and has a lower Return on Capital Employed compared to its peers.

Considering these factors, I believe that Parkland’s underperformance in recent years is justified and may persist in the future. Given these considerations, I find it more logical to consider exposure to competitors (which I will mention during the article), leading to my decision to assign a ‘sell‘ rating to Parkland.

Business Overview

Parkland Corporation is a Canadian company engaged in the retail and wholesale marketing of fuels and petroleum products. It stands as one of North America’s largest independent marketers in this industry. Parkland operates across various facets of the energy sector, encompassing fuel distribution, convenience store retailing, commercial fueling, and more.

The company’s operations include fueling stations under diverse brands like Fas Gas, Chevron, Ultramar, and others, depending on the region. Additionally, Parkland provides a range of services related to the energy industry, from delivering fuel to commercial customers to managing cardlock networks and offering heating and lubricant products.

While it’s common for companies of this nature to derive a portion of their income from convenience stores located at gas stations, Parkland’s reliance on this segment is notably low. In 2021, it accounted for 6% of its income, reducing further to 4% in 2022. For comparison, its counterparts, such as Alimentation Couche-Tard, derive 25% of their sales from this segment, and Murphy USA stands at 20%.

This aspect holds significance as revenues from non-fuel sources are typically less affected by crises, exhibiting lower cyclicality. Moreover, the gross margins associated with non-fuel revenues are considerably higher than those from fuel sales. In 2022, the gross margin for non-fuel revenues stood at 43%, in stark contrast to the 8% observed for fuel-related revenues.

Hence, I believe that the greater the contribution of these non-fuel revenues to a company of this nature, the higher the quality attributed to it. Consequently, this should be reflected in the valuation assigned by the market.

Transition to Electric Vehicles

As widely recognized, society is currently undergoing a shift towards electric vehicles (EVs) and greener energy sources, such as renewable energy.

While this transformation poses a significant challenge for gas station companies, it’s crucial to note that the transition to EVs is expected to unfold gradually. Most likely, there will be an extended period during which both electric and internal combustion vehicles coexist on the roads. Estimates suggest that by 2030, internal combustion vehicles will still constitute 50% of annual sales. Therefore, the point at which EVs make up 100% of annual vehicle sales remains in the distant future. This underscores that the need for gas stations to cater to millions of internal combustion cars will persist in the coming decade or even longer.

Another noteworthy aspect is that Parkland is actively developing charging stations in Canada. However, it’s essential to highlight that progress seems relatively slow, as they anticipate having only 50 locations by 2024. This stands in stark contrast to Alimentation Couche-Tard, which boasts 320 locations in Scandinavia alone.

While the company has the potential to gradually convert its existing gas stations into charging stations, it is equally crucial for it to swiftly gain scale and build a reputation among electric vehicle owners. Given its comparatively low income from convenience stores, becoming a leader in charging stations could serve as a valuable means to mitigate terminal value risk.

Key Ratios

The company’s revenue has grown by 19.5% annually in the last decade, but a significant portion of this growth has been inorganic, i.e., through acquisitions. For reference, here are some of the latest acquisitions.

• Pétroles Crevier: An independent fuel wholesaler.
• M&M Meat Shops: A Canadian frozen food retail chain.
• Vopak Terminal of Canada: A company with two distribution terminals for the storage and handling of refined products in Montreal and Quebec.
• Certain assets of Cenovus Energy: Comprised of 163 retail sites, including Husky-branded locations.
• Gulfstream Petroleum: This company sells retail, aviation, commercial, lubes and liquefied petroleum gas.

This demonstrates how active the company typically is in M&A. The opportunity to make small acquisitions that complement the business arises due to the market’s fragmentation and the limited competition entering the sector. This is because it is not a sector that expects much growth and has a poor image, as mentioned earlier, related to the transition to electric vehicles.

The company’s growth has been financed with 60% through debt issuance and the remaining 40% through the cash generated by the business. Consequently, the company currently carries a significant level of debt, with a Net Debt/EBITDA ratio of 3.7x. Over the last three years, this ratio had been at 4.5x.

A positive aspect is that a substantial portion of the debt has maturities extending beyond 2026, alleviating the need for imminent refinancing. There is a portion maturing in 2024, but beyond that, the majority is long-term. Nevertheless, it appears crucial for the company to continue reducing its leverage level, given that competitors maintain an average ratio of 1.65x. This highlights an area where Parkland appears to be somewhat behind its peers.

Notably, 32% of the capital has been utilized for financing acquisitions, while an additional 37% has been allocated to repaying the issued debt. In the last twelve months alone, the company has retired $860 million in debt. While the company also pays dividends, it is not the primary focus of its capital allocation strategy and has represented only 6% of the capital used in the last five years.

To assess management’s success in capital allocation and value generation, particularly through acquisitions, we can analyze the Return on Capital Employed ((ROCE)). This metric has averaged 9.5% over the last decade and currently stands at 9.75%, roughly in line with historical performance.

As mentioned, the company often makes acquisitions that contribute to the goodwill on the balance sheet, currently totaling $2.5 billion. This inclusion tends to distort the ROCE calculation. If we adjust this metric by excluding goodwill, the average figure would be 12.8%.

For a broader perspective, let’s compare these figures with those of peer companies mentioned earlier. Parkland, with a revenue more reliant on fuel sales, exhibits lower EBITDA margins and ROCE compared to peers. Despite recent EBITDA growth, it generates less value compared to, for instance, Murphy USA, which has experienced higher growth, boasts a higher margin, and a more than double ROCE.

Additionally, considering Parkland’s higher debt levels, the current valuation (EV/EBITDA 7.5x vs. an average of 9.8x) appears justified. Therefore, there seems to be no immediate opportunity for a multiple re-rating.

Valuation

The company originally aimed to achieve $2 billion in Adjusted EBITDA by FY2025, but with cost-cutting initiatives, they anticipate reaching this goal by FY2024. For my projections, I will estimate that EBITDA will nearly reach $2 billion by FY2025, excluding Adjusted EBITDA. Additionally, for the current fiscal year, I am factoring in a 5% decline in revenue based on the performance observed in the first three quarters.

We have also accelerated our $2 billion ambition by a full year from 2025 to 2024. For some time, we have been laying the foundation to deliver $2 billion of adjusted EBITDA in 2024. The outstanding work of our team gave us confidence to share this target with our shareholders.

CEO Robert Espey during Q3 2023 Conference Call

Assuming an EV/EBITDA multiple of 8x, which is somewhat lower than the peer average of 10x, and seems justified by the perceived lower quality of the business, we could expect a return of 10% per year, along with a dividend yield of 2.95%

The attached image provides a visual representation of the average EV/EBITDA ratios of its peers, emphasizing Parkland’s historical trend of trading at a discount.

Final Thoughts

In evaluating the Parkland case, it appears that its lower valuation is justified by its less favorable characteristics compared to peers in the sector. Despite a preference for the industry, Parkland exhibits suboptimal qualities for this type of company. Given the choice, a willingness to pay a premium for Alimentation Couche-Tard (OTCPK:ANCTF) or Casey’s (CASY), or considering Murphy USA (MUSA) with its share buyback program, seems more appealing. Consequently, I recommend a ‘sell‘ rating for Parkland based on these considerations

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.