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Thank heaven for 7-Eleven?
Stock Spotlight: Investors have "slurped" up the stock but gas pains could eat into profits.
April 22, 2005: 2:08 PM EDT
By Parija Bhatnagar, CNN/Money staff writer
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NEW YORK (CNN/Money) - People joke about the ubiquitous Starbucks on every street corner. But with nearly 6,000 stores nationwide, you really can't miss 7-Eleven.

The Dallas-based king of convenience retailing is an Everyman's store, selling an average of 2,800 items per store. And lately, 7-Eleven has been trying to go more upscale.

In addition to the inexpensive Slurpees, Big Bite hot dogs and Big Gulp soft drinks that 7-Eleven (Research) is known for, the company has also started offering its customers higher-priced offerings such as food from a salad bar, sushi rolls and even prepaid cell phones.

Are consumers biting?

In January, the company posted its 33rd consecutive quarter of same-store growth in merchandise sales.

But 7-Eleven also operates gas stations at about 1,900 of its stores. Soaring oil and gas prices have helped fuel sales...and really excite investors. As a result, 7-Eleven's stock lately has behaved more like an energy company as opposed to a retailer. Shares surged 50 percent in 2004.

The company is scheduled to report its first-quarter results Tuesday and with analysts forecasting a 52 percent jump in earnings from a year ago and sales increase of a respectable 13 percent, 7-Eleven's not giving Wall Street much to complain about.

But given 7-Eleven's strong run last year, is a pullback in the cards? Or should investors take a Big Bite of 7-Eleven for their portfolios?

Stock up on some Pepto for the gas pain

Plenty of retailers, including Wal-Mart (Research), have been bellyaching about rising fuel prices hurting their price-conscious shoppers. Not 7-Eleven.

Perhaps that's because the company's fortunes have risen in tandem with the gush in oil prices. More than a third of 7-Eleven's total revenue comes from gasoline sales. And while merchandise rose 7 percent in 2004 to $7.9 billion, 7-Eleven's total gasoline revenue spiked 26 percent to $4.2 billion.

Much of this increase was the result of higher prices, not a big increase in the amount of gas sold, however. The number of gallons sold by 7-Eleven rose just 6.4 percent in 2004.

Here's why that could be the sign of a problem: If gas prices rise further, analysts worry that consumers will not take as many trips to 7-Eleven to fuel up. And that could hurt merchandise sales.

But 7-Eleven could be hurt if gas prices take a dive as well. That's because gasoline is a low-margin product to begin with. So if gas prices have topped and start to retreat, that could squeeze profits.

This dilemma could be a reason why 7-Eleven's stock has fallen slightly so far this year following last year's big run.

Not your father's 7-Eleven

Analysts say 7-Eleven's push toward higher-priced merchandise to offset some of the risks associated with gas sales is a step in the right direction.

But the real challenge for the company will be to change consumers' perceptions of 7-Eleven, namely that it's more than just a quick pit stop for drinks, snacks and gas.

To its credit, the company's been tinkering with its product mix in order to become a more viable competitor to supermarkets and drug stores. During the past year, 7-Eleven has started to sell fresh fruits and gourmet deli sandwiches. It has introduced kiosks with ATM functions and options for bill payments and money transfers as well.

So far, that has helped lead to solid gains in same-store merchandise sales.

The company is also taking a page out of Wal-Mart's book and is hoping that investments in new technology will enable it to more efficiently manage in-store inventory, which should lead to lower costs in the long-run.

A pricey convenience?

With all this in mind, is 7-Eleven's stock still worth buying?

Earnings are expected to increase about 20 percent a year over the next few years, which is about 5 to 6 percent than the average growth rate for other convenience stores and drug stores, according to Morningstar analyst Mitchell Corwin.

But managing its growing store count could be a challenge. Despite its enormous store base, the company has been opening 100 new locations a year in the U.S.

Corwin said that some investors are already put off by the razor-thin margins associated with convenience store retailing. Net profit margins for 7-Eleven were less than 1 percent in 2004. And the bigger 7-Eleven gets, the more likely it is to see its operating expenses go up. It's also likely to become more vulnerable to fluctuating oil prices if it opens more stores with gas stations.

What's more, shares trade at about 21 times earnings estimates, which is no bargain when compared to the closest thing the company has for a pure-play competitor. Regional convenience store operator The Pantry (Research) trades at 14 times fiscal 2005 earnings estimates.

So even though 7-Eleven has been doing an admirable job of sprucing up its image, this already appears to be priced into the stock. In other words, it doesn't make sense to pay champagne and caviar prices for a Slurpee and hot dog.

Click here for more on 7-Eleven's makeover.

Click here to read more about "Singles shopping" at Wal-Mart.

Click here to read more about Wal-Mart's rival "Teflon" Target.  Top of page

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