Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us. Up next to the Goldman Sachs Retail Conference is Valvoline. Joining me on screen. We've got Sam Mitchell, the company's CEO; Mary Meixelsperger, the company's CFO and Tony Puckett, a man that we don't always see on these types of events, the Senior Vice President and President of Quick Lubes. Ladies and gentlemen, thank you so much for joining us. We're really excited to have you here on stage. It's been it's been a wild ride over the last 12 months. And I mean -- hear more about it. How the evolution is progressing, how do you survive through COVID-19, where the priorities are. With that, let's jump right into it. Sam, I know you've got some prepared remarks and a couple of slides to walk us through. Why don't we jump into those.

Yes. Thanks, Jason. I'll take a few minutes upfront here to walk through the presentation. Sean, you have a quick safe harbor comment, I'm sure.

Yes. I do just want to remind everyone that any statements we make today that are not historical fact are forward-looking statements. Those statements are based on assumptions that are valid as of the day that we're doing the presentation today. But are subject to risks that could cause actual results to differ materially. Valvoline doesn't assume any obligation to update any forward-looking statements unless required to by law. Sam?

All right. Thanks. Well we think there are 4 major things that you need to understand about Valvoline when considering an investment. The first has become really obvious this year and how we've performed through the COVID-19 environment. This business model is very resilient. Demand tends to be very steady. It's certainly impacted by miles driven, but as miles driven has recovered drop that summer months, the Valvoline business has bounced back very fast. And so first and foremost, a very resilient business model. Secondly, we've become a world-class retailer. 13 straight years of same-store sales growth going on 14 straight years and not modest sales growth. But last 5 years, we've been averaging 8% plus. Third is that we're in the midst of driving a strong shift towards our service business. Since our separation from Ashland a few years ago, we've been investing heavily in our Quick Lubes business. It's a great business. We have a competitive advantage there. And as we invest in it, it's driving a fast ship towards a makeup of our profit generation. And soon, our Quick Lubes business will be contributing more than half of the company's profits. And then fourth, this is a unique investment opportunity. It's one that there is a strong growth over here with the growth in Quick Lubes, also a growth opportunity in the international business. But we generate a lot of cash. The margin on this business are very strong, 20% EBITDA and 20% less return on invested capital. And with that cash flow, we're able to invest and grow this business and self-fund that. So the business is a really strong business. We're very well positioned as we prepare to begin our fiscal '21 in October. So let's jump into the presentation. And cover some highlights of how the business model works. This is a simple road map that we shared on Investor Day that we held back in May of 2019, It helps you understand our portfolio strategy. So Quick Lubes business focuses on growth. We expect the Quick Lubes business to be generating growth in the double-digit range, in the low to mid double-digit range, and we've been delivering that over the last few years. We'll dig into that certainly today. The Core North American business is more of a maintained strategy. And we've had some challenges there in certain segments, but we've made some very good progress stabilizing that business. You see that in our results over the last 6, 7 quarters. And we expect that to be the case moving forward. Core North America generates a lot of cash, and we expect to be a good stable business for us for years to come. And then the International business is a developed strategy. We had a strong brand and strong capabilities in all the regions where we compete around the world. And it's a nice growth opportunity for us. And so while we won't be focusing on the international business today, we do have a business that is solidly profitable with some excellent growth opportunities. The investment strategy and how we think about capital allocation is Core North America generating that strong cash flow, roughly I think it's just under $500 million of cash flow generation that's being used to invest in the faster-growing Quick Lubes business and then modestly on the international business. But we're investing in projects that generate 2x the cost of capital. So this is key to driving shareholder value is how we allocate capital towards a fast growth, high-return business. Here's the proof of what we've been doing, that it is working. And as we allocate those resources to growth, here, you see our total system-wide sales growth for the Quick Lubes business close to 17% over the last 5 years. So this is being driven by continued growth in same-store sales, but also the growth in our system itself, franchisees are adding stores. And of course, we've accelerated the growth of the corporate stores too. When we break that down and we consider where we're going and the growth opportunity in front of us, we're able to drive growth on the top line, but also growth on the bottom line at the same time. So in the Quick Lubes business, when you take a look at our adjusted EBITDA, generating close to 18% compound average growth. We expect that to continue to be very strong because we've got 3 big levers. And that first is, we are very strong operators in driving same-store sales growth through the growth in our customer count and driving ticket. That's fundamental to how we operate the business. And we see that performance both in company stores and in our franchise stores. We have a great relationship with our franchisees, and we're getting really strong execution from them. So first and foremost, same-store sales growth; second, store growth itself, big opportunity for us long-term to continue to add stores, both in building stores, ground ups, but also making acquisitions and working with our franchisees on their growth plans, too. So 3 different levers for driving business forward. And I want to talk a little bit now about just the performance and then also the opportunity that's in front of us, the size of the market that we're going into. The same-store sales, as I've said, has been impressive. It's a long-term track record that we've built as very strong operators. And you can see this, looking at the last 5 years -- 5, 6 years since 2015, and then we broke down how we've managed through this COVID period. Certainly, it was a big challenge, when things kind of came to a halt back in March, April. We felt that in our system, too. And so that did have an impact on our second quarter same-store sales, particularly in March after we had a very strong January, February. And then in April, May, we were -- we probably hit that -- a stable place in mid-April. And then ever since then, we've seen continuous improvement and progress back towards positive comps. But by June, we