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Couche-Tardsetsitssightson industry'stopspot

Located on the historieIleJesusacross the Rivieredes Prlliries,this land

of parks and farmland is not exactlywhere you might expect to find NorthAmerica's most talked-about conven-ience chain.

Then again, like the fertile soil of itsLaval, Quebec, home base, Alimenta-tion Couche-Tard has cultivated a rieh

bounty of stores in a fairly short time.That collection has led this relativelyobscure companyto elaim the second-largest combined convenience storecount in the United Statesand Canada,

with expectationsof surpassingthe ven-erable 7-Elevensometime this year.

28 CSP January

--

By Angel Abcede and Mitch Morrison

Couche-Tard is not only the preem-inent roll-up performer in the conven-ience channel, but its model is also

radically different from both its acqui-sition-hungrypredecessors ofboth thelate 1980s and late 1990s and the tra-

ditional chains that saturate the neigh-borhoods we live in.

This voracious appetite to unitefragmented swaths in the Midwest,Southeast and on the West Coast is not

driven by gaudy fuelmargins, buy-and-sell speculation, blissful ignorance ofthe channel or unrealistic dependenceon silver-bullet solutions.

It is guided by Alain Bouchard, the

2 0 0 5

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modest yet self-assured French-speak-ing businessman who is driven less byego than by a global vision. He believesthechannelsfragmenmtionffilikethmof no other retail sector, and that his

business strategy of decentralizedman-agement, creating companies withincompanies to fUn each region, is the

answer to handling such disparatestores in far-away stretches.

While Couche-Tard has achieved

limelight status for a couple of years,the acquisition of the behemoth Cirele

K operation-with plans to make themoniker its U.S. brand-poses the

company's most severe challenge

L

[CSP-April '04, p. 28].And with pro-nouncements of an ambitious expan-sion plan on the horizon, the companyand its chief executive face unprece-dented scrutiny from industry watch-ers and investors.

KeyQuestionsThe purchase of the 2,290-store CireleK chain in December 2003was not thefirst time Couche-Tard assumed the

daunting task of integrating an entity

essentially th~ same size of its owncombined network of Canadian andU.S. stores.

The company faced similar chal-

lenges,albeit on a smaller scale,in 1999,when it surged from 295 stores to 1,275with the purchase ofWestem CanadianSilcorp Ltd. Analysts gave the Silcorpintegration high marks, as they did with

Couche- Tard's nine other acquisitionsin the United States and Canada, rang-

ing from as little as six stores to morethan 400 sitesfrom the bankrupt Ohiochain Dairy Mart.

Now, with Cirele K, the questionbecomes whether Bouchard and his

tight -knit group of top executives can

shepherd their latest acquisition intoits lower-cost, decentralized mindset.

The industry already knows muchabout how Couche-Tard restructured

Cirele K into separate business units,

allowing these regions to act as inde-pendent, autonomous entities. Withthat structure cornes reduced overhead

and a swifter model that not onlyresponds quicker to local competition,but can alsogenerate the cash flownec-essary to sustain even further growth

by acquisition.The strategyhas pluses and minuses.

The key question may not lie in thewhole,but in the fragmentedparts.

~

From his perspective, Bouchardfirmly believes consolidation in theindustry is necessary. "l'm surprised

that there's no single player with 10%of the market;' he says,estimating thata single company could successfullyachieve a network of 13,000 stores."The market has to be consolidated. Itmakes sense:'

But can Couche-Tard afford it?

Numbers Look GoodA study of Couche-Tard'sfinancialstellsa story of a company not only willing

to spend to reach its optimal potential,but also a chain with elear sight of an

acceptable debt load, an eye for favor-able-albeit variable-interest rates,

an aggressive focus on ridding costlylayers of management, and a mindsetof continual capital reinvestment via a

decentralized operational and manage-ment structure.

But placing Couche-Tard's financial

responsibility un der a microscope iscause for serious migraine. Truth is,proper financialunderstanding requires

same-store analytics,debt-to-cash-flowmeasures and actual multiples to assess

whether the operator has overestimatedits acquisitions or paid a reasonablepriee for companies such as Bigfoot,

Dairy Mart and, most importantly, the

voluminous Cirele K. For comparisonpurposes, Couche~Tard says it has

exceeded 15% annual growth over thepast fiveyears.

