Couche-Tard says it is victim of tobacco war in the United States

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MONTREAL - Convenience store operator Alimentation Couche-Tard says it is caught in the middle of a war among U.S. cigarette manufacturers that is hurting its merchandise sales.

Tobacco manufacturer Phillip Morris, the maker of the Marlboro brand, instituted a policy that forced retailers to reduce markups on its cigarettes in order to lower consumer prices and now its rivals have adopted similar action.

"There is a domino effect. They are at war, everybody trying to gain market share and we as retailers are in the middle of the war zone, so that's quite difficult to react to things we don't control," Couche-Tard CEO Alain Bouchard said Tuesday during a conference call.

Couche-Tard introduced its private label Crown brand to offset some of the financial pain, but it said other items sold in its stores are the unintended casualties of the conflict.

"When you lose a cigarette buyer you lose other parts of the basket. Tobacco is certainly the one we need to resolve."

Still, Bouchard said the impact on its results should dissipate in the coming months as it the one-year anniversary of the introduction of these cigarette measures approaches.

The Quebec-based retail and fuel station operator missed expectations in the second quarter of fiscal 2013, even though acquisitions helped its revenues and profits to soar.

It earned US$175.2 million, or 94 cents per diluted share for the period ended Oct. 14.

That compared with US$113.5 million or 61 cents per share in the same quarter a year earlier, prior to a major acquisition that gave Couche-Tard its first presence in Europe. The company is already one of North America's biggest operators of convenience stores and gas bars.

Couche-Tard, which reports in U.S. dollars, said Tuesday that revenues surged to US$9.31 billion from $5.15 billion in the prior year, mainly due to acquisitions and higher fuel prices.

Bouchard said recent acquisitions "contributed nicely" to its results despite the challenge of uncertain economic conditions, the competitive tobacco category in the United States and relatively high fuel prices.

Adjusting for one-time items, including foreign exchange gains and acquisition costs, it earned $167.6 million or 90 cents per share, up $53.3 million from the year-ago period.

However, Couche-Tard (TSX:ATD.B) was expected to have 94 cents per share of adjusted earnings on $8.9 billion of revenues in the second quarter of its fiscal year, according to analysts polled by Thomson Reuters.

The company continued to be helped by a double-digit growth in its high-margin fresh food offering, which Bouchard said continues to be "a bright spot for us."

Merchandise sales grew by $344.6 million, with sales for stores open at least a year increasing by 0.4 per cent in both the U.S. and Canada, the lowest level in four years. Excluding tobacco sales, same-store sales in the U.S. increased by 2.7 per cent. Merchandise profits increased by 0.5 per cent in the U.S. and fell by 0.2 per cent in Canada.

Martin Landry of GMP Securities said the overall results were "slightly below" expectations due in part to higher amortization and financial expenses.

He said same-store sales in the U.S. were weaker than the historical average of four per cent, mainly due to the tobacco war. But even excluding tobacco, these sales were below the approximate six per cent range of recent quarters.

In Europe, Couche-Tard said progress is going as planned with opportunities being identified to realize $150 million to $200 million in synergies over three years and growth following the $2.9-billion acquisition of Statoil Fuel & Retail.

Couche-Tard wouldn't provide numbers on how same-store sales changed in Europe but Bouchard said the company wants to take its time to make sure it makes the right changes to deliver improved results.

"We need to take the appropriate time to create real value and not destroy anything. Patience is a virtue. We are very optimistic about the near future," he told analysts.

Fuel revenues increased by $2.9 billion or 81.5 per cent, due to $2.8 billion from acquisitions but high pump prices put pressure on volumes sold but generated $154 million in additional revenues.

Landry said investors should be attracted by Couche-Tard’s growth prospects and geographic exposures "which are better than most of the Canadian large-cap consumer universe on the S&P/TSX, and thus could lead to a multiple expansion for the company’s valuation," he wrote in a report.

"While the Statoil Fuel & Retail acquisition adds a level of risk to an investment in Couche-Tard given the increased debt levels, in our view, the quality of the asset targeted (market leader) and the significant accretion potential could outweigh added risks. Couche-Tard’s management has had an excellent track record of creating shareholder value through acquisitions, which should reassure investors."

Canada's largest convenience store chain is the second largest in North America. Its network is comprised of 6,172 convenience stores, 4,590 of which include motor fuel dispensing in 43 U.S. states, the District of Columbia and all Canadian provinces. It also operates 2,301 stores in Europe.

The company employs 78,500 people, including more than 60,000 in North America.

On the Toronto Stock Exchange, Couche-Tard's shares closed down 73 cents, or 1.5 per cent, to C$46.54 in trading Tuesday.