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It’s been more than a year since I last wrote about Arko Corp. (NASDAQ:ARKO). Back in March 2023, I noted that despite a 20%+ decline in the stock, Arko was still trading at a premium to peers. Since my article, Arko’s shares have continued to underperform, declining by another 26%.
Figure 1 – ARKO has declined by another 26% since March 2023 (Seeking Alpha)
At just under $6 / share, Arko has now declined by more than 40% since I initiated on the company in late 2022. However, as I am fond of saying, even bad companies may be good for a trade if the price is right. Has Arko’s share price reached a buy level in my view?
Brief Company Overview
First, for those not familiar with the company, Arko Corp. is the sixth-largest operator of convenience stores in the U.S. with over 1,500 company operated locations plus wholesale distribution of fuel to another 1,825 locations (Figure 2).
Figure 2 – ARKO overview (ARKO investor presentation)
Arko is a serial consolidator in the fragmented convenience store industry, having completed 25 acquisitions since 2013, taking store count from ~300 to over 3,000.
Although Arko has grown significantly from its acquisitions, the company believes it still has a lot of growth potential, as the convenience store industry remains highly fragmented, with the 10 largest operators accounting for less than 20% of the industry store base of ~150,000 (Figure 3).
Figure 3 – Convenience stores is ripe for consolidation (ARKO investor presentation)
Poor Financial Performance The Root Cause Of Stock Weakness
The root cause of Arko’s poor stock performance has been its weak financial performance, as the company delivered $0.24 / share in EPS for 2023, a 55% YoY decline (Figure 4). Importantly, both revenues and earnings for Q4/23 missed analyst expectations by $0.06 and $200 million respectively.
Figure 4 – ARKO Q4/23 financial performance (ARKO Q4/23 earnings release)
The negative 2023 highlight for Arko had to be its operated retail stores, which saw a sharp 5.3% YoY decline in same store fuel gallons sold. While fuel margins stayed robust at $0.388 / gallon in 2023, the decline in volumes led to lower fuel contribution of $360 million (-11.3% YoY).
Figure 5 – ARKO saw decline in fuel volumes (ARKO Q4/23 earnings release)
Arko’s fuel volume decline is odd, as data from the EIA suggest gasoline demand was roughly the same in 202 (Figure 6).
Figure 6 – EIA data suggest fuel volumes were steady (EIA)
In fact, Arko competitors like Alimentation Couche-Tard (ATD:CA), the largest convenience store operator in the U.S., saw only a 0.6% YoY decline in same store fuel volumes in its U.S. operations in the 40 weeks ending February 4, 2024 (Figure 7).
Figure 7 – ATD Q3/F24 volumes were flat (ATD Q3/F24 earnings release)
So it appears Arko’s operated convenience stores have been ceding fuel market share to its competitors over the past few quarters.
Fortunately, Arko’s merchandising revenues, which grew 11.6% YoY (2.5% SSSG excluding cigarettes), helped offset some of the decline in fuel contribution.
Wholesale volumes was another bright spot for Arko, as fuel supply gallons grew 7.3% YoY and consignment volumes grew 7.7% YoY (Figure 8). However, these wholesale gallons are much lower margin than fuel sold in company-operated stores.
Figure 8 – Wholesale volume was a bright spot (ARKO Q4/23 earnings release)
Taking A Breather From Acquisitions?
For an acquisitive company like Arko, the company has been surprisingly quiet on the acquisitions front in the past few months, with the most recent acquisition completed in June 2023.
I believe this pause is actually a good thing, as my prior analysis showed Arko appeared to be overpaying for acquisitions, paying between 13-19x EV-to-annualized EBITDA (Figure 9).
Figure 9 – ARKO was paying top dollar for acquisitions (Author compiled with data from company reports)
The pause in acquisitions also allowed the company to catch up in terms of operating efficiency, with ~2 million customers now signed up for Arko’s loyalty program (Figure 10).
Figure 10 – ARKO now has 2 million customers in its loyalty program (ARKO investor presentation)
Introduction Of Pizza Could Be A Game Changer
Furthermore, an under-the-radar announcement by Arko to offer a premium “take-and-bake” whole pizza for $4.99 for Arko members could be a game changer, in my opinion.
Figure 11 – Improved pizza offering could be a game changer (ARKO investor presentation)
Arko appears to be taking a page of out Casey’s (CASY) playbook by focusing on improving the quality of its pizza offering to attract foot traffic. While consumers know Casey’s for being one of the largest convenience store chains in the U.S., a little-known fact is that Casey’s is also the nation’s 4th largest liquor store chain and 5th largest pizza chain (Figure 12)!
Figure 12 – CASY overview (CASY investor presentation)
Equity Still Looks Expensive
Looking at Arko’s valuation, despite the stock’s steep decline in the past year, Arko shares have gotten even more expensive, trading at 52.3x Fwd P/E compared to 24.6x for Casey’s and 15.0x for Murphy USA. (Figure 13).
Figure 13 – ARKO valuation vs. peers (Seeking Alpha)
On Fwd EV/EBITDA, Arko’s valuation is more inline, with the company trading at 11.4x Fwd EV/EBITDA compared to 9.9x to 12.7x for peers.
The problem for Arko appears to be its capital structure, as the company relied heavily on debt and leases to finance its acquisitions. This makes Arko vulnerable to the current high interest rate environment, with the company’s 2023 operating income of $118 million almost entirely eaten up by $91.5 million in interest and other financial expenses.
As long as interest rates remain high, I fear Arko’s shares may continue to come under pressure, as the company has little ability to meaningfully delever, with most of its cash flows going towards servicing debt and leases.
Conclusion
Despite a further 26% decline in Arko’s stock price, the company still screens expensive compared to peers on Fwd P/E, as the vast majority of the company’s cash flows have to go towards servicing debt and leases.
I remain cautious on Arko and remain on the sidelines on the company until the company can show sustained improvement in financial performance or deleverage its balance sheet.
