Driven Brands Holdings Inc. (DRVN) Earnings Call Transcript & Summary

Great. Well, thanks everyone, once again, I'm Liz Suzuki. I'm the senior hardlines retail analyst here at Bank of America. And I'm joined by the team from Driven Brands. So I've got CEO, Jonathan Fitzpatrick; and CFO, Tiffany Mason. So thank you guys both for joining us today. So first, I was hoping that you could give a little bit of background on Driven and just how the portfolio of what are independently very strong brands all came together.

Sure. Well, thanks for having us. Good to be in person. Good to shake some hands over the last couple of days. That's been good. We operate 4 operating segments. Our core growth brands are our Car Wash business, which we've been in for about 18 months. We've got about 350 car washes in the United States, all company-owned, about 750 in Europe, which are independently operated, think sort of franchise-light. We've got our Maintenance segment, which is dominated by our Take 5 quick lube brand, an amazing quick lube business that we've grown from less than 50 stores to now almost 700 stores. It's about 23% franchise and has great growth ahead of it. We've got our PC&G segment, which is really defined by our sort of collision and glass businesses. So franchise collision business is about 95% insurance pay. So we do about $2 billion of system-wide sales, majority of which is paid by our insurance partners. We just entered the glass space at the end of 2021, which we're excited about the glass opportunity. That'll be where we'll deploy some capital. And then lastly, we've got sort of our Platform Services, which is really a distribution-based segment. So when you look at all these things, how they work together, really, there's a couple of things. One is we've got over 80% franchise business model. So we've got great cash flow characteristics, very asset-light. We generate a ton of cash. We generate -- or convert sort of EBITDA to free cash flow at about 95%. We then take that cash and invest it back into our higher-growth businesses. We operate in a highly fragmented space, as you know, Liz, like we're about 80% independently operated or small chains. So we -- our competition is relatively unsophisticated. We're pretty big, but we still have only a 5% -- less than a 5% market share. So that sort of scale benefit continues to compound as we continue to grow. The last thing I would say is how it sort of all comes together is we've got multiple levers to grow the business, right? So we can grow company stores, franchise stores. We've been highly acquisitive for the last decade. And we'll continue to deploy capital into both company stores, while obviously grow our franchisees without capital requirements there. And then we'll continue to be acquisitive. So the only other thing I would say is we've been pretty -- we've invested pretty heavily in our sort of data ecosystem. So we have about 20 million unique customers today that sit in our data lake. We're collecting about 900,000 new unique customers on a quarterly basis. That's all coming through our point-of-sale systems that we collate on a daily basis. What's pretty amazing about the automotive aftermarket space is customers very freely and willingly give you their name, their address. We have about a 92% e-mail collection rate. We marry that with the VIN number and the service history. So over time, we'll continue to leverage that data asset and really sort of unlock the data and digital opportunity in front of us. So that's kind of a quick overview of Driven and where we are today.

Great. And the Car Wash business is relatively newer to your portfolio. But what were the characteristics of the International Car Wash Group that made it such an attractive acquisition target?

Yes. Well, it starts with unit level economics. They're phenomenal. Like the -- this is the express tunnel carwash business. So it's typically 100-, 120-foot tunnel. It takes about 3 minutes for a consumer to go through that. We then provide our consumers with free vacuum stations. So an amazing business, very, very nascent industry. There's probably opportunity for 5-plus thousand incremental new units in the United States alone, very labor-efficient. We run those stores with about 4 people. So the machines do the work. There's a really nice subscription revenue component to that business. So we acquired that business about 16 months ago. We're now generating about 50% of that revenue from monthly subscriptions. That's growing. We think there's opportunity for 15-plus percent increase in that revenue from the subscription. And then obviously, all that translates into phenomenal unit level economics. So those businesses are generating mid- to high 30% 4-wall EBITDA margins with very low labor. It's a high customer satisfaction business. People love how they feel about themselves and their car when they leave our car washes. So we acquired over 100 units last year. We've now got about 350. We've given guidance that we'll open 45 greenfield locations this year. We'll continue to be acquisitive, although the M&A landscape has got quite frothy, let's say, but we're focused on the smaller acquisition targets, which are still in that single-digit multiple. So we love the business. Again, it's pretty nascent in the United States. I think there's a ton of room to grow it both organically. I think there's incremental M&A opportunities, and we think that, yes, the business will continue to grow, both in terms of same-store sales and subscription revenue.

And I guess the auto service industry was pretty severely impacted by the pandemic, given that new miles driven experienced the biggest decline we've really ever seen since the government started tracking data. I mean how did Driven navigate through these last 2 years? And what were some of the opportunities that came up that you might not have seen otherwise?

