CST Brands Inc (CST): Another Spin-Off Favored by Hedge Funds
CST Brands Inc (NYSE:CST) was spun-off from oil refiner Valero Energy Corporation (NYSE:VLO) in May 2013 following pressure from Paul Singer’s Elliot Management. Many hedge fund managers increased their holdings of the divested company during the fourth quarter of 2013, including Brian Jackelow of SAB Capital Management (who is the ninth largest shareholder with a 3.0% stake, which amasses 2.30 million shares), Vinit Bodas of Deccan Value Advisors, Cliff Asness of AQR Capital Management and Richard Chilton of Chilton Investment Company.
CST Brands Inc (NYSE:CST) is a $2.4 billion market cap independent retailer of motor fuel and convenience merchandise items. It operates approximately 1,900 urban locations in the U.S., concentrated in Texas and Colorado, and eastern Canada, concentrated in Quebec. Its spin-off from VLO has been followed by sales of their retail operations by other oil companies, such as the divestiture of Murphy USA Inc (NYSE:MUSA) by Murphy Oil Corporation (NYSE:MUR) in September 2013 and the planned sale of its gas stations by Hess Corp. (NYSE:HES).
Following its spin-off, CST Brands Inc (NYSE:CST)’s strategic focus has shifted from maximizing fuel volume to expanding fuel gross profit dollars and optimizing in-store customer traffic. Its growth strategy includes opening more larger stores that generate higher sales and margins than legacy stores, developing a wholesale fuel distribution business in the U.S. and acquiring smaller competitors. With its strong urban footprint in growing markets, significant real estate ownership (CST owns 79% of its stores versus 52% for peers) and a retail business that is less prone to online competition, CST is well-positioned operationally.
Financially, the company looks sound as well, with a manageable debt load (interest coverage ratio of 22.2X versus a peer group median of 9.2X). It has a high free cash flow yield of 11.3% (versus 0.0% for peers) and a recently started dividend that yields 0.8% (versus 0.0% for peers). In addition, margins should improve going forward due to food service enhancements, private label programs and efficient merchandise logistics.
Following a strong performance in 2013, when the stock appreciated by 29%, CST Brands Inc (NYSE:CST) has been weaker in 2014, declining 10% year-to-date, partially due to disappointing guidance for the fourth quarter. Valuation-wise, the company looks attractive, trading at forward P/E and EV/EBITDA multiples of 15.3X (versus 15.6X for its peer group of automotive retail stocks) and 7.6X (versus a peer group median of 10.5X), respectively. A narrowing of the EV/EBITDA multiple gap by half to 9.0X would imply a stock price of $40 or 24% upside from current levels. Combined with its operational and financial strength, CST is an attractively priced stock that is well positioned to benefit as more travelers hit the road due to a recovering economy.