CATEGORY Retail; Transportation, Energy, and Storage SIC CODES 5411, 5541 NAICS CODES , ,

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1 INDUSTRY Convenience Stores and Gas Stations LAST QUARTERLY UPDATE 10/3/2005 CONTENTS Industry Overview Quarterly Industry Update Business Challenges Trends and Opportunities Call Preparation Questions Industry Forecast CATEGORY Retail; Transportation, Energy, and Storage SIC CODES 5411, 5541 NAICS CODES , , RELATED PROFILES Beer, Wine, and Spirits Distributorships Car Washes Fast Lube / Auto Oil Change Service Food Distributors Grocery Stores and Supermarkets Petroleum Wholesale Distribution The convenience store (c-store) industry includes about 60,000 companies with combined annual sales of $200 billion. Major companies include 7-Eleven, Pantry, and the retail divisions of large oil companies like ExxonMobil and BP Amoco. About 70 companies operate 100 or more stores, but most operate a single store. The industry is highly fragmented: the 50 largest companies hold less than 40 percent of the market. The average store has annual sales of about $2 million. COMPETITIVE LANDSCAPE Demand depends mainly on the volume of car driving and on consumer income. The profitability of individual stores is closely linked to location and product mix. Large companies have advantages in buying gasoline at bulk prices, but small companies can compete effectively by having superior locations. Annual revenue per worker is close to $300,000 for both large and small companies. PRODUCTS, OPERATIONS & TECHNOLOGY The industry sells mainly gasoline (65 percent of revenue); groceries (12 percent); cigarettes (11 percent); beer and wine (4 percent); and prepared food (2 percent). About 15 percent of industry revenue comes from c-stores that don't sell gasoline, typically in urban locations. An average c-store covers 1,500 to 2,500 square feet and has three to four gassing stations with a total storage capacity of 30,000 gallons. Traditionally, merchandise sales are geared to impulse buying of high margin goods by walk-in customers. A typical store may stock from 500 to 1,000 different items. An average store may sell close to a million gallons of gasoline per year; the average gross profit per gallon is about 13 cents. Chains not owned by oil companies generally buy gasoline from major oil companies or independent refiners under multiyear supply contracts, with delivery from local terminals at the "rack rate" (local market price). Contracts usually specify minimum annual purchases and may contain incentives for taking a high volume. The gas sold at stores may be branded or unbranded. Single-store operators often pay higher wholesale prices for gas. Typically, the gasoline inventory at each store turns over every seven days.

2 Given the limited space in a store, deciding what merchandise to sell is a key function of management. Merchandising often concentrates on goods with high volume (beverages) or high margins (drugs), or goods with low margins but that draw customers into the store (such as lottery tickets, toilet paper, and milk). Chains monitor their merchandise mix very carefully using highly sophisticated sales' tracking computer software that can identify, for example, products that are often bought together, or products that sell best at lunchtime, etc. Local managers often have some latitude in adjusting the merchandise mix to suit local needs and tastes. Merchandise is typically bought from several wholesalers, often under longterm supply contracts. 7-Eleven uses a single national distributor for all its grocery products, while beverages and snacks are bought from other wholesalers. A large chain may operate its own distribution system, with regional warehouses that package shipments from several wholesalers into daily deliveries to individual stores. SALES & MARKETING Many c-stores do no marketing at all, relying instead on their convenient location and outdoor signage to attract customers. Window and in-store advertising are common. Large chains often advertise on regional or national TV and radio. FINANCE & REGULATION Revenue is seasonal and depends on favorable weather; summer typically brings in the most revenue. Receivables are low; 80 percent of sales are for cash and 20 percent are paid with a credit card. Inventories are relatively small but turn over frequently, from 20 to 40 times per year. Gasoline inventories may turn over every week. C-stores often sit on valuable real estate. Large chains may hedge against higher gasoline prices through commodity futures' contracts. Gas stations are subject to federal government regulations that apply to underground storage tanks (USTs). Under the Resources Conservation and Recovery Act, the EPA regulates the use of USTs, which have in the past been sources of environmental damage through leaking. Some states have Trust Funds to ensure cleanup of contaminated gasoline sites. In some states, operators of USTs must post surety bonds to cover possible cleanup costs. Chains that franchise locations are also subject to various state franchise laws that generally operate in favor of franchisees. Stores that sell alcoholic beverages must be licensed and are subject to various state and federal regulations. REGIONAL & INTERNATIONAL ISSUES Because they retail gasoline, c-stores are sharply affected by the price of crude oil. International events such as supply shortages and distribution disruptions can rapidly boost oil prices. HUMAN RESOURCES Most jobs in c-stores require only limited skills and therefore pay only a low wage. Many stores use a large number of part-time employees, who receive few fringe benefits. Labor turnover is a major problem for many companies. Industry Employment Growth Bureau of Labor Statistics Average Hourly Earnings & Annual Wage Increase