The rapid spree and integration thatstarted with Silcorp has preeluded anapples-to-apples scenario, though thecompany does offer such a glimpse on

a limited market basis. It is also impos-sible to predict interest rates,which thecompany to date has effectivelyexploited with superior variable rates.One other aspect that's elear,sayfinan-cial analystswho track the company or

have observed this retail phenomenon,is Couche-Tard dgesn't assess assets

based merely on yesterday's perform-ance (or even today, for that matter)but by their potential.

"The difference in what makes

Couche- Tard better is they're a mer-

chandiser first and foremost," saysMichael Van Aelst, an analyst at CIBCin Toronto. "They integrate their acqui-sitions. Many of the roll-up companiesfrom the 1990s got caught when they

made acquisitions but didn't integrate

them. Couche-Tard alsogenerates a lotof cash flow:'

Approaching year end, Couche-Tardwas operating with a $600 million debt

january csP2 005 29

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and $350million in revenue-a strongbalance, analysts say.

There are other critical differences

distinguishing Couche-Tard from itsforerunners.

One is store-level execution. "That's

their greatest strength;' Van Aelst says."They're very decentralized.When theybuy the Circle K-type chain, they're

applying their operational styleto thesecompanies. They're getting rid of theiroverhead, applying their discipline onnegotiations with vendors, their leases.Everyone tells me the same thing:

Executive Teamand Regional Leadership

Alain Bouchard

Chairmanof the board,

president and CEO

RealPlourde

Executive vice

president and COO

They're tough but fair."And there's the commitment issue.

Couche- Tard's leadership, led byBouchard, has worked in the conven-ience channel sin ce the 1980s, as

opposed to the outside speculatorswhojumped in during the mid-1990s hop-

ing to parlay rapid-fire acquisitions intoa quick, profitable get-out plan.

And perhaps the last important dis-tinction between Couche-Tard and the

Swifty Serves and Convenience USAsof the convenience landscape is mar-

gin mentality. The latter chains sought

RichardFortin

Executivevice

presidentandCFO

JacquesD'Amour

Vicepresidentofadministration

New North American senior vice presidents:

StephaneGonthier,Easternregion; Brian Hannasch,Westernregion

California,Washington,

Oregon,NewMexico,partsofArizona and Texas.

Region head: Joy Powell

No. 01 corp. stores: 283

Nevadaand parts of Arizona.

Region heatl: Geoffrey Haxel

No.ofcorp.stores:526

30 cSP January

Strengths: Growth potential for the market

isstrong.

Challenges: Peculiar labor laws and a high

standard of living stymies the building of a

strong store-Ievel management team.

Plans: Divest eight sites; develop a co-

brandedQSRin Yuma,Ariz.;enhance20sites

with high-margin productsover fiscal2005;

and improve 125stores with automation.

Strengths: Most established portion of the

CircleKchain,guided by experiencedman-

agement.

Challenges:Facingimprovementsinautomationand image.Manyof the sitesare

older and need refreshing.

Plans:Improvetechnologyand eutoperating

costs; implement Store 2000 standards at

five locations; develop proprietary brands,

especiallyin water and beverages;and grow

through new builds and small acquisitions.

to ride fat margins on fuel and smokes

for rich profits.One of the extraordinary qualitiesof

Couche-Tard's financials ishow utterly

ordinary its margins are. According to. financialreports,the chainwillnet lessthan 12cents for every gallon of gaso':line sold in the United States.Merchan-

dise gross profit? About 32.6%.

Cutting G&ABeyond operations and store sales,Couche-Tard is also famous, ifnot infa-

mous, for cutting costs tied to general

.-C=Corporate stores

L=Licensed and Iranchised stores

2 a a 5

and administrative expenses (or G&A)

or, as Bouchard puts it, "everythingfrom above the store to me:'

For Cirele K,that meant entire cor-

porate departments~legal, account-ing, hum an resources, information

technology-gone. A lot of marketing,much of the category managementteam, advertising, communications-

gone, with salary cuts putting to ques-tion those left. That's not to sayall thee:x:periencehas left the company. Keyplayers at former Cirele K corporatewere repositioned in the regions, with

Iowa, Illinois, Indiana,

Michigan,Kentucky,Ohio

and Pennsylvania.