It feels like about 10 years, right? The last 2 years feels like about 10 years at this point. But look, like most people in that late March, early April 2020 time frame, we were all trying to figure out what's happening. We saw a pretty significant decline in our business very immediately right at the end of March, early April. The nice thing about our business was it bounced back incredibly quickly, right? By June, we were basically back to flat comps. So we had sort of an 8- to 12-week sort of decline, and then we bounced back very quickly. And I think one of the reasons for that is most of our businesses offer needs-based services, right? So this is nondiscretionary. Our business has performed very well in sort of good times and bad times. People need those services. Our average household income of our consumer is sort of between $60,000 and $70,000. So those consumers were still driving and using their vehicles throughout the last 10 year -- or 2 years. They weren't sort of at home on Zoom calls and stuff like that, right? They were out and about working. So I think the needs-based service component of our business really sort of enables us to do very well in all economic times. But Tiffany, I don't know if you wanted to add anything?

Yes, I think that's right. And I think aside from the business just automatically bouncing back from the standpoint of us being in the needs-based service environment, I think we did a really nice job early on of whether it was our Take 5 quick lube business, making sure that we changed our marketing message, right, to really resonate with consumers, make sure they understood that it was a 10-minute take -- stay in your car oil change which was important, obviously, in the early days of the pandemic when folks were concerned about their health and well-being. And so we prompted that message quite frequently, changed our marketing message, made sure we were doing it through the digital channel, being in front of the consumer when it mattered, and that's really resonated. So we've picked up a lot of new customers as a result of that and also been able to drive repeat traffic. So we certainly took some action in addition to just being able to rebound naturally from the from the rise in VMT.

Yes, that's a good lead-in to my next question, which is really about what changes you think have been more temporary in nature, be it like any impact you got from stimulus, whether that helped any spending in this category. And then what you think has been more permanent.

Do you want to start?

Sure. Yes. So look, I think the best thing that happened to our industry, right, is obviously the strict stay-at-home orders lifting, right? So that was by far the best tailwind for us as you think about the pandemic. As soon as the strict stay-at-home orders lifted, we started to see people become mobile again and our core customer get out and about. So that was by far the best thing. I think, certainly, any time consumers have more money in their pockets, there's just an added spring in their step. But because we provide discretionary services, right, they're going to maintain what is arguably, at least their second largest asset, if not their first. And so they're going to spend on the maintenance in their car because they need their car to get to and from work. So I think stimulus certainly helps give people that extra alibi, right? But they're going to spend -- it might just shorten the time between intervals a little bit. But those intervals are going to come in our business regardless. So our business is nice and healthy. I mean I think if you look back at our history and you look at the 12 years prior to the pandemic, any economic cycle that we had seen up into that point, we were able to withstand. So we did, on average, about a 4% comp over that 12-year period prior to the pandemic for a reason, right? And that's because it's a resilient business that needs space.

Yes. And Jonathan, you mentioned that your average customer is probably not doing a lot of work from home right now. And we've still seen really high levels of that in our surveys that are run nationally. But do you feel like that could be a structural headwind? Or for your customers, it's not even that much of an option?

Yes. I'm not sure you're surveying people in Jonesboro, Arkansas and Dothan, Alabama as much as maybe New York and other places like that. So Look, our customers have been driving. They continue to drive. We've seen sequential improvement in what our customers are doing over the last 6 quarters. I think if you look at overall VMT, vehicle miles traveled, we're basically back to pre-pandemic levels. Industry forecast for this year was sort of 6% increase over 2019. So industry forecast, let's assume it's broadly accurate. So I think we feel really good about what the consumer is going to do. There is a little bit of impact to what we call congestion miles, which is a subset of VMT, so that's really that rush hour miles. Obviously, in big cities, you still don't have everyone back to the office. Really, the only impact on congestion miles is our collision business. We've got a really nice, pure franchise collision business, which is about 1,000 locations, and we do about $2 billion of system-wide sales. So -- but we're not seeing any slowdown in that business, right? So we've seen -- we've got really good sort of back orders of work to be done there, work in progress. And then again, when we think about our collision business relative to the overall size of Driven, if you look at our 2022 EBITDA guidance of $465 million, that collision -- franchise collision business represents less than 10% of that total. So there is definitely, I think, some long-term impact around sort of the hybrid work model. Maybe congestion miles take longer to get back, but from us, from our perspective, it's a relatively small impact in the overall Driven pie.

And do the customer demographics vary pretty widely between the different business segments, like between car wash versus oil change and everything else?

It's pretty consistent, Liz. Like we talk about sort of the average household income being in that sort of $60,000 to $70,000 range. Obviously, we go up and down that continuum. That's the average. But I was in car washes last week and I saw a line and there was a Ford F-150, there was a Toyota Camry and then there was a pretty brand-new BMW going through the line, right? So I think we cater to a massive total addressable market in the space. But again, our average is that sort of $60,000 to $70,000 household income, typically married, typically both people working in the home.

And I guess for that demographic, I mean, gas prices are starting to spike. It can cause quite a bit of sticker shock to drivers. So historically, have you seen any reduction in vehicle service demand when gas prices are rising so quickly?

You want to?