are in positive comp territory, and we produced a very strong June in the high single digits, and we would expect that to continue through our fourth quarter with the momentum that we've had. So really fast recovery from the COVID-19 impact and growing same-store sales at a faster rate than, say, the improvements in miles driven. So we're pretty much at the growth rates were at for COVID-19, even though miles driven is still in the range of being down, say, mid-single digits versus where you typically expect it through the summer months. Now on the size of the market and the opportunity we have to continue to gain share. So on the left side of the chart here, you see that Valvoline is doing roughly 18 million oil changes through our Quick Lubes centers. And that's in a Quick Lubes market of around 100 million oil changes here in the U.S. So good solid share, of course, in the Quick Lubes market. But really, the opportunity is much bigger than that. Not just taking share from JP Lube and other competitors, it's been larger at the IFM market, 450 million oil changes is what we're going into. And the proof of that is that the new customers that we continue to attract to Valvoline are coming -- the majority are coming from outside the Quick Lubes space. And you see that in the chart in the middle, where it's car dealers, tire repair, DIYers, as in age out of DIY. They become Valvoline customers on the DIFM side, too. So we have a large share growth opportunity in front of us. And we believe that to be true because of the data that we have and the continued growth that we're seeing in new customers and a superior customer experience that we can offer versus some of the other choices in the DIFM market. Sean, go ahead. And then -- and so now we'll talk store growth here. And this gives you a sense for what we've been doing over the last few years in investing in new store growth and so we've guided that we expect to add a target of 100 stores per year. We'd like to do even better than that, and we've been ramping up our roundups. When we went public a few years back. We are starting from ground zero. It takes about 18 months to develop a new store. But as we've been filling up that pipeline, we've now grown to a place where Tony will add how many stores in fiscal '20 when we finished opening up all stores in September, just under 40. Yes. So we'll be just under 40%, and we expect to be roughly in the 50% range moving forward there. On top of that, of course, are the franchise growth stores and the acquisitions that we've made, contributing to an average of 110 new stores per year. As far as what we expect now moving forward, and how our new stores will begin to contribute to profit growth, I think this is one of the exciting parts of the story is that the profit growth coming from the new store investments that we've been making, it is yet to hit our income statement. That starts to happen in fiscal '21 and really accelerate in fiscal '22. So you can see, fiscal '22, we expect the EBITDA contribution from the new store investments to be adding $28 million to $31 million of EBITDA and that accelerating in the out years. So I really feel like this is underappreciated that people haven't fully understood the investment in the profit contribution coming from just the ground ups. Next slide, we'll take a look at the contribution from the acquisitions that we've been making and the opportunity for continued acquisitions. So we've had big success here in the last few years as we've ramped up our efforts, and they've contributed meaningful profitability, $47 million in fiscal '19. In this COVID-19 environment, we believe that it's even improved. The opportunities have improved for us to have continued success here. And so we've been working hard in developing relationships with, say, first, all the quality regional operators in the Quick Lubes space, and we would expect to have some success in making those acquisitions benefiting us in fiscal '21. And there's a number of smaller operators out there, too. You can see 500-plus potential targets that we'll be working on in the years ahead. So another lever of growth for us is certainly acquisition. And so just summarizing these levers for growth, same-store sales. We believe this is a long-term opportunity to continue to drive same-store sales growth because it is a combination of many new customers. Oil changes per day is how we measure it, and it's also driving ticket. Ticket growth comes from both the growth in synthetic oil changes. We're roughly about 1/3 of our oil changes are synthetic, and that will continue to grow as more of the car park requires synthetic oil changes. Synthetical oil change commands about double the posted price of a conventional oil change. Conventional at roughly $45, synthetic all changed closer to $90 across the system. So we pick up significant growth in our ticket. And also, of course, there's a nice margin pickup with that, too. And then finally on same-store sales growth is just greater penetration of the services that we offer. We continue to get better at how we present these services. We don't upsell our customers. Instead we build a trust by educating them and doing a better job in providing the service, one big opportunity that we're executing against in the year ahead is our battery program, where we've improved the testing of batteries to, say, give our teams more confidence that our consumers -- our customers more confidence when they need a new battery, a new Valvoline branded battery. So a lot of levers for driving same-store sales growth. So we're very confident that will continue to grow at a healthy rate. And then the unit growth, as I've just laid out, through building new stores, making those acquisitions, working with our franchisees. Our largest franchisees have development agreements where they've committed to new store growth in their regions. And so we have a lot of confidence in the unit growth being a big lever for us. And then as I mentioned earlier, the acquisitions. So when you add the 3 up, you've got 3 powerful levers for driving both top line growth, share growth and as we've demonstrated, driving profit growth with that, too. And then wrapping up with a slide that we shared on Investor Day, and we'll continue to share with investors to make sure that people understand the significant shift that is happening within the portfolio as we execute on this tremendous opportunity. And so we expect by fiscal '22 that Quick Lubes will be contributing more than 50% of the company's EBITDA. And of course, as we think longer term, that number, that mix will continue to strengthen. There's a lot of benefits to that, of course, too, because of the control that we have and how we execute the markets that we're that we're growing into. I think it just improves the consistency and stability of our earnings and the confidence in continued growth. So just summarizing, then the picture here that we share, we have a business that is well managed, very strong resiliency and a tremendous opportunity to grow as we become more and more service driven. So with that, I want to turn it over to questions. And Jason, why don't I turn it back to you, and we'll handle the Q&A.