3 Bureau of Labor Statistics Convenience Store Sales Growth Expected - Convenience stores (c-stores) will experience a 30 percent increase in sales by 2010, according to a study by Bain & Company. The predicted growth is primarily due to the continued consumer appetite for convenience, but some is expected due to products, such as health and beauty, that aren't traditionally big sellers for c-stores. A component of the survey also suggests that consumers would buy more of these non-traditional products if prices were lower. Home Depot to Enter Convenience Market - Home Depot, which has a presence in 49 states, will test c- store and fuel pump integration at a few of its locations. Home Depot is the latest mega-retailer to enter the c-store market, and is fueling c-store owners' fears about the continuing trend toward large retailers offering one-stop shopping. The success of Home Depot s venture should be monitored closely by c- stores near test sites. Up to one-third of Home Depot s locations is logistically able to offer c-stores and/or gas pumps, according to Energy Analysts International. Fuel Prices Not Affecting Demand Yet - Despite high fuel prices, consumers aren't driving less, which is welcome news for c-store and gas station owners. One reason for the steady demand is that the high prices are a result of high demand, in contrast to historical price spikes that resulted from low supplies, according to The Christian Science Monitor. A demand-driven price increase means that consumers can't, or won't, adjust driving patterns because of prices. However, some industry experts fear that supply can't keep up with long-term sustained demand, which could ultimately cause supply problems for c-stores and gas stations. Cigarette Tax Increases Revisited - Many states have increased excise taxes on cigarettes in recent years to reduce smoking among the US population. This tactic has generally lowered sales, but may also be creating an underground market for cigarettes, according to an economist at George Mason University. An underground market simply means that smokers are getting cigarettes outside of traditional retail markets, which angers some c-store owners for whom cigarette sales make up a major portion of profits. States may revisit tax increases to prevent underground crime, which would force smokers back to traditional retail markets. Gas Theft, Along with Prices, Rises - C-store and gas station owners face increased cases of gas theft as prices continue to rise. The demographic of gas thieves has changed from low-income individuals to owners of expensive SUVs who can't afford to fill their tanks. Store owners have implemented new policies such as mandatory pre-payment before fueling, which has had mixed success. Some stores have also bought new video technology that helps police catch thieves; however, the technology's expense keeps many owners from implementing it. CRITICAL ISSUES Volatile Gas Prices - The wholesale price of gas can vary substantially throughout the year, making it

4 difficult for retailers to maintain an adequate margin and requiring frequent retail pricing changes. Spot wholesale gas prices often vary by more than 10 cents per gallon in a month. National retailers are large enough to reduce costs by buying gas directly from major producers, while smaller fuel operators must buy through a middleman, a regional wholesale supplier. After increasing by 45 cents per gallon between August 29 and September 5 following the devastation caused by Hurricane Katrina, the average US retail gasoline price fell by more than 11 cents between September 5 and 12. Increasing Competition - The convenience store (c-store) industry is experiencing competition from many sources, as supermarkets, dollar stores, superstores, drugstores, and warehouse clubs incorporate gas stations and mini-marts. Hypermarkets (grocery or discount warehouse chains with parking lot gas stations) are especially tough. The strategy of using gas sales and convenience items to draw customers into stores to buy higher-margin items is being copied by other retailers. Although laws prevent retailers from selling gas below cost, mass merchants can sell at very low prices because of substantial discounts from wholesalers. Advanced monthly retail sales of grocery stores rose 4.3 percent in the first eight months of 2005 compared to the previous year; gas station sales rose 19 percent. OTHER BUSINESS CHALLENGES High Labor Turnover - Because of low pay and difficult work schedules, many convenience stores (cstores) have high labor turnover. Employee screening, hiring, and training are a major activity for store owners. Outsourcing services for payroll and benefits management or management training is becoming more practical, as stores have limited human resources to handle employee concerns. Rising Cost of Building New Stores - The average cost to build a new c-store in an urban location is close to $2 million, largely because of higher prices for land. Higher construction costs have caused operators to share locations with food franchises, such as Wendy's or Taco Bell. Long-term Decrease in Cigarette Sales - US cigarette consumption per person has dropped 40 percent in the last 20 years. A trend likely to continue as higher taxes make cigarettes more expensive and advertising restrictions make cigarette smoking less popular. Tobacco sales account for a high proportion of c-store revenue, as much as 35 percent for some chains. Underground Storage Tanks (USTs) Still Potential Problem - Despite the large expense that gas station owners have incurred to replace defective USTs in recent years, many new tanks still leak gas into the ground, which requires large investments to clean up. EPA regulations can require substantial fines for gas seeping into the ground. The potential for groundwater pollution lawsuit liability has increased insurance costs for c-stores. BUSINESS TRENDS Technology Automation Aids Security - Technology includes security cameras for liability reduction, cash safe monitoring and shrink reduction, payment networks, driver's license validation, inventory control, tank monitors, car washes, and freezer and dispenser controls. Since high employee turnover can mean more human errors due to unfamiliarity with procedures, technology and automation can save stores from costly mistakes. Scanner Technology - Bar code scanning helps managers price and stock merchandise to meet customer demands, although the c-store industry has been slower to adopt scanning technology than grocery and retail stores. According to the CSNews, just more than half of c-stores use scanners. Fresh Products - As c-stores carry more fresh food products, the need for more frequent and smaller deliveries has grown. Rather than distribute products to their stores from a central warehouse, many companies have vendors deliver product directly to stores. INDUSTRY OPPORTUNITIES

