What follows is an article I wrote on Seeking Alpha about Murphy USA common stock, which was spun off from Murphy Oil in August 2013. Based on a relative valuation to comparable companies, and a free cash flow valuation model, I concluded that Murphy USA had potential for about 45% upside to the then-current price of $38.43.

Here is the link to my Excel valuation spreadsheet.

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Spinoffs are generally underfollowed by analysts and can often see undue selling pressure caused by shareholders of the parent company looking to dump the stock. This can lead to enterprising investors being able to pick up some great bargains if they’re willing to read through an SEC Form 10. These are not the glamour stocks you hear everyone talking about, but the less the following, the better chance we have of picking up a great bargain. As Joel Greenblatt said in his book, “The Little Book that Beats the Market”: “Over the long run, the market gets it right….and is a very rational fellow.”

Murphy Oil (MUR) has just completed the spinoff of its retail fuel product and convenience merchandise subsidiary, Murphy USA (MUSA). I will show that Murphy USA (MUSA) is exactly what we look for as value investors: A great business at a cheap price. I will do both a comparable company valuation and a free cash flow to equity valuation to show that MUSA is underpriced by at least 40%.

**Key Highlights**

- 1179 retail fuel stations in 23 states
- Majority of sites are company-owned, about 90% of them
- Most of locations are adjacent to Walmart stores. The strategic relationship with Walmart expected to be a key driver of growth over next several years.
- Announced expansion plan for approximately 200 new sites with Walmart over the next 3 years, with total locations by 2015-2016 reaching 1408.

Source: http://corporate.murphyusa.com/content/documents/corporate/2013-MUSA-Retail-Strategy.pdf

The proximity of Murphy USA (MUSA) locations to Walmart stores generates a significant amount of customer traffic. MUSA’s focus is on low-priced convenience products complementary to Walmart’s products. Also, a fuel price discount program is in effect for over 950 locations if customers use Walmart gift cards or Walmart MoneyCards. This lowers the price of fuel by about 0.10 to 0.15 cents a gallon for those customers participating and becomes an incentive to stop by and fuel up at a Murphy USA location.

Murphy USA also has the lowest relative fuel cost among the selected competitors below, which will drive high fuel volumes and gross profit.

In addition, they have a low cost operating model due to the fact that most of their stations are 208 or 1200 square-foot kiosks with very low capital expenditures and maintenance requirements. Many stations require only one or two attendants to be present. Add to that the fact that the majority of their locations are company-owned and there isn’t any rent expense, and you have the makings of an efficient Walmart-like low-cost operation.

Another advantage that Murphy USA has is supply optionality for their fuel. They have a wide array of midstream assets (pipelines, terminals) in the Midwest and the South that they use to distribute fuel. They have access to numerous terminal locations, and a distribution system that allows them to send trucks to the terminal that has the most favorable prices, reducing their fuel costs, and enhancing their margins.

Also, they expect to increase revenue by selling “Renewable Identification Numbers (RINs)”, which are numbers attached to a batch of biofuel, created by blending ethanol and bio-diesel. Murphy USA can source the fuel directly at their terminals and blend it, allowing them to generate RINs that they can sell in the market. (Since 2005, the EPA set annual quotas dictating what percentage of motor fuel consumed in the U.S. must be biofuel blended into fossil fuels. A certain amount of RINs must be submitted to the EPA yearly for companies to remain in compliance. Companies that can’t create enough RINs are obligated to purchase from a company like Murphy USA, hence the opportunity for additional revenue.)

**Opportunity for Expansion**

Below we see the existing Murphy USA network in blue dots. As we can see, their operations are mostly focused in the Midwest and South to Southeast. The yellow dots represent Walmarts in MUSA’s adjacent and core areas, so there is plenty of room to expand MUSA’s network of locations.

