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Convenience Stores Ripe for Mergers

NEW YORK -- The North American convenience-store industry, dominated by mom-and-pop operators, is ripe for consolidation, a trend that would favor the large publicly traded store operators, analysts at Merrill Lynch say.

“With significant scale advantages, economics favor large chain operators in the c-store industry,” the analysts said in a report released Tuesday. “With a still high degree of fragmentation, the publicly traded c-stores stand to be beneficiaries of the inevitable consolidation we foresee.”

According to a report in the Toronto Globe and Mail, Merrill Lynch reinstated coverage of industry leader 7-Eleven Inc. with a “neutral” rating and a $30.22 a share price target. It said the neutral rating was based solely on valuation, given that 7-Eleven is already trading at near-peak multiples of its earnings.

Shares of 7-Eleven, the largest North American convenience store chain with 5,800 stores in the United States and Canada, have risen 332 per cent in the last three years and are currently trading at $31.58.

Merrill Lynch also reinstated coverage of The Pantry Inc., the leading convenience-store operator in the Southeast, with a “buy” rating and a $49 target. Shares of The Pantry were trading near $41.14 in New York Wednesday.

Although the company faces higher risks because of its higher exposure to gasoline sales, it has “ample acquisition opportunities” in its main southeastern U.S. market, where there are more than 40,000 stores that it could potentially buy, the report said.

The brokerage also raised its target on Canadian market leader Alimentation Couche-Tard Inc. by $2 to $22.50 (Canadian) and reinstated its “buy” rating, noting that the Laval, Quebec-based company has proven it can acquire assets and successfully integrate them.

Shares of Couche-Tard, the largest convenience store operator in Canada with half of the market share and the second-largest independent c-store operator in North America, have shot up 121.6 per cent in the last three years and were trading up 19 cents or 1 per cent at $19.19 in Toronto Wednesday.

“Couche-Tard currently trades at a significant discount to U.S. industry leader 7-Eleven but at a premium to Southeast regional operator The Pantry. We anticipate a narrowing of the gap between 7-Eleven and the other two players over the coming 12 months,” the report said.

It noted that the publicly traded convenience stores have outperformed the S&P 500 composite index and the S&P 500 retail index for the past four years.

In addition, growth in the convenience store industry surpassed that of any other retail segment in 2003 and 2004, the Merrill Lynch report said. The acquisition and improvement of operations of the smaller operators will be a significant growth driver for established operators such as Couche-Tard and 7-Eleven, it said.

According to the National Association of Convenience Stores (NACS), the majority of convenience store operators in the United States are composed of chains of 10 or fewer outlets. The proportion of outlets controlled by the four well known non-oil-company chain players -- 7-Eleven, Couche-Tard, Casey's General Stores Inc. and The Pantry -- account for only 8 percent of the total. Single-store operators still account for the majority of outlets, 61 percent in 2004, while chains make up 39 percent of the outlets, the report noted.

“One of the primary reasons for our sanguine outlook for the publicly traded convenience store operators is the consolidation opportunity,” the report said. “As established, well-capitalized c-store operators continue to redefine their in-store offering, the introduction of additional products and services should serve to improve profitability and further establish the c-store as a destination for consumers.”

Risks to Merrill Lynch's targets include volatility linked to selling gasoline and the fact that cigarette consumption -- a main driver of sales for convenience stores -- is in a state of long-term decline.

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