Awesome. Thank you, Sam. Great recourse, a great climb up . [Operator Instructions] I'll throw a couple out and get started with one sort of generic kickoff. Say on the -- in Mary, you guys have talked to a lot of investors, and you've obviously been tracking new stock price and where the debates are? What, if anything, do you think the market or investors overall are missing, not understanding, not appreciating about the Valvoline story?

While I do think more and more investors are beginning to appreciate the strength that we have in our model, our Quick Lubes model, the competitive advantages that we have here. And we still get poked at. Can you really still grow same-store sales like you have been growing? But as we take them through the capabilities that we have built and how we build competitive advantage, I think the confidence is growing and our ability to continue to deliver very impressive same-store sales growth. But I think the piece that's still underappreciated is the growth rates and the contribution from new stores and how that's going to really accelerate the growth overall in the Quick Lubes business, both the -- understanding the size of the market. I think what I tried to share today, too, and what we've done in our last major presentations, is that it's not just growing into the Quick Lubes market. It's a much bigger market that we are growing into. So the runway for store growth is very long for us. And it's also right in front of us, and we're executing really successfully against that. Those new stores, as I mentioned, they haven't contributed meaningful profit in the last couple of years. But that starts to happen in fiscal '21 and really accelerates from there on out. So that's the piece I think investors don't fully have baked into their model. And then on the more defensive side with Core North America, we've had some pressure there. And yet, we've taken some steps that have really helped to stabilize that business. And I think we've made some good progress towards stabilizing Core North America. It's a good business for us. We have a great brand. We have great relationships with our retail partners with some very large national account installers. And it's a business that we are going to defend, protect and use to provide that investment in our Quick Lubes business. So I feel really good about the progress there. And hopefully, investors begin to appreciate that, that is a good solid business for us and it will be for years to come.

I want to go deeper on both of those. But for the time being, let's park Core North America and just -- and really go deeper on to the Quick Lubes side before we come back to Core North America. So the new store builds at an inflection point -- interesting, and I think this next question is very much related. But since your IPO, we look at revenue growth out of Quick Lubes from fiscal '16 to fiscal '19, a 22% CAGR; EBITDA, a 17% CAGR. Those are both phenomenal numbers. But when we contemplate your business model. It's what surprised some is the lack of operational leverage. There's a lot of fixed cost there. And why shouldn't EBITDA actually outpace revenue? And then we contemplate sort of your forward algorithm. When we stack up the same-store sales outlook, the unit outlook, the franchise and acquisition outlook. It looks to get to the kind of a mid-teens revenue growth figure and you're suggesting sort of mid-teens-ish EBITDA growth. So we're no longer having profit lag but we're not seeing profit outpace sales growth. I guess the question is, why not? What's holding it back? Why would we actually get deleverage in the last couple of years? Why don't we start to see more operational leverage going forward? Sorry, I know a lot in there.

