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

Good morning, everyone. I'm Simeon Gutman, Morgan Stanley's hardline, broadline and food retail analyst, which means why am I covering Driven Brands, just joking. Thanks for being here. I have a quick disclosure to read. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. It's my pleasure to welcome Driven Brands represented by Jonathan Fitzpatrick, President and CEO and Head of IR, Kristine Moser, being that this is our first in-person event. This is our first in-person conference with Driven Brands. It's been one of the better performing stocks even since its IPO relative and in a way, absolute. And I think like the story is performing better than, I think, the way that it was set out even an IPO. I'm going to -- do you have anything -- an initial remarks to say. Yes, I'm going to turn it over to Jonathan and then we'll get into a Q&A.

Thanks, Simeon. And it feels like a set up before he puts me on the rack after that anyway. Thanks. Thanks for being here. We're happy to be here. Kristine Moser, my partner, Head of IR. So a little bit for those who don't know anything about Driven Brands. We're in the automotive aftermarket service category, $350 billion total industry. What's unique about this industry is it's still about 80% fragmented. So the majority of our competition are still small chains and independents. Driven has about 4,700 locations globally with the majority in North America. We service about 50 million vehicles a year. And with we've been growing that very nicely over the last number of years. We really have two parts to our business. People can sometimes think it's a little more complicated than it is. We've got our sort of cash generating highly franchised businesses, which are lower modest growth businesses, which generate a ton of great free cash flow, and then we reinvest that back into our three priority businesses, which are our carwash business. So think of express tunnel car washes, our quick lube business operates under the Take 5 brand and then our relatively new entrants into the glass space. So we've got this great double platform of moderate growth, great cash flow franchise businesses. We then take those returns and put it back into our faster-growing businesses. So that's kind of how you should think about Driven Brands. Unit growth is very important for us. We still think we've got about 12,000 units of white space in North America. We've got a pipeline today between company and franchise pipeline of over 1,500 locations with deep visibility into the next 2 to 3 years in terms of when those stores will open. The return profiles on those openings are very, very strong. I'm sure we'll talk about some of that later. Q3, 39% year-over-year revenue growth, 32% EBITDA growth. And one of the nice things about our business is we've been highly acquisitive over the last number of years. So we think of ourselves in terms of unit growth, having three levers we can build, we can buy or we can franchise. We did publicly put out last year that our 2026 EBITDA target is $850 million. And we feel like we're very much on track to minimally hit that by the end of 2026. So with that, I'll turn it over to Q&A.

Thanks. Yes. Do you think you're running -- or when do you transition from running a portfolio of businesses to one brand? And is that the goal? Do you want to create this one brand halo and everything operates under the same halo over time?

Yes. It's kind of a complicated question because we've got four operating segments with at least one sort of marquee brand in each of those operating segments. So we don't have a desire to necessarily create everything into one brand. But what we're pretty excited about is today, we've got about 29 million unique customers in our data ecosystem. We're growing that at about 1 million new customers every quarter. And one of the things that we're excited about is, over time, how do we leverage that customer base with the breadth of offerings that we have really to think about capturing even more wallet share from folks that are spending in the automotive aftermarket. So we're not really thinking about, are we going to change the brand structure but really sort of create an overall sort of Driven Brands ecosystem where people in the automotive aftermarket, will come in through driven and then have opportunities to buy for any of our sub-brands.

So a portfolio of businesses remains with some connections through this ecosystem?

100%.

And then unlocking the data, some of the brands have natural connections. Can you talk about some of the businesses that are naturally connected versus the ones that may be more disconnected?

So it's interesting within Driven, we run multiple -- obviously, multiple businesses, which have very different interval cycles from a consumer perspective. So our carwash business, we could be seeing 300 customers a day, 50% of that revenue comes from subscriptions. So those customers are generally coming 1 or 2x a month, so pretty high interval business. In our quick lube business, we've got about 750 locations today. Average car count is a little north of 40 cars per day. Those customers, we've got an 80% NPS score and over a 75% loyalty score in that business. Loyalty as defined by comes more than twice in a 12-month period. So we do have some intervals there basically twice a year in our quick lube business. And then some of the other businesses are more episodic. So something happens whether you need a collision repair, you need your glass change. So we really sort of look at the total population of all those customers and how we can direct them to one of our businesses depending on their sort of interval need state.

