Wednesday, June 3, 2009

Core-Mark Annual Shareholder Meeting (2009)

I attended Core-Mark's (CORE) annual shareholder meeting on June 2, 2009. The meeting was held in a small conference room at the Hyatt Regency San Francisco Hotel. The only refreshment offered was Starbucks coffee. I was a little disappointed, because food-related companies sometimes display their own products. I did not get a chance to try Java Street items or other Core-Mark products.

Around eight people sat in the audience. Core-Mark's executive team, except for the CFO, sat in the front. Other than my friend and I, everyone attending the meeting had a business or employment relationship with Core-Mark. The Chairman of the Board handled the formal part of the meeting.

Core-Mark started out as a tobacco storefront in San Francisco. It grew into a major supplier of consumer goods to various retailers and became known as Fleming Companies. In 2003, Fleming Cos filed for Ch 11 bankruptcy/reorganization. In 2004, Core-Mark emerged from the ashes of Fleming Cos. For more information on Core-Mark's history, click on the following link:,_Inc

Cigarettes and other tobacco products accounted for 74.9% of Core-Mark's net sales in 2008; however, cigarette sales accounted for only 29.2% of Core-Mark's total gross profit in 2008. (See 10K, page 3.) In short, while Core-Mark continues to sell cigarettes, it has revamped itself into a food/consumer kiosk company. Food and non-food (batteries, etc.) products accounted for 71.0% of Core-Mark's gross profit in 2008. (See 10K, page 4.)

Core-Mark supplies convenience stores, such as 7-Eleven, with refrigerated kiosks containing various products. These kiosks contain packaged salads, bakery items, drinks, sandwiches, juices, fruit, and other items. Core-Mark touts its ability to re-stock its kiosks several times a week, which allows customers to select fresh food. In other words, Core-Mark strives not to be like your grandmother's food kiosks, which tended to sell month-old sandwiches, cigarette packs, and stale candy.

I was the only person who asked questions at the meeting. CEO J. Michael Walsh graciously answered all my questions. I asked how the company would deal with declining cigarette sales and higher "sin"/SCHIP taxes. Mr. Walsh answered that cigarette consumption has been declining for a long time, and as a result, Core-Mark had consciously shifted to the new consumer trend, which was selling fresh food products. He said that Core-Mark wanted to become the leader in fresh food products.

Mr. Walsh also said that higher cigarette taxes actually helped Core-Mark's bottom line. He indicated that rising cigarette taxes allowed Core-Mark to get a higher return on its "working capital." This concept is a bit counter-intuitive, but I will explain it as best as I can.

According to the CEO, Core-Mark must buy "stamps" from states before it can purchase cigarette cartons. These state-issued stamps allow Core-Mark to purchase a certain number of cigarette cartons over a certain period of time. Different states levy different taxes per carton. In California, the current carton tax is $8.70; it is higher in New York.

The "stamp" process functions as a VAT, allowing states to ensure they are paid carton taxes up front rather than at the final point of sale. This process helps states keep track of cigarette sales and may reduce the black market for cigarettes. This system is not perfect. Some entrepreneurs buy cartons in states with lower carton taxes and then illegally re-sell them in nearby states that have higher carton taxes.

Higher carton taxes may help Core-Mark, because Core-Mark buys "stamps" at the beginning of the month; however, it does not have to actually pay for the stamps until later--sometimes up to 30 days later. In the meantime, it still receives its allotment of cigarette cartons and the cash from those carton sales/distributions. That regulatory quirk means Core-Mark sometimes gets a "free" money float of up to 30 days, which helps increase its liquidity. In short, the way states issue "stamps" may result in some companies receiving temporarily subsidized cash flow, which minimizes capital costs. (I hope I've explained this correctly--if not, feel free to correct me by adding a comment.)

Mr. Walsh also indicated that Core-Mark was in a position to consolidate deliveries and take market share from less efficient competitors.

I then asked why cigarette companies wouldn't decide to sell directly to customers, thereby eliminating Core-Mark as a middleman. Mr. Walsh replied that doing so would cost cigarette manufacturers "more money." They would have to "build the infrastructure" first and deal with the "administrative burden" of handing 100,000+ billable accounts. In fact, Mr. Walsh said that some cigarette companies, such as Philip Morris (PM), were favoring third parties as distributors to cut costs. Mr. Walsh's explanation makes perfect sense. If Core-Mark has a highly efficient supply/distribution chain, then its advanced inventory management might act as a wide moat. Walmart, for example, is able to cut its costs by having superior inventory management, but its internal tracking system took years to develop.