5 Expanding Products, Service - To maintain overall profit margin and as a reaction to increasing competitive pressure, convenience stores (c-stores) have introduced product lines and services to boost sales. Bakeries, deli sandwiches, and catered meals-to-go are becoming popular with small independent and large chain operations. Some stores are employing staff to pump gas and wash windshields for customers, some offer ATMs, and self-serve or Internet kiosks. Combining locations with fast food is also a common trend, decreasing land and construction costs while increasing traffic flow. New Technology - New technologies are being implemented in c-stores to increase efficiency. Some stores have installed solar panes used in a thin-film solar canopy, which provides up to 90 percent of the energy needed to run the gas pumps. Pumps also offer a "touch-and-go" screen for customers to order sandwiches and drinks, and get local weather, news, and traffic information. Point-of-sale (POS) computer systems allow managers to order product more accurately. More c-stores are also using EBT, an electronic funding system that uses new technology to immediately deliver government-funded benefits, like food stamps, and federal and state assistance programs to customers. Advertising Opportunities - As increasing numbers of c-store operators shift their marketing strategy toward brand building, television plays an increasingly important role in the marketing of both small and regional chains. A new instore ad system by Onvance encourages impulse buying. Stock Levels - New technology, like computerized ordering systems, is expected to help c-stores keep products in stock while maintaining lower inventories. With new software, store managers will be able to upload a computer-suggested order from the backroom PC to a handheld device, go to each product on the shelf, scan the product (or barcode if the product is out of stock), and either accept or override the suggested order, thereby automating the process. Phone Cards - C-stores are the main distribution channel for the rapidly growing prepaid phone card industry. Retailers find phone card margins up to 25 percent for long distance and 15 percent for wireless. Marketing and theft are the main issues with phone card sales. New phone card products that c-stores can offer are prepaid Internet, residential long distance, and cell phones. CONVERSATION STARTERS How does the company protect itself from volatile fuel prices? The wholesale price of gas can vary substantially throughout the year, making it difficult for retailers to maintain an adequate margin and requiring frequent retail pricing changes. How much competition does the company have from mass merchants like Wal-Mart? The convenience store (c-store) industry is experiencing competition from many sources, as supermarkets, dollar stores, superstores, drugstores, and warehouse clubs incorporate gas stations and mini-marts. How does the company hire, retain, and manage employees to reduce turnover? Because of low pay and difficult work schedules, many convenience stores (c-stores) have high labor turnover. To create competitive advantage, what new product lines or services is the store planning to offer? To maintain overall profit margin and as a reaction to increasing competitive pressure, convenience stores (c-stores) have introduced product lines and services to boost sales. Does the company plan investments in new technology to cut costs? New technologies are being implemented in c-stores to increase efficiency. Does the company plan to advertise on local radio or TV? As increasing numbers of c-store operators shift their marketing strategy toward brand building, television plays an increasingly important role in the marketing of both small and regional chains. QUARTERLY INDUSTRY UPDATE QUESTIONS What is the company doing to ensure its sales increase over the next five years?