Region head: MichelBernard

No. of COlp.slores: 504

, Tennessee,Georgia,North

Carolina,SouthCarolinaand

parts of Mississippi.

Region head: RobertCampau

No.of (orp.stoles: 279

rpm

Louisiana,Arkansas,Alabama,Florida

and parts of Mississippiand Texas.

Region head: Charles"Mick" Parker

No. of (Olp. stoles: 562

':::JRCE:Alimentation Couche-Tard2004 Annual Report

a large number of division managersfrom the old CireleK givenkey roles inthe new structure.

Moving then from what looks goodon paper to what works in the field ispivotal.What must occur in this newlydecentralized structure translates into

entrepreneurship. Yes,that good 01'American concept, but with all theflaws along with the ideals.

"When 1worked there,we alwayshadfranchiseeswho wanted to go it alone;'saysone former CireleK executivewho

asked not to be identified. "Then they

mentshaveoccurredin this region,with

planstoupgradecontinuing.

ln thepas!,theregionneeded

to build operationalexpertise.Withthat

accomplished,the region must moveforward

with confidence.

Plans: Open10new locations and 20 QSRs;

convert200stores,mostly in Ohioand Illinois,

to the CircleKbrand; and implement Store

2000 in 80 sites.

Stlengths: Strong team of former CircleK

corporate executives with acquisition

experience.

Challenges: Needs to build store count to

achieveoperational efficiencies.

Plans: Streamline by cutting 25 storeswith

25 more under review. While cutting, the

overall goal is stHI to reach its 500-store mark

by mid-fiscal year.

managementteamthat usedto oversee

2,300stores.

Challenges:Recoveringframhurricanesthat

devastatedtheregion,takingoutroughly30

storesandresultingina lossof2,600business days.

Plans:Rebuildfrom hurricanedamage,

modernize75stores,further emphasize

merchandisingprogramstargetinglocal

needsandopenadozennewQSRs.

went independent and realized how

much corporate support they had:'

It alsomeans gettingby on less,cast-ing some to question whether Couche-

Tard may be too lean and risking anengine burnout. "People are over-whelmed;' saysanother former CireleKexecutive,speakingof not only Couche-Tard's corporate suite but also the

reglOns.Integrating a chain larger than itself

has its challenges,saysBrian Hannasch,one of two senior vice presidents

recentlyrepositioned to overseeregionsin North America. "Cultural shift was

the biggestthing;' he says."Going froma centralized to decentralized approachtook some adjusting to:'

While workloads may have shiftedand positions changed or eliminated,

Bouchard says the cuts made sense."Cirele K had a G&A of $23 million

[for IT/IS]," he says. ''l've seen com-panies as big as them running on [$6million]."

Widespread cuts, ineluding person-

nel, have brought Cirele K's G&A to$12 million, Bouchard says.Accordingto Hannasch, savings inelude every-thing from renegotiating with vendorsto assessingPOS and hardware use. lnterms of HR, accounting and finance,"aIl the costs above the store have

receivedelosescrutiny;' Hannasch says.ln the bump and tussleof that shake-

out, top corporate executivesfrom Cir-ele K's former base of Tempe, Ariz.,landed in leadpositions in the Southeast

and Florida. That leadership may provepivotal in bolstering those regions.

The Southeastern region must bulkup to meet economies of scale, need-ing almost 200 additional stores to sus-

tain its corporate structure. ln Florida,four successive hurricanes caused

]anuary CSP 312 005

extensive damage this year not only interms of property and goods, but also

in lost sales.The company reported $2million in lasses for the second fiscal

quarter ending Oct. 10, 2004, and atleast $1.5million predicted for the thirdquarter due ta the storms.

Insurance daims in the $25 million

range willput the company back in theblack, but construction is slow and

complicated by unresponsive govern-ment officialsand backlogged contrac-tors, Boùchard says.

California poses its own set of chal-

lenges. One of the biggest surprisesBouchard sayshe's encountered is the

sheer cost of transferring experiencedstaff ta California. The high standardof living was cost-prohibitive, he says.

