The U.S. convenience store market continues to grow, but it’s highly competitive and definitely not for the faint of heart.

According to market research firm IBISWorld, overall U.S. convenience store revenue is expected to rise 4.9% from 2011 to 2012, which is higher than the average annual growth rate of 2.8% in the five preceding years.

However, the convenience store market remains highly competitive, with the top four companies controlling just one-third of it. Most players are single-store operations that employ 10 people or less. That’s because convenience stores remain a business with low barriers to entry and, as IBISWorld points out in its report, smaller operators are able to compete because they’re better able to adapt to changing trends and customer preferences than larger chains.

In addition to other convenience stores, operators also compete with a wide range of other businesses, such as grocery retailers, fast-food outlets and even big-box stores like Wal-Mart (NYSE: WMT).

Long-Term Trends Still Favor Convenience Stores

Even so, the convenience store market is well-positioned to keep growing as our lives grow more hectic and time gets tighter. For investors, the key is to zero in on companies that have the ability to change with customers’ tastes and diversify away from low-margin gasoline sales. They should also have strong balance sheets that will help them snap up smaller competitors with attractive locations.

One company that matches up well with those criteria is Casey’s General Stores (NasdaqGS: CASY). Casey’s operates 1,700 convenience stores in 12 Midwestern states. That’s a fraction of the size of market leader 7-Eleven, which has 48,000 stores in 16 countries, with 9,460 outlets in North America.

As well, franchisees mainly operate 7-Eleven stores, where Casey’s owns the vast majority of its outlets, as well as its distribution center. That makes it better able to adapt to changes in the fast-changing convenience store market.

Casey’s also focuses on improving the stores it acquires, particularly by adding kitchens that churn out freshly prepared foods, such as pizza and doughnuts. That’s in contrast to many convenience stores, which mainly offer pre-wrapped fare. The company’s fresh food lineup also helps it stay on the right side of the healthy eating trend.

Another way Casey’s ducks the competition is by focusing on smaller centers. Roughly 60% of its outlets are located in towns with populations under 5,000, and 75% are in communities smaller than 10,000 people. This small-town focus lets it dominate its local markets. These areas are also often too small to attract the attention of major chains.

Higher Costs, Challenging Cigarette Market Are Weighing on Casey’s Profits

The company reported its latest quarterly results on Monday evening. In its fiscal 2013 second quarter, which ended October 31, 2012, Casey’s revenue rose 7.2%, to $1.91 billion from $1.78 billion a year ago. Despite the gain, net income slipped 12.7%, to $32.86 million from $37.63 million. EPS fell 13.3%, to $0.85 from $0.98, on more shares outstanding.

Revenue matched the consensus estimate, while EPS was well ahead of the $0.87 that the Street was looking for. The stock gained 5.5% in the wake of the results.

The company’s operating expenses increased 10.6%. That was partly because it’s now keeping 150 of its stores open 24 hours a day. It also started pizza delivery to 103 outlets and remodeled another 51. In addition, Casey’s is now operating 27 more stores than a year ago.

Prepared food and fountain drinks were a particularly strong area for the company. In the latest quarter, same-store sales of these products were up 10.1%, with an average margin of 62.5%. That’s mainly because of the extended hours, the addition of pizza delivery and the company’s ongoing store upgrades.

Strength in prepared foods helped offset lower sales of gasoline. As well, sales of groceries and other merchandise suffered due to competitive pricing for cigarettes and an increase in the Illinois state excise tax.

Expansion Plan on Track

Casey’s remains heavily reliant on gasoline, which accounted for 72% of its sales in the six months ended October 31. That is an ongoing risk of investing in the company. The cigarette market also remains highly competitive and will likely continue to shrink as more Americans stop smoking.

However, rising sales of prepared foods are helping mitigate these risks. As well, residents of the company’s mostly rural markets are more car-dependent than urban dwellers, which should help support fuel demand.

The company’s balance sheet also looks healthy, with cash and cash equivalents of $39.3 million and long-term debt of $660 million. That will help support its ongoing expansion: its goal is to increase its total number of stores by 4% to 6% annually.

In the first half of fiscal 2013, Casey’s opened eight new outlets and acquired three. It also completed its purchase of 22 Kum and Go locations and opened its first stores in Tennessee and North Dakota. The company now has 13 stores under construction and has agreed to acquire another eight.

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