6 Studies indicate that people will increasingly look to c-stores for more types of merchandise as their lives become more hectic. Thus, c-stores can offer products that consumers don t currently buy in c-stores at lower costs to increase sales. How does the company prevent gasoline theft? Some stores are implementing policies that require customers to pay before pumping; others have installed expensive security cameras. High gas prices have led to an increased number of thieves, which means that the threat of theft can more significantly impact a store s bottom line. OPERATIONS, PRODUCTS AND FACILITIES QUESTIONS How many stores does the company own? About 6,000 companies have multiple stores. In how large an area does the company operate? Most companies operate within a few counties, but some cover several states. Does the company operate a distribution center for its stores? Larger chains may use a central distribution facility, but many contract with a regional wholesaler for merchandise distribution. Who does the company buy its merchandise from? Does the company sell gasoline at its stores? Seventy-five percent of c-stores sell gasoline. What percentage of revenue comes from gas, merchandise, and commissions (such as for lottery tickets and public telephones)? Typically, 65 percent of revenue is from gas sales, 30 percent from merchandise, and 5 percent from commissions. What are the best-selling merchandise products? Tobacco, beverages, beer, and snacks are typically big sellers. How many gallons of gasoline does the company sell per store? The average store sells approximately 105,000 gallons per month. Who does the company buy gasoline from? Companies usually use several suppliers. Does the company have supply contracts for gasoline or does it buy on the spot market? C-stores typically have multiyear supply contracts with minimum buying levels and financial incentives for large purchases. CUSTOMERS, MARKETING, PRICING, COMPETITION QUESTIONS Is the company adding new products to appeal to a particular customer market segment? What types of media does the store use for advertising? Television is playing an increasingly important role in the marketing of both small and regional chains. Does the company do market research to determine product mix? How does the company determine pricing for its products? Many companies price products relative to prices at local supermarkets. How many other retailers in the area also sell gas? Cheap gas has become a popular way for other retailers to attract customers. REGULATIONS, R&D, IMPORTS, AND EXPORTS QUESTIONS How has the underground storage tank (UST) cleanup rule affected the company? Replacing USTs has been a major expense for many companies.

7 Does the company post surety bonds to provide for possible future cleanup costs? Some states require bonds; others require payment into a cleanup trust fund. ORGANIZATION AND MANAGEMENT QUESTIONS How does the company hire, retain, and manage employees? Because of low pay, personnel turnover is typically high. What, if any, changes has the company made to combat crime? FINANCIAL ANALYSIS QUESTIONS How seasonal is the company's cash flow? Summer is usually the period with the highest revenue. How quickly does inventory turn over? A week is typical. What are typical gross margins for gasoline and merchandise? For gas, 13 cents a gallon is a typical margin; 35 percent is typical for merchandise. How much does the company depend on cigarette sales? Cigarettes often account for 35 percent of merchandise purchases. Has the company recently remodeled or upgraded its pump operations? More c-stores now have pay-at-pump options. BUSINESS AND TECHNOLOGY STRATEGIES QUESTIONS What new product lines does the store plan to offer? Nontraditional product lines, like gourmet food and beverages, trendy teenage accessories, and toys have been added by some companies. Is the company considering major additions such as a restaurant franchise or laundromat? Additional services depend greatly on the demographics of the area. Does the company plan to add services such as Internet access, photo kiosks, or ATMs? Customers who use services usually also buy merchandise. US personal consumption expenditures of gasoline and oil, major indicators for convenience stores and gas stations, are forecast to grow at an annual compounded rate of 0 percent between 2005 and Low Growth in Consumer Spending of Gas, Oil Source: IERF, Inc. First Research forecasts are based on INFORUM forecasts that are licensed from the Interindustry Economic Research Fund, Inc. (IERF) in College Park, MD. INFORUM's "interindustry-macro" approach to modeling the economy captures the links between industries and the aggregate economy. The purpose of the Profiles is for sales call preparation and general business and industry analysis. Profiles provide

8 general background information only and are not intended to furnish detailed information about the creditworthiness of any individual borrower or purchaser or to be used for making any loans, leases or extension of credit to any individual borrower or purchaser. First Research, Inc. is not an investment advisor, nor is it in the business of advising others as to the value of securities or the advisability of investing in securities, and the Profiles are not intended to be relied upon or used for investment purposes. Copyright 2005, First Research, Inc. All Rights Reserved. This information cannot be copied, sold or distributed in any manner without the written permission of First Research, Inc.