Indeed, salaries in the United

States, where the dollar outweighs theCanadian dollar, may challenge thehighly lean operations and manage-rial mindset the company boasts.Speaking on condition of anonymity,two former executives said the chain

had planned to cut salaries at the endof 2004 and that, overall, Couche-Tard has an unrealistic view of what

category managers ought ta be paid.

As a result, the talent attracted mayreflect those lower wages.

Asked about compensation pack-ages, Bouchard's office in an e-mailresponded, "With respect ta the work-ing conditions and salaries,we do notwant to go into details.This said,we have

very competitive working conditionsand alwaysmanaged ta haveamong our

teams the best resourcesin the industry.We can easilycompare ourselves ta thedata published by NACS."Also, samemanagers have had their salariesaltered

ta be based more on performance.Perhaps further strengthening

32 cSP January

"Goingfromacentralized todecentralized

approach [after

the acquisition]took some

adjusting tO:'-Brian Hannasch

Couche-Tard

Bouchard's point is the

message from one for-mer Cirele K executive

interviewedfor this story:"Some left thinking theycould get better salarieselsewhere, only ta findthat there'snot that muchout there:'

Buying DisciplineHuman resources aside,Couche-Tard has found

financial pull by loppingoverhead from its pur-chases and executing awell-thought-out M&Aapproach.

"Some companies

have a disciplined buying strategy,butthese guysarevery process-driven;' saysBillTrefethen of Scottsdale,Ariz.-basedTrefethen & Co., which Couche-Tard

has retained for its US. acquisitions."If

you're a student of mergers and acqui-

sitionsand roll-ups,most of the roll-upsare failuresbecause the logic in the roll-up is ta eut the G&A.The problem withthat isyou loseefficienciesonceyou pass

a certainsizeand, more importantly,youloseyour connection with your market.For instance, Quebec is very differentfrom Ohio. Couche- Tard's decentral-

ized approach has kept them from los-ing touch with their markets:'

Another move that has drawn praiseis the company's sale-leaseback strat-

egy.At the end of the company's sec-ond fiscal quarter last year, it enteredinto a sale-leaseback of 322 Cirde K

properties for nearly $253 million,which was used ta reduce the com-

pany's long-term debt."The real estate does hold a lot of

value;' saysVan Aelst of CIBC."But in

2 0 0 5

their case, they don't liketa be a capital-intensivebusiness. They' d rather

reinvest the capital in .

their stores, equipment,pay down the debt:'

Analystscitethe prac-tice as a way ta contraIdebt and allow the chainta focus on its core

objective: running aconvenience business.

Still,some Couche-Tardwatchers remain cau-

tious of the buy-and-absorb model. "It seems

alittle like empire-build-ing. There's very littleopportunity ta run

same-store analysis,"says a Canadian

analyst who spoke on condition his

name not be used because he currentlydoes not officiallyfollowCouche-Tard.

"On the surface theyare good integra-tors-they have found more cost

rationalization than anyone predicted:'

Analyzing the Deal

On a spring weekend in 2003,Couche-Tard's top brass-Bouchard, Real

Plourde, Richard Fortin and JacquesD'Amour-went home with a con-

suming homework assignment:Review

a weighty dossier detailing the Cirde Knetwork-store by store. Bouchard'steam figured ta pursue a piece of thechain, perhaps in Arizona or Florida,

states with the highest concentrationof stores.

The following110nday,armed witha field of notes, the four were in agree-

ment: Go after the whole pie. ln theensuing months, Couche- Tard's

vaunted ~1&-\methodology would betesteè.:ike ne ~ther.

Couche~Tard'sABCsofDifferentiation

34 CSP ]anuary

ADOITIONALPROFITCENTER$.Theseinclude franchised fast-food locations

offering burgers, sub sandwiches and

high-end coffee.

BEERCAVES.Popular in Montreal, beetcaves are an important part of Couche-

Tard's upgrade strategy in the Uniteq>

States, too.

CONCEPT STORES. Couche-Tardihas

employed a wide range of themes, from

jungle looks to mountain cabins, ParistqBrooklyn,yuppie chic to submarines. TheM

runfrom outrageous to sUbtle,witp eacp

region able to tailor the theme to the.region.