Where is Driven in terms of its data journey from where you are today, where you want to get to? And is there a best-in-class in automotive service that you're aspiring to get?

Yes. I think there's -- when we look at best-in-class, we probably look at folks outside of automotive. I think there's some great consumer-facing brands that really do a phenomenal job with sort of almost like an omnichannel approach to the customer, whether that's a great digital platform, great ability to transact and make it easy with a brand to transact digitally. So I think we look outside of automotive in terms of best-in-class. You can almost think about a ski resort in some of these amazing ski resort companies where you go there and they really make sure that you spend all your dollars in one of those entities. So that's how we're thinking about this. In terms of the stage, Simeon, I think we're still pretty early in this journey. We have the data. We've built out the data ecosystem. The nice thing is the consumers in our space freely and willingly give us their personal information. So we start with a place of consumers giving us their data, and then we can marry that with the vehicle information, the miles, the VIN number. And then we'll append that through third-party services to get an even better view of the customer. So I would say we're still pretty early, but we have a team that's working on sort of a multiyear north star journey for this digital transformation.

And are there interactions being made today where you're connecting someone from car wash to oil change and that's driving business, is that happening?

100%, we're doing that today. So in any location where we have incremental customers basically within a 3- to 5-mile radius, we are communicating with them on a direct-to-consumer digital way to let them know that if they've come to a quick lube. By the way, there's one of our car wash locations within their same sort of trade area or vicinity. And that's already an impact on both top and bottom line sales.

So the last three years, the business has been somewhat battle-tested. A lot of things have been thrown at it, and it seems to be doing just fine, pandemic, reopening, inflation, maybe weakening consumer. Can you talk about macro and in a scenario which you envision something creates a stumbling block for the business, what is that? And then thinking about broadly how the business performs in a weaker backdrop recession?

So I think everyone is concerned about how the state of the consumer is today. And as we look into 2023, look, a couple of data points. When we looked at the business back in '07, '08, it was a much different business. The business was still positive back in '07, '08. It had a quarter of sort of slightly negative sales. So I think the business is fairly recession-resistant or resilient. When we look at what happened in March of 2020 with COVID, we were basically back to 0% comp sales by mid- to late June. So within sort of 90 days. Our core customer is a $60,000 to $70,000 household income. They use their vehicles to live their lives. Not many of them are sort of sitting at home doing Zoom calls for the last two years, they were out and about. Obviously, miles-driven has rebounded. So we're seeing a very steady demand curve within our business. Obviously, within the portfolio, we're going to see different -- slightly different demand curves. We've seen a little bit of softness in the retail side of our car wash business, offset by a massive growing subscription side there. So I would say we remain cautiously optimistic with the consumer, again, because it's needs based services. So when you think about sort of the discretionary funnel for folks, cars are pretty low in terms of stopping that spending. What we do know from customers is there's an anxiety about deferring maintenance for their vehicles because the longer you defer, you sort of feel that you could have a sort of a catastrophic repair bill down the road. So I would say sitting here today, where we've performed very well in 2022. And I'd say that we're cautiously optimistic about how we're going to do in 2023.

The last quarter's performance highlighted something maybe more acutely than what we have seen, which was one part of the business underperformed a little bit another side of it more than offset it. First, is that by design? Or did you find a new wrinkle of this model saying, "Hey, this could happen from time to time, and this is acceptable". I'm sure you're very competitive and saying, no, this is unacceptable. But is that how we should think about the business that it's diversified?

Yes. I mean look, that's what we are. We're a platform company, and we set out to build this platform company back in 2012. And by default, the platform company has sort of natural diversity and sort of hedges in it. What we've said before is we don't need all parts of the business firing on all cylinders to continue to deliver sort of the guidance and hopefully beat the consensus numbers that are out there. So we feel really good about the natural diversity within the business.