Yes, sure, sure. So look, I think we've certainly tipped the scale now at just over $4 at the pump. $4 doesn't necessarily give us any sort of heartburn, right? We think that the consumer -- while it creates some dinner table conversation, right, it doesn't necessarily send us running for the hills, provide any significant risk. I think that most recently, I think we saw a pretty significant shock in 2008. And if you go back and you look at history in 2008, what we saw in terms of the impact on VMT was about a 2% decline. Jonathan mentioned a few moments ago that the industry forecast for VMT in 2022 is about 6%. So if you use 2008 as a proxy and you take 2% off 6%, right, there's still nice healthy growth to be had in 2022. That's good for our business. The fact of the matter is, like we said, our core customer is using their car to get to work every day, right? So to a certain extent, we provide needs-based services, they need to drive, they need to get to work. They're going to continue to use our services. And unfortunately, they're going to have to pay at the pump to a certain extent. I think there is a -- $5 starts to get a little bit hairier, right? So I think there's risk and I really think it's about how long does this sustain, right? So it's not keeping us up at night right now, but we've got to continue to watch the environment.

Yes. And I guess the question becomes if gas prices are rising, but wages are also rising at the same time, which they're expected to, like which has historically been a bigger factor that drives demand.

Yes. And absolutely without a doubt, in our industry wages are important, right? So even before what we're seeing today in the current economic climate, in the current geopolitical climate, right, I think the forecast for 2022 was DPI was going to be flat, but even flat DPI was well ahead of 2019, right? And that's a good situation to be in, again, for our business. So I think as -- wages are definitely the leading factor when it comes to auto aftercare.

Just continuing on the topic of inflation, which is everyone's favorite today. How have rising product costs, freight, transportation and wages impacted your top line as well as your margins?

Yes. I mean big question. Look, 80% of our business, our units are franchised, right? So in a weird way, we benefit from franchisees taking price, right, because we get paid off the top line in terms of the royalty. In terms of our company assets, our biggest commodity expense would be oil in our Quick Lube business. We've got a great partner with Castrol that has done a nice job for us over the last 3 years. We're one of their biggest customers, right? We're well north of 10 million gallons of oil a year that we buy from them. We did take price 3 times last year in our company Quick Lube business. We've seen our price move from an average price of pre-pandemic about $78 for what we call average check, so the average ticket about $78. That's moved to now most recently about $88. So it's gone up $10. There's 2 components to that shift, Liz. One is sort of a mix shift. So we're now at 85% premium oil mix. We define premium oil as either semi-synthetic or full synthetic. So that costs more. The second is the 3 price increases that we've taken. When we think about price, we are super thoughtful around how to take price, when to take price, how much price to take. I don't think really many businesses really understand the true elasticity of price in their business. So when we take price, we look very closely at what happens to repeat rates and then what happens to customer feedback through our NPS scores. To date, with the 3 price increases that we did in 2021, we've seen no dilution to repeat rates or to customer satisfaction scores. So that's good. We do think that in the current -- if the current oil price environment stays the same, we will see a price increase from our suppliers in the May time frame. We're already planning to implement price increases in April ahead of that. So we sort of get that into our system ahead of times. And it will be pretty nominal, Liz, right? When you think about $88 average ticket right now, you're talking about maybe a $2 price increase. Again, when you need to get your oil changed, $2 on a base of $88 is not a massive increase. The other thing in that particular business, it's a very differentiated operating model. So it's a 10-minute drive-through, stay-in-your-car experience, right? So it's a better operating model than the vast majority of our competition. So I think that gives you a little power to take that little bit of price.

And has it been difficult to source certain types of products across your segments like automotive paint, glass, replacement parts in the maintenance category? And then what do you think are the advantages that Driven Brands has over your smaller competitors from a sourcing perspective?

Sure. It's been better than you would think in terms of inventory availability or supply chain availability. I think in the middle of the summer last year, we had some pressure on oil availability and certain SKUs within the oil. We have the ability to source from third parties outside of our Castrol contract if need be. So we were able to get it. At sort of the worst supply chain environments, call it, late summer last year, we were at inventory fill rates in our oil change business at about 88%. We're now back above 95%, so essentially fully in stock. In terms of other big commodities or things that we buy, paint, we've not had any issues. We've got incredible paint partners with Sherwin-Williams and Axalta. In terms of parts, we have some great providers that we work with also direct through OEs and the dealership network there. So we've not had massive parts issues. I would say that we've lost a de minimis amount of business because we didn't have parts or supply to service those customers. I think what makes it probably a little bit easier for Driven Brands versus that 80% of our competition, the oil is a good example, not many people buy 10 million gallons of oil from Castrol. So Castrol is probably going to prioritize us over some other folks. In other parts of our business, we used our balance sheet and we'll order 6, 9, 12 months out to make sure that we have parts and product availability. So I think this scale benefit that we have is compounding and will only get bigger over time. So I think for the most part, it's been challenging, but we've been able to handle it better than most in the industry.

Just on that topic of scale. You mentioned that you still have a pretty small market share today. I mean how do you -- how quickly do you think that can -- that industry consolidation can accelerate? And why do you think the industry remains so fragmented today?