Valvoline Inc. (VVV) Earnings Call Transcript & Summary

A new addition to our conference this year, but certainly fits the bill of an aftermarket company. Valvoline is a supplier of engine and automotive maintenance products and services, and I think most well-known for their Valvoline motor oils. They operate 3 segments, including Core North America, which sells to many of the large distributors, which are presenting today, along with repair teams, Valvoline Instant Oil Change, of which there are nearly 1,400 locations and probably one of the cleanest feeling oil change locations you'll be able to find and through their International segment. Valvoline has 189 million shares at $28 for a market cap of $3.8 billion, net debt of $1.2 billion for an enterprise value of $5.3 billion. Presenting today, we are lucky enough to have CEO, Sam Mitchell; and CFO, Mary Meixelsperger. Thank you so much for being here, team.

All right. Thank you, Carolina. Well, I'm going to do the talking today, and I've got Mary and Sean along with me to answer any questions to help with that. But first, of course, I have to call out the safe harbor statements, forward-looking statements. We will be making forward-looking statements, and there are, of course, risk and uncertainties associated with that. So please read it. We'll be talking about adjusted results. And in fact, you will have some key items when we talk about some of the key metrics in our business, too. With that, let me go ahead and get started. First of all, just introducing Valvoline. I feel like there's 4 things that people need to understand about our business and our business model. One is it's a very high-return, resilient business model that performs across cycles. It's not a cyclical business. And if we've proven anything this past year in dealing with COVID, we've proven that the business is quite resilient, and we'll share some numbers that help you understand that. We've become a world-class retailer, and we also have a very long runway for growth. We have now delivered 14 straight years of same-store sales growth in our Valvoline Instant Oil Change Quick Lubes business. I don't think there's too many retailers who can say the same thing. Third, since our separation from Ashland 4 years ago, we've been powering a shift to a much more service-oriented business model. And this is especially true with our Quick Lubes business and investing our free cash flow into Quick Lubes' growth. So we've been driving a business transformation, and we're beginning to see the benefits of that transformation, especially this past year, but most notably when we think about and we forecast our future, you'll see what kind of impact that is having on our financial profile. And what's also impressive is that the growth has been self-funded. So because of the strong cash generation in our business, both on the product side and on the service side, we're able to self-fund that growth. So these are the factors that drive shareholder value for the Valvoline business. Quick introduction then to just some of the statistics. Approaching $2.5 billion in sales. I mentioned that we have strong margins and strong return on invested capital. Our EBITDA margins are consistently above 20%. You see that in the bar chart below. The return on invested capital is also north of 20%. System-wide, we're approaching 1,500 stores in the Quick Lubes business, selling in 140-plus countries around the world. But you see over the last 5 years where we've dealt with periods of significant raw material inflation and then the COVID impacts of this past year, we've been able to consistently deliver results. In terms of our channels to market and understanding the business model and some of the customers that we sell to, you see some of our largest customers here, which include both U.S. DIY retailers. Also some very large national accounts on the service side of the business. So on the do-it-for-me side of the business, we'll sell to both large national chains like a Goodyear, Monro, also car dealers, car dealer networks like the Hendrick Automotive Group, and selling through WDs. We also reach a large number of small garages around the world, too. So we have kind of a nice balance in our business of both large national accounts and then smaller accounts too. The Quick Lubes business is the one Valvoline Instant Oil Change that has been growing into the DIFM space aggressively and creates really the most significant opportunity for growth in the years ahead. So we thought it would be interesting to compare Valvoline's performance versus some of the other presenters in the conference today and some of the -- our customers that we work very closely with to grow and manage a healthy business. And so just highlighted Valvoline and some of these key statistics versus some of the other participants in the aftermarket. One, starting with same-store sales growth. We just -- this figure, just looking at the last quarter. So post the most significant impacts of COVID, which occurred back in late March into April and May. So just looking at the last quarter, the automotive aftermarket is doing quite well. So Valvoline at 8.3% average of the aftermarket of these key accounts, 6.6%. I would have to say, though, if you looked over a longer period of time, particularly over the last 5 years, Valvoline has been averaging about 8% same-store sales growth. I think that's a figure that's quite a bit higher than the rest of the automotive aftermarket. In terms of revenue growth and EBITDA growth, you see that, again, Valvoline compares quite favorably to the market. Our margins are higher at the EBITDA line, free cash flow, pretty consistent, strong