So you mentioned we're really two brands, which is a nice simple -- two businesses, we're franchising not. That's an easy way to think about it, easier than how we complicate it. It seems like more of the forward growth is going to come from company-operated segments, Car Wash, glass, Take 5 to a certain degree. Are you comfortable with a higher mix of units and EBITDA coming from corporate? And how do you weigh some of the puts and takes on the business' capital intensity?

Yes, leverage was always going to be talked about, I suppose. So when we think about company stores, if you look at our quick lube, our glass and our carwash company stores, First of all, they're sort of not your uncle's company stores. These are delivering over 40% 4-wall EBITDA margins. So these are highly profitable terrific return businesses. And we will continue to add stores in each of those categories. When you look at the investment profile for each of those businesses, I think it's important for people to understand. In our car wash business, if we are taking down real estate we could be all in for sort of $4 million in terms of real estate and the building and equipment. We can sale and lease back that and get literally all the capital back out. So we're recycling capital within the car wash space. In the quick lube space, cost of building a new quick lube is about $800,000, and the stores are breaking even in less than six months, so highly cash generative. And as you look at the pipeline for our quick lube business, this year, we'll open double the amount of franchise locations than company stores. And as we look at the next sort of 3 to 5 years, we'll see at least 2:1 openings franchise versus company. And then the glass business, which we've been in for about a year now, we've already become the second biggest glass player in North America. We've got 180 locations, about 700 mobile units within our portfolio. We will now pivot towards greenfield openings with glass. The beautiful thing about the glass capital is it costs us about $150,000 to open a new glass location because we're finding existing R&M facilities. So for 150,000 projected stores are going to do north of $1 million and 35% 4-wall EBITDA margins. So the return on capital there is phenomenal. When you come back to how do we feel about that versus franchise, we'll continue to franchise our business. As I said, the quick lube will become heavily franchised, but these are uniquely strong operating profitable company store businesses. None of our company stores require specialized labor. That's really, really important. So our stores are highly labor efficient. Typically, 4 to 5 people that are working in the stores, we can train people within sort of three months how to operate the services. We don't require skilled technicians or mechanics or body shop people. So I think the unique sort of labor component, along with the unit economics makes us feel very comfortable with continuing to grow the company stores.

I want to ask about the competitive landscape, particularly around oil change and car wash. Car Wash being a great business. It sounds like it's the worst kept secret in the finance circles.

Not in private equity anymore. I think 25 of them are in the business at this point.

Exactly. So that's where I want to go. Do you feel that competition is increasing, decreasing or about the same, everyone probably knows someone who's investing in some kind of car wash business? So that's the perception. Curious how you feel about it?

Yes. I met a hedge friend, friend of mine, on the plane last night. He was talking about how car wash business, I need to get into that, too. Look, the car wash business is a phenomenal operating business. First of all, it is typically 3 to 5 people. I've talked about sort of the return on investment, where if you want to flip the real estate, you can get all your capital back out. It's a business where the machines do the work, which is terrific. It is a highly subscription-based business with a lot of companies at 50-plus percent revenue coming from subscriptions. It's actually a feel good category within automotive, no one particularly likes getting their oil changed or new tires or whatever the case is. Car Wash, definitely people feel good about it. So -- and here's the great thing is it's still a very nascent industry. So I think we've got room for this express tunnel car wash to double, triple quadruple over the next 10 years. It has received a lot of institutional capital over the last five years because the private equity world sees the compelling economics and the ease of operating the business. They typically -- our buyers are not builders and typically not in all cases, great operators. So look, we -- by design, we are now the largest operator of express tunnel car washes in the United States by unit count. We've doubled the size of the business since the acquisition in August 2020. We think that the business model is incredibly compelling, and we will continue to invest significant capital into that. We've migrated to a greenfield approach. So we sort of built some scale in 2021 with M&A. The multiples in M&A are still quite frothy. Actually, they haven't come down. We're starting to see a little bit of moderation now because of the debt markets. But we will open approximately 40 greenfield car washes this year, plan to sort of double that amount next year. So we'll migrate to greenfields, where I think there's still some pretty heavy activity on the M&A side.

What's market share today for carwash? And what's a reasonable number to aspire to over time?