**Comparables Valuation**

Murphy USA’s competition: Susser Holdings (SUSS), CST Brands (CST), Casey’s General Store (CASY)

Company | Enterprise Value (Millions) | EBIT/EV(Last 4 quarters EBIT) | ROIC=NOPAT/Invested Capital | P/E (most recent 4 quarters) | P/EBIT (most recent 4 quarters) | Price per Share |

MUSA | $2411.15 | 9.79% | 11.68% | 15.13 | 7.64 | $38.43 |

SUSS | $1572.98 | 8.37% | 7.5% | 18.25 | 7.77 | $48.44 |

CST | $2971.34 | 7.40% | 9.85% | 17.57 | 10.22 | $29.74 |

CASY | $3314.53 | 6.34% | 7.68% | 23.28 | 12.16 | $66.59 |

NOPAT = Net Operating Profit After Tax = EBIT (1-T)

Invested Capital = Total Equity + Total Liabilities – Current Liabilities – Excess Cash

Excess Cash = Cash and Equivalents – Max (0, Current Liabilities – Current Assets)

As we can see in the above table, MUSA is relatively cheap compared to its peers at an EBIT / TEV yield of 9.79%, and also has a more attractive ROIC (Return on Invested Capital) than its peers at 11.68%. Its P/E is also the lowest of the group.

I have taken EBIT and Net Income from the most recent four quarters of data available for each company. If I would take MUSA’s 2013 results as of the end of June 2013, and annualize them the numbers for MUSA would look even more attractive.

**Free Cash Flow to Equity Valuation Assumptions**

Current Number of Stores: 1179

Square Footage Breakdown

- 208 square-foot stores: 77%
- 1200 square-foot stores: 4%
- Large-format 2400 square-foot stores: 7%
- Other: 12%

Of the approximately 200 new sites with Walmart over the next 3 years, a little less than half will be 1200 square feet, and the rest will be 200-800 square foot kiosks. We can see in this the company’s desire to build more of the higher earning 1200 square foot stores. Of these new 200 locations, I assume 40% will be 1200 square feet, 40% will be 200 square feet, 10% will be 500 square feet and 10% will be 800 square feet. In calculating new sales per share, we assume annual sales of $4744 per square foot, which is given in the company presentation.

Effective tax rate for 6 months ended June 30, 2013: 39%

Number of Stores expected by end of 2013: 1240

Number of Stores expected by end of 2016: 1408

This is about a 4.5% store growth rate over the next 3 years. I assume after that, the store growth rate slows down to 1% a year from 2017 onwards to be conservative.

Annual Merchandise Sales Dollars by Square Foot: $4,744

In approximating sales per share for each year, I did the following:

For 2013, I just annualized sales by taking revenue for the 6 months ended June 2013 and multiplied by two. For 2013, the company says in their investor presentation: *“2013 includes upside from a number of factors which may not repeat year on year. E.x. Strong contribution from midstream, and unusually high RIN sales prices.” *Therefore, for the years 2014 and onwards, I assume the company’s EBITDA margin will revert to an average of their past EBITDA margins from 2012, 2011, and 2010.

To get annual merchandise sales in 2014 for the 208 square foot stores:

(208 sqft.)*($4744)*(0.77)*(1240 stores) = $942.15 million annual merchandise sales for 208 sqft stores

To get annual fuel and ethanol sales, I simply took the $8330 million in fuel and ethanol sales in the 6 months ended June 2013 times 2 to annualize, giving us approximately $16.66 BN and divided it by the number of stores in 2013 of 1179 to get about $14.13 million in per store fuel sales per year. For valuation purposes I assume this number would hold relatively constant over the next few years.

So, the total annual sales for all 208 square foot kiosks in 2014 would be $942.15 M + ($14.13 M)*(0.77*1240stores) = $14,433 M = $14.43 Billion. In the same way, I calculated the annual sales of all the different sized stores. Adding all this up, I approximated sales per share for each year based on number of locations, assuming the relative mix of square footage stores would remain constant.

I then assumed an EBITDA margin to come up with EBITDA per share for each year. EBITDA margin is estimated using the average of EBITDA margins from 2010 of 1.71%, from 2011 of 2%, from 2012 of 1.58%, and from the 6 months ended June 2013 of 2.04%, which comes out to 1.83% on average. Management sees the opportunity to enhance margins as this quote from their Form 10 explains: *“We source fuel at very competitive industry benchmark prices due to the diversity of fuel options available to us in the bulk and rack product markets, our shipper’s status on major pipeline systems, and our access to numerous terminal locations. In addition, we have a strong distribution system in which we utilize a “Best Buy” method that dispatches third-party tanker trucks to the most favorably priced terminal to load products for each Murphy USA site, further reducing our fuel product costs.”*

I assumed depreciation and amortization expense as a percentage of sales will be similar to its average value over the past few years. For 2010: 0.36% of sales, for 2011: 0.33% of sales, for 2012: 0.39% of sales, and for 6 months ended June 2013: 0.42% of sales. Averaging this gives us depreciation and amortization expense of 0.375% of sales on average, from which we are able to get EBIT per share.