Yes, yes. So I appreciate that. We're starting from a good place. We're driving really strong top line growth and very strong EBITDA growth, too. But yes, you're seeing EBITDA not grow quite at the same rate of sales. I would expect over time that, that is going to narrow. But let me first say that we study this, too. And as strong operators, we expect very good leverage as we grow same-store sales, our profit growth rate should be growing with those core stores. And in fact, it is. And Sean, we might need to take a look at the slide numbers here. But a slide that we shared in an earlier presentation this year at CAGNY, laid out the leverage that we have in our existing store base. And we added about 500 basis points over the last 4, 5 years. In our existing store base. So as we've driven same-store sales, our EBITDA margins have improved dramatically, significantly for those existing stores. So what's happening right now, Jason, is that the impact of the new store investments that we've been making is having a negative impact on the EBITDA growth. And that's because those first couple of years, they're maturing. Year 1, we kind of -- we're typically in about a breakeven mode from the day that store opens to month 12, we kind of get back to breakeven, modestly contributing in year 2. That's really year 3 that you start to pick up that you start to pick up that profit growth. So that's really been the biggest dilutive effect. As we make acquisitions, particularly on the company side, it has a little bit of a negative impact, too, on those EBITDA margins. And as we make those investments and then we start to improve those operations. So those are your 2 factors. And I think for investors, we're looking for ways that we can share more data around that. So there can be a lot of confidence in the leverage that we create as we drive same-store sales and make very smart, high-return investments in new stores. The one piece, maybe where there hasn't been leverage, it's really around labor. We've had some labor inflation that we've been managing through. And I think, too, making some smart investments in labor that are helping drive performance. We've actually -- and Tony can speak to this a little bit more. But we've made investments in some of our highest-performing stores or high-volume stores now have 2 managers instead of a 1 service manager model. We have 2 service center managers. And with that, we drive customer service even higher. So it's helped accelerate the performance of those stores. So those are the reasons why you see a little bit of that deleverage, but the confidence that we have in our model is quite strong that there's leverage in same-store sales growth. And so as we get to these initial -- this initial investment of growth in particularly these ground ups, I think we'll start to see that gap slow because we'll have more of a consistent trend of new stores opening up.

And by the way, standing out, so in the CAGNY presentation that we have on our investor website, Slide 34, is the one that you're referencing.

Okay. 34, CAGNY, if somebody wants to look bet up on our investor website. Jason?

That's helpful. That's helpful. I've got a lot more questions, but we also are starting to get quite a few questions coming in from the audience. So I want the audience's voice to be heard. So I'll jump into a few of those. First, and we've talked about this before, you've gotten other questions. I think you're probably prepared for it. But with the growth of Quick Lubes and where companies with similar growth rates trade, why not separate that business out to be a stand-alone entity. So I think they're really focusing on potentially some of the parts argument, which does on surface, look to be pretty compelling.

Yes. I think it is compelling to consider the value of the Quick Lubes business. And when you consider where some of those other businesses are trading it kind of gets back to the point that the quick lubes within Valvoline is a bit underappreciated. So it's up to us to make sure people understand what's happening with our business and how fast that business is growing. As we've laid out our strategy, we, of course, believe that the businesses are stronger together and a big part of the strength of the Quick Lubes business does tie back to our vertical integration and the product performance, the product contribution to the business. So this is a competitive advantage for us that we see and the profit contribution from products and how that helps the performance of a new store investment, driving that return on investment at a faster pace our franchise system is very profitable for us because it's not at the 4% or so royalty. The product profitability to our franchise system is a multiple of that 4%. And so it's still key to driving return on investment and drives an advantage for us in how we're set up as a business, the integration of product supply chain and how Core North American Quick Lubes work together for the benefit of both businesses is increasingly important. So that's why I take that. But again, it's a good idea to take a look at when you look at the valuation of Valvoline to consider where -- how Quick Lubes should be valued and even how Core North America should be valued as a strong margin business that's generating excellent cash and return on investment. We certainly believe we're undervalued.

One other point, at least, and I know I was multicasting over here looking at the other questions, and maybe I missed it, but I believe there's a bit of a margin transfer math that we look at some of the parts. In other words, I think you're selling a lot of oil from Core North America into Quick Lubes, pretty much at cost. And if we're going to really contemplate a separation of the business, we're going to have to layer on a tolling charge on to Quick Lubes. So effectively just moving some margins and profit off of Quick Lubes, and back on to Core North America. Is that right?

Yes. So just for everyone, the -- and understanding our P&L in the operating segments, the product profitability in the Quick Lubes business is fully captured within the Quick Lubes business. And so there's not a transfer from Core North America if -- the product profits are part of the Quick Lubes P&L.

But the profits are more than they would be if you were buying from a third party supplier.

Absolutely, they're at cost. They're at our manufacturing costs, Jason. And the same is true with the last-mile distribution costs, the Core North America business has direct markets as well as channel partner markets that deliver the last mile into all of our stores and all of that stock cost for Quick Lubes as well. So as you think about that, I think more of it as our supply chain being a corporate cost center that's charging to each of our segments at cost for the product that's coming out of the supply chain. And so if Quick Lubes were independent, there would be a markup on both product cost and the related distribution of product cost.