Yes. Market share is tricky because you look at the overall industry, you've got to look at sort of hand car wash, in-bay automatic and express. We look at our business today with 400 express tunnel car washes in the U.S. We'd be disappointed over time if we can't triple or quadruple that number.

And there is no shortage -- so you're opening new ones. But in terms of acquisitions, you can still find reasonable small size or medium-sized ones to make the math work?

We sure can. And we've tried to be pretty disciplined that we're staying at basically high single-digit, very low double-digit LTM multiples. We're not talking about 2-year pro forma adjusted. We don't need platform because we have the largest platform in the United States. So really, it's an infill strategy right now when we're in a market, and we've got a presence, and we want to buy 2, 3, 4 stores to start rounding out that market. So we'll continue to do, I would say, very surgical and tactical M&A, typically in smaller bite sizes and remain very disciplined around that double-digit LTM multiple.

Transitioning to $850 million EBITDA by '26. It's one of the most famous taglines in our coverage now. How much more confident -- so a couple of parts, and I'll start with the first one, how much more confident do you feel in this target versus maybe when you laid it out?

Well, I suppose we laid it out knowing that we had a pretty good chance of hitting it. It would be pretty dangerous to put it out there if we didn't think we'd hit it. Look, we are delivering, we came out our first year's EBITDA guidance was $285 million when we first came public, I think our current guidance is slightly north of $500 million this year. So we feel like we're on track and remain very confident that we can exceed that number by 2026.

And is there a margin or a return threshold, we're fixated on hitting the number. But thinking about the other side of it to ensure that their shareholder value being created. Is there are margin associated with that number?

Yes. I mean, I think what we've always said our long-term growth algorithm is to deliver sort of mid-single digits, low to mid-single-digit same-store sales and to keep margins. Basically, we're at 25% margin right now for Driven Brands. I think our goal is to keep that margin intact. Still have some lumpiness quarter-to-quarter because as new stores come on, they're going to be sort of margin dilutive as they ramp. But by 2026, we'd be disappointed if we're not still at that 25% level, if not expanded by that.

And just to add a point on top of that as well. I think if you take a look at the history, given the fixed variable nature of our business. We've had some very good success of dropping margins to the bottom line. We expanded 200 basis points since -- from where we were two years ago, year-over-year, this year versus last year we're flat, which I think is a great measure of success in the current environment, being able to maintain that margin and grow at the rate that we have been. But as we look forward, there would be certainly a natural tailwind to that margin that would be available to us, which certainly would be our goal to capitalize on, but the basis of the $850 million guidance was on a flat margin.

Shifting back to Car Wash. It's really the only segment that's performed a little weaker than expected. We talked about the long-term opportunity. Some of the weakness is more macro related, but do you think there could be some of this competition just infill of Car Wash, could some of that? Or is this is just a weak moment in time for the industry, consumers pulled back because it's easy to and that's what we're looking at?

I think there's three major forces driving it. First of all, you got to remember, when we look at our business, we look at the retail side, which is almost the a la carte purchasing of car washes and then we look at the subscription side of our business. Our subscription side of the business continues to grow. So that's growing. And if you would think that the consumer sentiment is going to hurt anywhere in the business, you would think it would hurt the subscription side. We're actually growing that very nicely and very pleased with the progress there. I think the retail side has a couple of things. I think it's partly where your location is in terms of geography. I think certainly, competitive intrusion does have a small piece of it. And then I think, obviously, as you look at the consumer savings are sort of back to pre-COVID levels. People are starting to put things on their credit cards. So there is a bit of a discretionary nature there. So I think it's probably a little bit of a moment in time, too, with the consumer. So I would think about geography, I would think about competitive intrusion. And then I would think about sort of a little bit of consumer sentiment there.

And you may have mentioned this when we talked about weaker macro backdrop. The carwash history through weaker environments is what?

We didn't own the Car Wash back in '07, '08, but the data that we've seen was it performed pretty well in '07, '08.