I then asked about Core-Mark's pension plan, which is underfunded. (See 10K, page 11.) Under ERISA and other laws, different levels of pension underfunding trigger different corporate fiduciary duties. Companies typically indicate pension funding levels by referring to one of three funding categories: "80% and under"; "80% to 60%"; or "60% and under." When a pension plan falls in the "60% and under" category, it may be a sign that pension assets and investments are being poorly managed. Core-Mark's CFO indicated that the pension was at the 60% level.

I then asked about Core-Mark's executive team and board, which appeared to be non-diverse. More specifically, all Board members appeared to be older Caucasian men. I asked what Core-Mark was doing, if anything, to increase its executive team's diversity. Mr. Walsh pointed out that Core-Mark's CFO was obviously not a white male (she is a white female), and the company was open to diversity. He said that Core-Mark was always open to qualified candidates. Mr. Walsh also indicated that the Board was chosen by Core-Mark's unsecured creditors following Core-Mark's Chapter 11 filing. (In other words, the unsecured creditors were responsible for the Board's composition, and they might be the more relevant party to contact on this issue.)

For a company that was in bankruptcy court just five years ago, Core-Mark has done remarkably well. I especially enjoyed CEO J. Michael Walsh's demeanor and responsiveness. Unlike many CEOs, he answered every single question thoroughly. He had no trace of the arrogance so common in upper-level management. It was a pleasure to meet him.

I had only one issue with the meeting. The Chairman interrupted me once when I was in the middle of a question to ask me for my name, how I held my shares, and the number of shares I owned. He asked me these questions after I had already announced my name and shareholder status. I thought it was inappropriate to ask me how many shares I owned. A shareholder is a shareholder, period. Companies should welcome questions from all shareholders, not just major ones. To date, this is the only company I've seen that has requested this kind of information, i.e., the number of shares held. (There was another issue, but it was minor--a shareholder relations representative wanted me to fill out a name-tag and then complained that my handwriting was illegible. Note to all shareholder relations personnel: you get one day a year to make ordinary shareholders feel welcome. Use it wisely.)

I don't have an opinion on Core-Mark's stock. I haven't bought products from their kiosks, and I'm not a smoker, so I don't have sufficient personal knowledge to state an opinion. It does appear, however, that Core-Mark provides a valuable service to many convenience retailers.

Note: the picture above is of Mr. Walsh and myself.

Disclosure: I own an insignificant number of Core-Mark (CORE) shares.

Update on June 5, 2009: The more I think about the sin/stamp tax issue, the more I think I may have reversed the payment schedule. Perhaps CORE has to buy stamps first and then wait a month or more before receiving cartons to distribute. Otherwise, I am still unclear as to why CORE would make more money when the number of smokers decline. Any comments are appreciated.


Christopher Schulz said...

Interesting blog.

This always appeared a bit of an orphaned company after ch. 11.

I have my own theory on how the whole
stamping of cigarettes works.

It is more hilarious than what you think by qualifying the benefit as a float issue..

CORE generates something known as cigarette holding profit. but never has reported a cigarette holding loss.

what goes on is that during environment of rising state and fed taxes, the company sits on inventory of cigarette packs that have already been slapped with taxation labels (stamps) and can be sold into the market as is.. call this legacy inventory. old inventory that is fully stamped does not get retaxed to an increased tobacco tax etc, but simply is sold to retailers at prices reflecting the tax hike.

AS you can see in 2009 so far, the federal legislation introduced created a big 50-state tax hike and resulted in a fairly sizable cigarette holding gain.. this is a pure profit event.

the 2009 profits look unsustainably strong simply by virtue of the one time positive effects. but tax hikes are recurring across many states.

Apart from any float issue you observe this profit recognition on inventory liquidation can be quite substantial given the tax hikes in question. 100 MM in cigarette inventory repriced at +20% means 20 MM more profit in that period before taxes.

Hope this makes sense. Core has over time nicely benefitted from these tax hikes, although in the ordinary course of thigns the gross margin on this distribution is lower than with other consumer packaged goods, fresh foods and merchandising servcices.

When tax hikes kick in, generally the volume drop of cartons sold in the period is typically more than offset by the big profit short in the arm. the nature of tobacco tax hikes are that they hikes are typically generous in % terms.

Matt Rafat said...

Mr. Schulz: Thank you for taking the time to post a comment. The "cigarette stamping" issue has been bothering me for a long time.