OO-IT-YOURSELF.Couche-Tard opts

learn and operate, choosing to becom.~the franchisee in ail of its QSRs.

VERYTHINGPROPRIETARY.Couche"

Tard has developed a long line of propti..

etary products to differentiate itself as a

bran.d:slush-style drinks calledSlochè,.a

line of "grdssed out" candies, a.gourmét

lineof premade sandwiches, waters, juice$and even cigarettes. The Florida region

is developing what will be the next pro~

prietary product: a new energy drink.

GASOLINE-FREE.Bouchard emphasizes

the importance of being able to competè

without gasoline. Because of the evolui'"tion of loçallaws, many of their location$

inMontrealhave to compète withoutgasq~line and have done sofor years. He sêY$

he was happyto hear that one ofhis U.S.

regions was "finally"opening a store inuniversity setting that hadno gasoline.

2 005

6

The executive team embarked on a

sèries of steps that have become thecompany protocol for weighing majoracquisitions.

~ Step 1:Don't Overspend. The

key,saysBouchard, is to get a priee the

company can live with for the longterm. With the Cirele K deal, Couche-

Tard definitely entered a buyer's mar-ket. The chain's owner, Houston-based

ConocoPhillips, was like many oil

companies keen on divesting its retail

operations.Couche-Tard ultimately paid $830

million for nearly 2,300 stores. Back in1996,when Cirele Kwas a 1,900-storechain, then Stamford, Conn.-based

Tosco Corp. purchased the chain for$710 million in cash and stock.

~ "Couche- Tard only makes acquisi-tions that willhelp the bottom line;' saysAnthony Zicha, director at Scotia Cap-ital, Toronto. Zicha, who has foilowed

Couche-rard for 17years,saysthe com-pany has a history ofbuying weil.

~ Step 2: Review Human

Resources. A criticalpieeeto any pur-chase,Bouchardsays,is the layerof man-

agement closeto the field.ln the CircleK acquisition, a review of those peoplebecame a sticking point in the negotia-tion proeess. According to Bouchard,

ConocoPhillips said such an extensivereviewwas not possible,prompting himto consider ending talks.With negotia-tions jeopardized,ConocoPhillipsacqui-eseed. Bouchard and his staff visited

roughly 400 sites,talking to managers,inquiring about their proeessesand howthey worked as a team.

~ Step 3: Decentralize Opera-tions. Couche-Tard has said much in

the past about building up or breakingdown acquisitions to meet their deeen-

tra1ized,regionaily structured business

SPLITONCOUCHE-TARDln aDTNEnergy/CSPDailyNewsPoilinwhich250responded,

resultswerefairlysplit onwhetherCouche-Tard/CircleKwill

succeedasagrowth-by-acquisitionchaininthe UnitedStates.

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model.With the Midwest "platform;'

that meant acquiring smaller chains to

build up to the company's efficiencyquota. With CireleK,that meant divid-

ing the chain into four regions,disman-tling corporate and giving regionalCEOs almost autonomous control.

That control cornes with additional

responsibilities. Rolland Trayte, who

now heads his own Tempe,Ariz.-basedconsultingfirm, used to headthe loss-prevention unit atCirele K corporate. He saysthe division heads he led in

each of the regions are now

running loss prevention inthose markets.

"Now that they each haveto handle what I used to do,

they're saying, 'Wow, you

used to do a lot in dealingwith all these vendors and

handling contracts;" Traytesays."And I spoke with ven-

dors before I left, saying,'Hey, you're going to give[the regional managers] the

same deals you gave me, right?' Theysaid theywould, but l'm not sure if thatwas the case:'

A former Cirele K executive says

pro~ and cons existwith the decentral-ized model. "ln some ways, it's goodto allow the regions to act independ-ently, but you can lose buying powerand. .. it makes it more difficult for

vendors to provide quality supportwhen [every region] is looking forsomething differene'

