NASDAQ:CORE Core-Mark Holding Company

Sector financial performance:

This company, a wholesale distributor of cigar, tobacco, food, confectionery, beverage, and grocery, has been grouped into wholesale cigarettes& food sector.

While it has been the truth that consumption of cigarette has been declining for years, our company’ sales volume data indicate that demand from existing stores for cigarettes did not decrease until 2016 as manufacturers continued to raise their products’ price (reduce the promotion of their price) and/or increasing exercise tax in some of regions. Demand for food distribution seems to have been strong and help offset the decline in cigar sales in the past several years.

While companies usually are able to pass on the increased price from supply side to customer side so that they can maintain the fixed profit per sales unit, the increase in cigarette’s price from manufacturer side has been giving huge pressure on cigar wholesalers’ gross margins, which have usually been very small due to the nature of intensive competition in this sector. And the decrease in sales volumes and downward pressure on gross margins inevitably resulted in significant shrinks in those companies’ profits (operating income decreased by 22% - 36% in fiscal 2017 compared with 2016 so far) and may push profits of some of wholesalers into negative range (operating margin 5% currently) if they were not able to pass the increased price to stores or save costs by other ways. The recently rising demands for food distribution, with higher margin, seem to be offsetting the lost profits of companies in this sector resulted from declining cigar sales/volume.

In this situation, lifting sales of cigarettes by grabbing more market shares from other competitors and pursuing growth from business with higher margin such as grocery food and fresh food distribution ( around 13% gross margin for food distribution compared with 5% for cigarette) have become the only ways for current wholesalers to keep growth of their profits.

A typical gross margin for companies in this sector is around 5-6% with around 5% SG&A spending as percentage of sales. Therefore, their operating margins usually have been very close to fall below zero.

According our analysis, there is a large span between companies’ enterprise price/adjusted EBI from 19-39 with interest/EBI ratio of 20-30%. 

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Company performance:

It seems the new increase in sales of cigarettes in this company primarily was from acquisition and newly gained market shares. The continuing increase in cigarettes’ price, mainly driven by exercise tax and manufacturers, started to exert pressure on demand of consumers after 2015 and caused cigarette sales volume to existing customers go down.

It seems that this company has been successful in grab market shares of cigarettes as some of other wholesales’ profitability continued to get worse when the total demand for cigar declined and manufacturers raised their product’s price.

It seems that this company’s organic sales for food and other item continue to increase benefiting from the natural increase in demand from convenience stores.

Higher non-cigar products sales seem to have been offsetting the decrease in profit resulted from decreasing cigar carton sales.

For the first nine months of fiscal 2018 compared with the same period of 2017(ended 20180930)

Cigarette per carton price increased 4.8% (exercise tax and manufacturer price) and organic carton sales decreased 7.4%. The organic non-cigar products sales to existing customers also increased.

For fiscal 2017 compared with 2016

Cigarette per carton price increased 9.3% (exercise tax and manufacturer price) and organic carton sales decreased 9%. The organic non-cigar products sales also increased.

Sales of this company increased 9% (8.6% for cigarette and 11% for food and other items) in the first six months of fiscal 2017 compared with the same period of 2016, attributable to contribution from acquisition and new agreement with large retailor chain for food distribution and an increase of 8.2% in cigarette price (exercise tax mainly), offset by losing retail customers and decrease in volume of cigarette carton to existing customers.

Sales of this company increased 31% (37% for cigarette and 18% for food and other items) in fiscal 2016 compared with 2015, primarily attributable to contribution from acquisitions and new gained business of cigarettes and the increase of 2.7% in cigarette price of manufacturers. Carton sales were flat.

Sales of this company increased 7.7% (8% for cigarette and 6% for food and other items) in fiscal 2015 compared with 2014, attributable to contribution from acquisition and new gained business of cigarette, increased sales volume of cigarettes to existing customers, and an increase of 3.5% in cigarette price.

This company’ gross margins as percentage of sales went down from 5.8% of 2015 to 5.3% of 2018. The decrease in gross margin is primarily due to the inflation in price of cigarette, which has gone up significantly in the past four years. Because the profit for a carton of cigarette is usually fixed, the decreased sales volume resulted from increased price caused the margin as percentage of sales smaller. It is also possible that this company may have failed to pass all inflation in price/reduced promotion from manufacturers to the stores in the situation that the total demand for cigarette has declining. Another reason responsible for margin’s declining is that the new acquisition and agreement, while brought increase in sales, diluted the whole margin of this company because most of them are in cigarette segment that has more than half lower gross margins than that in food segment.

As a result, its operating margin went down to 0.4% and cash flow as percentage of sales down to 0.2%. 

Stock price

This stock currently has an enterprise price/EBI ratio of 39, which we think, is relatively overvalued compared with its peers.


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