I was just going to add on, if you look at some of the industry research, they had '08 at around mid-single digits, around 5%. And then in 2009, it was about another 8%. So fared fairly well relative to retail overall and then rebounded fairly quickly, just looking at the broad category. I think that what Jonathan mentioned is important, though, that was before the rise of the membership, which tends to be stickier, given that not just are you bringing on a membership, but the way that you interact with your Car Wash brand changes quite significantly. You come more frequently. You become a member of that retailer versus just somebody who comes and happens to drive-by and come through. So really, it changes the nature of the customer.

And we're right now rebranding our car wash portfolio. So when we first got into the carwash business in August of 2020, we had about a little under 200 locations. Those locations had about 6 or 7 different brand names on it, some really horrendous brand names as I look back at it. And we sort of made the decision now to migrate everything to the Take 5 carwash brand. By the end of this year, we'll be about halfway through the estate. We think it will take another 12 to 18 months to bring everything together under one car wash. Everything we open now, the 40 or so units this year plus the double of that next year will all open under Take 5, Car Wash. So we do think that there will be some nice tailwinds around sort of the network and brand equity and brand awareness when we've got everything under one, under one brand name.

Promotionality or promotions within the Car Wash. It feels like the industry has gotten a little more promotional. Has that stabilized or it's becoming increasingly so?

We've not seen sort of a race to price from the bottom when we look at the markets that we're in, I would say, the sort of what we call the roadside price, the minimum price is sort of still in that $8, $9 typically in the markets. We've not seen competition try and drop that down to $6 or $5. Typically, where you see the highest promotion activity is when a store opens, and they're trying to drive their membership that they'll offer very sort of steep discounts for the first 30 or 60 days. But we've not seen a movement of price down. I will tell you, we are testing some different pricing scenarios in some markets that we're working on. We actually feel that given our size and strength, and I would say, sophistication we're very comfortable leaning into price if need be. And price doesn't always mean the lower entry price, it could be priced around subscriptions and then really sort of good management of your revenue mix through the sort of 5 or 6 different washes that you provide.

I think the one thing I'd add there is the way that we look at the car wash business is a little bit different than other players who are in there from a monoline perspective as well. We look at the car wash business, given the frequency and the fact that we're seeing 300 car washes a day as a low-cost customer acquisition entry point. So when we talk about how do we bring people into our ecosystem, we take very much an LTV approach to that customer acquisition and figuring out how we can move people across our ecosystem and kind of a share of wallet strategy. So I think the way that we look at it wouldn't necessarily be the same way that other players in the space might be talking about it.

On the shift to glass, we have about nine minutes. If folks have questions, just gently raise your hand and then we can start transitioning over. The question on glass is you just announced that you're going to be trend or migrating the glass business to Auto Glass Now. Similar to your recent migration under Take 5 in the Car Wash. How should we think about the benefits and costs of this rebranding and there will be a similar trade name impairment to what we saw in the carwash side?

So let's start with the impairment is de minimis, like literally de minimis. It's maybe a couple of million bucks, I don't think it will even be that much. In terms of the cost to rebrand the stores, it's going to be less than $50,000 to rebrand the store. And this is all part of our sort of medium-term strategy with glass. When we think about our glass business and the reason we got into it, just three customer sets that we think about. One is retail customers. The second is our commercial or fleet customers. And then lastly is the insurance space. So we've got the scale now where we're starting to have really good conversations with our insurance partners. Remember, we do about $2 billion of collision repair for our insurance partners today. So we're a big known entity for them. So I think it was important for us and for our insurance partners to create one homogeneous brand name in the United States, which we will be calling Auto Glass Now. A lot of these names originated from the Yellow Pages years ago where people wanted A's in their name. We did look at whether Take 5 glass made sense. And just given that there is a speed element to our quick lube and our carwash business. It sort of -- it didn't feel like Take 5 glass was the right methodology. So we tested that. So I think as we look at next year, all of our locations will be operating under Auto Glass Now. And that really starts to continue to bleed into the opportunity to add significant insurance business to that already very strong business.

And in addition to what people kind of think of in terms of signage and branding and go-to-market strategy, there is an element of technology and standard operating procedures that really add a consistency that's both important for a great consumer experience, but very, very important when we're talking about the unlock of insurance, which Jonathan was mentioning.

