Does The Pantry’s Turnaround Strategy Need a Turnaround?

CARY, N.C. -- Turning around a company is never easy. It's a process that can take years. But when you are a publicly traded company, the pressure to resurrect your performance mounts much more quickly than with a private company.

Such is the case with The Pantry Inc., operator of Kangaroo Express convenience stores, whose publicly traded NASDAQ stock has suffered a negative return over the past five years. In February 2009, the Cary, N.C.-based retailer’s stock was trading at approximately $17 per share. Although the stock once traded as high as $24 in 2011, today it trades at about $13 per share. Jan. 31 was an especially difficult day for The Pantry's stock as it dropped 8 percent on a day when the entire market experienced a significant setback.

These figures are in comparison to Alimentation Couche-Tard Inc., operator of Circle K stores in the United States; Susser Holdings Corp., operator of Stripes and Sac-and-Pac stores; and Casey's General Stores Inc., which have all seen triple-digit stock advancements during the same time period.

The Pantry's stock underperformance has led to the formation of a new group called Concerned Pantry Shareholders (CPS). This new entity -- led by Houston investment groups JCP Investment Management LLC and Lone Star Value Management LLC, and owners of an aggregate of 478,186 shares (or 1.9 percent of The Pantry's stock) – recently nominated Todd E. Diener, former executive officer of Brink's International Inc.; James C. Papas, managing member of JCP Investment Management; and Joshua A. Schechter, director of Adrenas Co. Ltd., to The Pantry's board of directors.

The Pantry rejected CPS' board nominees, saying they don’t possess the "particular experience and expertise that the company is seeking in director candidates at this time." The retailer also responded by nominating Thomas W. "Tad" Dickson, former CEO of Harris Teeter Supermarkets Inc., to its board of directors.

In a Schedule 14A filing with the U.S. Securities and Exchange Commission on Feb. 3, CPS claimed that it has no interest in taking over The Pantry's board. "However, we are concerned that the board is not taking the appropriate action to address the company's perennial underperformance and unlock value for the benefit of shareholders," CPS wrote in the filing.

Despite CPS only owning a small percentage of The Pantry's stock, recent history suggests the dissident group should not be taken lightly. Last year, Elliott Management Corp. expressed concerns about underperformance of Hess Corp.'s stock. Although Hess executives also disagreed with the board of director candidates put forth by the leveraged buyout group, the company later conceded to many changes, including spinning off or selling its retail division, and dramatically raising its dividend.

Terry Monroe, a convenience store mergers and acquisitions specialist who himself took a retail chain public, believes that two factors could be affecting The Pantry's performance compared to the other three aforementioned public c-store companies. First is that Dennis G. Hatchell, brought on as The Pantry’s CEO in March 2012, has a grocery store background, which is clearly different from running a c-store business. "Therefore, I think it may be that Dennis surrounded himself with a lot of grocery store guys and not convenience store people as Couche-Tard and Casey's have," Monroe said.

The second factor is that some Kangaroo Express stores have not been able to get on track. "I have not seen all of their stores, but it is very possible that the bulk of The Pantry stores may be nothing but a lot of 'B' and 'C' quality stores, and don't have the horsepower to take the company to a higher level," he stated. "It may be a case of where the parts are worth more than the whole, but the company could never start to sell off assets because it would drive its stock price down lower."

Karen Short, director at Deutsche Bank AG, a firm that covers The Pantry, believes Hatchell was brought on because of his tremendous track record in merchandising, a weak point for The Pantry in prior years. The company, however, still faces challenges moving forward, she told CSNews Online.

"[The Pantry] needs to preserve its gross profit dollars from the pump because they don't necessarily generate enough gross profit dollars inside the store," Short explained. "In my opinion, there is a bit of a chicken-and-the-egg situation. They have to keep their prices at the pump a bit uncompetitive because they must preserve gross profit dollars, but they are therefore not getting the traffic as evidenced by the fact [that] traffic [same-store comparables] have been negative for a long time."

When The Pantry does get traffic at the pump, Short noted that the chain’s in-store offerings are not compelling enough to get customers to walk inside the store and purchase high-margin items. "It's more of a 'utility' purchase when people walk into a [Kangaroo Express] store," the Deutsche Bank director continued. "Some of the other convenience store operators tell a much different story. Susser has said that more than 60 percent of its customers don't fill up at the pump; they go to the store to buy Laredo Taco Co. [quick-service restaurant] offerings."

As for Casey's, the Iowa-based retailer does not provide a figure regarding how many customers walk into the store after fueling up, according to Short. "My sense is, though, that out of 100 customers filling up at the pump, 85 percent are going into the store. The Pantry seems to be the inverse of that statistic, or at least it was under former CEO Terry Marks and I don't think it has changed much since," she said.

Plenty of Positives

While The Pantry certainly has areas for improvement, industry watchers are quick to point out that the company also has plenty of strengths. For starters, the retailer operates 1,538 Kangaroo Express locations in 13 states and has plenty of real estate -- something that is tough to replicate. In addition, its Roo Mug coffee and soda promotions have been successful, Hatchell reported during recent earnings calls.

Bonnie Herzog, senior analyst at Wells Fargo Securities LLC, is bullish about The Pantry’s prospects. "With a large, established store base in the Southeast, [The Pantry] has multiple opportunities to improve revenue growth and margin in our view," she wrote in a Jan. 31 equity research briefing. "We believe [it] is in the early stages of a turnaround and, given its attractive valuation, we believe the risk/reward ratio of owning the stock at current levels is positive."

In fact, Herzog values The Pantry's stock at between $19 and $21 per share, much higher than its current share price.

Deutsche Bank’s Short holds a different opinion about the stock. Her target price is $13 per share, the same as its price today. Despite a flat outlook for the near term, she told CSNews Online that her "hold" recommendation on the stock is not due to a lack of success in The Pantry’s effort to reposition itself for growth. Instead, she said the stock price is simply not undervalued based on her valuation metrics compared to other publicly traded retail companies "due to the challenges The Pantry is facing."

Another checkmark on the positive side of The Pantry’s ledger could be Dickson if he is elected to the board of directors. He is well respected by retail experts and analysts alike. "Tad has significant retail experience in the Southeastern U.S.," Hatchell said during The Pantry's 2014 fiscal first-quarter earnings call. "We look forward to the guidance he can provide."

In an interview with CSNews Online, Monroe agreed with The Pantry's decision to nominate Dickson. "There are no seasoned convenience store guys listed on [CPS'] roster [of board of director nominees]," he said. "If my company were in trouble, I would be looking for the best convenience store operator in the country or the No. 2 guy and try to get them on my team instead of trying to reinvent the wheel."

Short, who formerly covered Harris Teeter before its sale to The Kroger Co. last month, told CSNews Online she "thinks highly" of Dickson. "He's very measurement focused and results oriented. Maybe The Pantry can use that," she said. "At Harris Teeter, he hired people who are extremely strong merchants and who will be staying at Harris Teeter with The Kroger acquisition. Tad is a great leader."

The Pantry declined to be interviewed for this story.