(Currently, CST Brands is known as Corner Store Holdings Inc. It will be known as CST Brands post spinoff so I will refer to it as such.)
Valero Energy is planning to spin off its retail segment some time in the 2nd quarter of 2013. Valero believes that investors and analysts have mainly treated their company as a refiner, ignoring the higher potential of its retail segment.
CST Brands is one of the largest independent retailers of motor fuel and convenience store items in the United States and eastern Canada, with 1027 convenience stores in the U.S. and 849 retail sites in Canada. It has an especially strong presence in Texas, with 627 stores in the state. It generates most of its revenue from fuel sales. There’s a lot more detail, for example, they sell home heating oil in Canada, but I don’t think it’s incredibly important in determining the attractiveness of this upcoming investment opportunity.
CST Brands claims that it will be competitively positioned and have good brand recognition following the spinoff, and I think this is true. It also claims that it will have growth opportunities, which I am very skeptical of, at least for the near term (next 5 years.)
In order to be concise, I will separate this report into what I believe to be the 3 most important things in regard to this spinoff: New Debt, Why Valero is Probably Interested in the Success of CST Brands, and Why CST Brands Stock Price Might Become Unreasonably Cheap
CST Brands will incur approximately $1.05 billion in new debt after separation, for which Valero will receive $1.05 billion in cash through a debt exchange involving a third party. CST will receive no cash from this debt exchange. CST expects this new debt to consist of bank debt, short-term notes, long-term notes or some combination of them. $500 million of the debt will bear interest at a variable rate, and the other $550 million will consist of 10 year bonds. CST expects to enter into a revolving credit facility with a borrowing capacity of up to $300 million, which is also expected to bear interest at a variable rate. CST believes that cash flow from operations will be sufficient to fund ongoing requirements. In addition, they will have access to liquidity facilities (the revolving credit facility.)
–Also, CST anticipates incurring $30 to $35m in capital costs for IT infrastructure for the first year following separation.
Why Valero is Probably Interested in the Success of CST Brands
CST intends to enter into long-term fuel supply agreements with Valero. Following the distribution of CST common stock to Valero shareholders, CST will depend on Valero as its primary supplier of fuel.
Valero will own 20% of CST common stock following the distribution (80% will be distributed to Valero shareholders.) This stock may be sold at any time, but of course, Valero would probably like to sell it for a good/high price.
CST Brands intends to lease office space in San Antonio, Texas, from Valero to serve as its corporate headquarters.
–Also, why CST’s management is interested/might be quite effective in the success of CST Brands:
Almost all of CST’s management has some or extensive history working for Valero/Valero’s retail segment.
(CST expects that equity awards will be granted to directors, officers and employees, although they haven’t written that they will be for sure. Also, they have indicated that the same incentives used for Valero executive officers will probably be used at CST Brands, although this isn’t for sure either.)
Why CST Brands (CST) Stock Price Might Become Unreasonably Cheap
The majority of Valero’s shareholders are institutional investors, and CST Brands’ business profile may not fit their investment objectives or be included in the indices that some of these institutional investors might be limiting their investments to.
There may be little or no analyst coverage of CST’s common stock after distribution.
Investors may show little interest in owning the debt-laden spinoff. Instead the spotlight will likely be on Valero’s increased strength and attractiveness as an investment.
I think it is a possibility that the perceived unattractiveness/lack of attention to this debt-laden spinoff will result in unduly low prices.
So, let’s take a look at some of CST Brands’ figures in order that we may determine if it sells at a bargain after the shares are distributed, and also in the weeks/months following.
Free Cash Flow for 2009, 2010, 2011, and first 9 months ended 9/30/12:
$197m, $193m, $183m, and $139m
Debt (following separation)
Conservative Approximation of EBIT (Earnings Before Interest and Taxes) following separation (using EBIT from 2008 to 2011)
Book Value (Net Tangible Assets) as of 9/30/12
CST Brands plans to pay a 25 cent annual dividend. I’m not really sure why, as it seems they will need as much cash as they can get to service their debt.
Of course I have no idea how many shares will be issued, but for the sake of example, if 100 million shares were to be issued, this would come out to about $1.80 per share of FCF, $11 per share of debt, $3 per share of EBIT, and $12.35 of Book Value.
CST’s Total Capitalization will be $1.568B, with $1.055B in debt and capital lease obligations and $513m in total net investment/stockholders equity, at the time of separation.
Note: I was kind of confused about the $343m in additional paid in capital shown in their total capitalization, because I read that only 10,000 shares of CST are currently owned by Valero.
Highly leveraged spinoffs can be great opportunities for making highly profitable investments. We’ll see what happens with this spinoff.
Another possible idea would be to buy Valero call options expiring in June of 2013 or around then, that way you could end up probably making a profit on shares of Valero and also end up owning shares of CST Brands. (If you don’t know about options, just ignore this.)
And lastly, concerns as to why CST Brands could be an awful investment:
CST Brands Free Cash Flow and EBIT are highly dependent upon wholesale prices for gasoline and diesel, which CST has no control over. (And although they generally increase retail prices as wholesale prices increase, sometimes they are unable to increase retail prices at the same rate as wholesale prices.) This could result in an unexpected decrease in earnings, and the negative effect of this on share price would be magnified by CST’s debt heavy capitalization structure. Not to mention it could compromise CST’s ability to service its debt obligations, which would also have a very negative effect on the price of its shares.
CST might actually be perceived as an attractive investment and receive a lot of attention, or for any other reason may never reach prices low enough to be considered a good investment considering the risks involved.
Disclosure: No position in Valero (VLO.) I might keep an eye out for CST Brands (CST) after its shares are distributed though.
Thanks for reading.
Disclaimer: I’m no expert, and this is definitely NOT investment advice. All investing is at your own risk.