I want to ask about electric vehicles. I'll get to you, sorry. Before since we talked about glass. We've talked about all the brands. Is there one business or one of the businesses within the Driven umbrella that you feel is misunderstood by the market?

Is there one business? I don't think so. I think as we're coming up on two years. I think people -- if they're spending the time to look at us understand, there's really our lower growth, great cash flow franchise businesses and then our three priorities. So I would say no.

Okay. We have a question right here in the front.

You mentioned fleet customers. Could you just speak about the opportunity across the portfolio?

Yes. So a lot of business with large rental car companies today, with large private fleets like [ PHH ] with -- and then as you sort of migrate down into the sort of more local and regional large municipalities, so we think fleet customers are really important. We have a dedicated team that focuses on that. Sometimes it can be harder to win the fleet business, but it becomes generally stickier business over time. So if we include our insurance business, 50% of our revenue today at Driven Brands comes from what we would call commercial or fleet customers. So it's a high priority focus for us, and we've been growing it at a very nice clip over the last sort of five years.

And I think what we can do that others can't is that full suite of services. So when you're talking about making the experience simple from the businesses we can offer the thing that they'd be looking for in one place versus having to go to even very strong players in each one of those categories.

[indiscernible].

It's been growing at a 20% clip for the last number of years. And I think as we continue to add glass in car wash and other services, I think that growth rate -- we'd be disappointed if the growth rate doesn't stay the same.

Go back to this electric vehicle topic. Look, you were been a private equity person for a long time. So you see and the industry seems to be changing its mind of what it wants to pay for these businesses that are associated with [indiscernible] of vehicles. So how should we think about it? It doesn't feel like there's any imminence to this threat even though the threat keeps getting bigger. Maybe there's some pendulum swinging the other way back towards hybrid. So curious how you think about it?

I think two things. One is strategically the last two big things that we've done over the last couple of years is Car Wash and glass. So we're certainly thinking about the future of Driven Brands, 10, 15, 20 years from now. Glass and car wash are agnostic as to what type of vehicle goes through those. When we think about our business, the sort of most exposed business would be our quick lube business. But you really just have to look at the numbers. I mean, the adoption rates are still pretty slow. In the United States, we're still sub-5%. And if every new vehicle starting today was hybrid, I think it would take until the very late 2030s to 2040 -- any sort of material impact on our business. So we feel really good about where we're positioned strategically. We did car wash and glass. Our quick lube business is based on finding great real estate. We have a dedicated team that's looking at the technology if and when there will be consistency in terms of what the battery is, is they're going to be battery swap outs, what are the other services. So one little anecdote is we have this great little brand called Meineke that just celebrated its 50th year anniversary founded 1972. It started off selling mufflers or exhaust. It was 95% mufflers. Today, it does less than 8% muffler sales. So I do think, and I embrace the change to EV because I think it's good for the entire world. But I think it's going to be slower, certainly in the United States than we think. And I think that the pace of change will give us plenty of time to pivot if we need to pivot.

I'm going to close out with leverage if there's no other questions. Leverage has been higher in the last few quarters, depending on how you calculate it, I think you're 5x target on a trailing 12-month basis. How high are you comfortable with leverage going? And does your current profile limit you at all in terms of investment or M&A?

So we include full year EBITDA, acquired EBITDA in our calculation. Not everyone necessarily agrees with that, but we think we're buying the business and we're going to include it. I think we've been hovering around 4.7% or so for the last couple of quarters. We've done a nice job shoring up our balance sheet. We've got about $1.5 billion of, I would say, capacity today. We'll continue to watch it. Having come from private equity. Obviously, I lived in a much higher leverage world, but we're very comfortable at that sort of guardrail broadly around 5%. I think it will go down and then interesting opportunities have come up. Again, we've got about $1.5 billion of capacity right now. So as we look into the growth CapEx that we need for 2023 and beyond, I think we're in really good shape.

Great. Any last questions? Great. Well, thank you very much, Jonathan. Kristine. Congratulations on your success. Happy holidays, and thanks for being part of the conference.

Thank you, Simeon. I appreciate it.