Still,while maintaining autonomy,

the regions communicate continuously,Bouchard says.Video conferences andmeetings keep the regions tied together,

and ideas from one region are oftenused nationally. For instance, a propri-

etary energy drink developed in the

Florida region is going to be used

nationally, Bouchard says.~ Step 4: Cut G&A.Trademark

to Couche-Tard's integration approachis cutting general and administrativecosts, but these go beyond salaries.Sources familiar with the cost cuts also

point to reductions in IT,saying that alarge and expensive-to-maintain enter-

Source:DTNEnergy/CSPDailyNewsPoil

36 CSP ]anuary

prise resource planning (ERP) systemwas dismantled in favor of systemsand practices Couche- Tard already

operated. '~As with the Dairy Mart headquar-

ters in Hudson, Ohio, Couche-Tard hasmoved the Cirele K offices from what

they considered an ostentatious Tempefacility to a more modest locationnearby.Per site,Bouchard sayshis G&Afigure is better thah the $43,600-per-

store number that NACS says is anindustry average.

~ Step 5: Disciplined Balance

Sheet. Bouchard points to positivecash flow and increases in store salesas indicators of his business success.

The second-quarter report ending

2 0 0 5

Oct. 10, 2004, showed merchandise

sales-exeluding Cirele K stores for

comparison-up Il % and gasolinesales up 10%.

A recurring theme in terms of salesis a reluctance to rely on gasoline.Bouchard saystying a Dunkin' Donutsfranchise to a site can bring in $17,500per week; with a Subway cornes

another $12,000per week, plus c-storesalesat $24,000-$25,000,and

the result is a profitable sitewithout gasoline sales.

So how has Couche-Tarddo ne in the box so far with

Cirele K? Same-store num-bers won't corne until next

year, but overall Bouchardbelieves the stores have

"met, but not exceeded,

expectations."~ Step 6: Improve,Dif-

ferentiate. Differentiation

cornes in store appearance,

proprietary products-

ineluding its own cigaretteline-and additional profit

centers. Plans to implement thecompany's Store 2000 concept hasoccurred mostly in the Midwest. lnFlorida, three stores have been reno-

vated under new concepts. The firstlocation saw a 30% increase in mer-

chandise sales after the first fiveweeks;the second, a 22% increase; and the

third just opened this fall.The lifts, Bouchard says, corne

mainly from foodservice, with anexpanded coffeeselection and an over-

aUbetter presentation of goods. Beerand coffee were definitely strong ele-ments, he says.

~ Step 7: Achieving ScaleThrough Acquisitions. To make

regional models work, Couche-Tard is

/

under self-imposed pressure to raise store count IDCali-fornia and the Southeast. Bouchard describes the Califor-

nia region as an area that has "opportunities for growth:'

Looking Back ... Going Forward

Looking to the Midwest-Couche- Tard's opening forayinto the United States-may be a precursor of what to

expect: a ubiquitous Circle K brand, impressive coffee

presence and aggressive cigarette pricing. Then again,there's that decentralized style that givesTegions certainautonomy.

What is apparent is that Couche-Tard remains on a

constant, albeit modified, hunt. "We think they need atleast 500 to gain efficienciesin [the United States], and we

would expect the company to announce [smaller]

acquisitions;' saysZicha of Scotia Capital, referring to theneed for critical mass in key markets.

One former CireleK executivefamiliar with the buyinggame gets nervous the more Couche-Tard talks about

acquisition. "Their whole strategy is based on buying andacquiring;' he says."1don't see a strategy for growing theinside of their business. You may want to grow and havea lot of stores, but to me, it's a scary goal-one that hasfailed good operators::

ln that vein, Couche-Tard has reconfigured 1,000stores

in consonance with its Store2000 design and has budgetedcapital funds to remodel 300 stores this fiscal year, with

plans to update its full network over the next severalyears.Indeed, to treat Couche-Tard as a relative riewcomer to

the convenience channel would be erroneous, as would

questioning its fundamental growth-by-acquisitionmindset. The company's track record has proven thatCouche- Tard understands how to operationally roll upand manage growth.

But questions remain: Has the confident companyundertaken too much weight in assuming a 2,000-store

behemoth? Does its vision translate into becoming a long-term powerhouse or a short -liveddiva?Only time will tell.

Bouchard feels he's already answered the questions,departing from his typical reserve to one of frustrationover WallStreet firms that can't understand his life'swork.

"Shareholders want to see growth' but Moody's doesn't;'he says."Theywant you to stop growing to see if the modelis right. But we've been proving the model for the last 10

1 , . h " ~years.tsng 1. .