From EBIT per share, I then calculated earnings per share for each year and assumed an effective tax rate of 39% as reported in Form 10 and outstanding debt of $650M with a weighted average interest rate of 5.49% as reported in their Form 10, leading to an interest expense of .0549*650M = $35.685M for 2014. It’s still unclear as to what percentage of debt the company wants in their capital structure, so I assumed yearly interest costs would remain constant for the foreseeable future.

**Capital Expenditures**

MUSA’s capital expenditures for the next few years according to company presentation:

2013 CAPEX: $204 million ($168 growth and $36 maintenance)

2014 CAPEX: $165 million ($135 growth and $30 maintenance)

2015 CAPEX: $149 million

I assume CAPEX is approximately $149 M for 2016 and onwards as well since the rate at which stores are built will eventually decrease, so growth CAPEX will decrease as well.

**Working Capital Investment**

There was actually a net decrease in operating working capital for the 6 months ended June 30, 2013 of $39.597 million, but since I don’t expect this to recur, I won’t add it to free cash flow. I assume working capital investments from 2014 onwards will be 5% of the sales increase from year to year.

**Free Cash Flow to Equity Formula**

FCFE = Net Income + Depreciation/Amortization/Noncash Charges – Fixed Capital Investment – Working Capital Investment

Stock Value = FCFE_1/(1+r) + FCFE_2/(1+r)^2 + FCFE_3/(1+r)^3 + …. FCFE_n/(1+r)^n + [ FCFE_n+1/(r-g) ]/(1+r)^n

Where “r” is the required rate of return, “g” is the assumed growth rate. The last term in the equation above is the terminal value representing an assumed growth rate of free cash flow equal to “g.”

I assumed a beta of 0.8 for MUSA. The competitors CASY and SUSS have betas of 0.65 and 0.51 respectively according to Yahoo Finance, so I’m being relatively conservative. Lowering MUSA’s beta to that of its competitors would result in an even larger potential upside.

Below is the valuation spreadsheet.

The free cash flow to equity model gives a value of $55.85 to Murphy USA (MUSA) common stock, which represents about a 45% upside to the 9-5-13 closing price of $38.38.

Potential Risks that Could Affect the Intrinsic Value Given Above

- Oil price increases may reduce the gross margin per gallon of fuel earned (currently $0.13) and passing cost increases down to the customer may be difficult.
- A general slowdown in the economy might reduce travel, recreation, and construction activity, which could result in declining fuel and merchandise sales.
- The interest expense on the current long-term debt of $650 million may reduce cash flows that may be needed for working capital requirements and capital expenditures. A reduction in credit rating could increase MUSA’s cost of borrowing.
- Interest rate increases will increase the cost of debt service further eroding cash available for capital expenditures and day-to-day operations.
- Murphy USA’s (MUSA) ability to grow and generate revenue depends on their continued relationship with Walmart. It that relationship ends or deteriorates, cash flow will decline and the business will suffer.
- MUSA has midstream assets such as pipelines and product distribution terminals that supply their retail fueling stations. If there is an interruption of supply or an increase in cost related to delivery of fuel to the market, or disruptions due to weather events or accidents, sales will be adversely affected.
- MUSA currently has only one principal supplier for over 80% of their merchandise. Any disruption in supply could have an adverse effect on their business.
- The free cash flow model given above may understate capital expenditure requirements and working capital requirements, reducing the cash flow available to the shareholder. Also, if the number of locations assumed over the years does not materialize, cash flow and sales will be less than what the model predicts. If the future EBITDA margin is less than the historical one assumed, or if interest rate expenses are higher than assumed, cash flow and share price will be less than what the model predicts.

**Conclusion**

Overall, I think Murphy USA (MUSA) is a great opportunity for investors to participate in an under-followed spinoff due to their great relationship with the biggest retailer in the world, Walmart. Along with that, I like their plans for expansion, and their high volume, low-cost model of business. The fact that MUSA is priced cheaper than its competitors and earns a higher return on invested capital, makes this stock a strong buy with about 40% upside to the current price.

**Disclosure:** I am long MUSA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.