cash flow generation at Valvoline and in the aftermarket. And so the opportunity then is when we take a look at where Valvoline trades today and trading at a discount to the aftermarket, you have to wonder why that is the case. And I hope that part of that is because investors are still coming to understand the strength of our business model and the growth opportunity in front of us. So it's -- certainly should encourage investors to take a closer look at the Valvoline business. Well, let's jump into then the rest of the presentation, and hopefully leave a little bit of time for questions. Our simple road map to driving shareholder value from a portfolio perspective is to aggressively grow the Quick Lubes business, to maintain our Core North American business. It had been under pressure, particularly in '18 and '19 from both raw material inflation, also the growth of private label and DIY retailer. We've made significant progress in stabilizing that as we move into our fiscal '21 and then really developing our international business. International is a business that we've been investing in for the last decade or so. And we have profitable regions all around the world and really nice growth opportunities for us as we built our capabilities. So Valvoline is definitely becoming a much more global company, too. But the shift in the portfolio is definitely driving towards services and the tremendous growth in the Quick Lubes business. In terms of how we're doing that, it's really taking the strong cash generation coming from our Core North American business with those high EBITDA margins, very low maintenance capital. So that cash generation, close to $500 million over the last few years, pre-COVID, that is then poured into growth in very high-return projects, primarily in our Quick Lube business. So this is how we think about capital allocation and reinvesting the cash that we're generating in the business. The results of that are impressive. And so when you take a look at the growth that we've been driving in our Quick Lubes business, this is taking a look at total system-wide sales, delivering most recently $1.5 billion of system-wide sales. And essentially, roughly doubling the size of the business since 2015. And so this is a combination of continued growth in same-store sales, but also then accelerating the pace of adding new stores to the system. And we'll take a little bit closer look at this in a moment, but the growth progress has been really impressive. Moving forward and taking a look at just the earnings in review and understanding the resiliency of the business and how we performed, both pre and post-COVID. The top chart shows you our revenue and adjusted EBITDA performance, both pre-COVID, really strong going into the impacts that began in March. So the results that we posted in Q1, Q2 were very strong. We began to feel the impact in March, but still delivered a very strong quarter. Q3, which was the toughest quarter for us. So again, we're in a fiscal year that just ended in September. Q3, that June quarter, is where we felt the impact most significantly in April and into May. But nonetheless, with our ability to reduce some discretionary spend and continue to manage the business, we made some really important decisions as we entered into the early impacts of the crisis, and they really paid off for us. One was stay open, and keeping our stores open. Keeping our employees engaged in the stores was key for us. Making sure that we could deliver against all customer needs across all channels, particularly as the DIY retail channel recovered quickly too. We were able to meet those needs. And as a result, we were still able to post a very profitable quarter. But then what you can see here is in Q4, the business really accelerated in terms of its recovery from the COVID impacts and posted an excellent quarter, and for the year then at $510 million of EBITDA, delivering 7% growth. Again, not too many companies delivered profit growth during this past year. So we feel great about the work that we did this past year and the performance of our teams around the world, and then certainly, in the Quick Lubes business, too, really across all channels. So -- and this is what gives us confidence as we laid out our guidance last week in our earnings call. And that said, next year, we expect revenue growth in the 12% to 14% range and adjusted EBITDA growth of 10% to 14% over the record year that we posted in fiscal '20. Providing a little bit more context on the next page, just highlights. Again, some of the key messages that I'd like you to take away from today's presentation is just the resiliency of the business model. And certainly, we showed that in how we performed. Results certainly exceeded expectations. We had a really fast recovery in the Quick Lubes business as we returned to positive comps in the month of June. And just saw a strong trend up across all of our regions, both company stores, franchise stores through the summer months and delivered an outstanding quarter in Q4. We also saw a strong recovery in our International segments. China leading the way. They first certainly felt the impacts early on, but posted an outstanding year. And while the results internationally were a little bit uneven with India and Latin America lagging because of pretty severe COVID impacts there. We nonetheless saw improvements throughout the fourth quarter on the International side. And then real strength this past year has been the Core North American business, the product side of the business, particularly as we benefited from the strong performance in the DIY retail channel. But also some of the cost savings work that we had done in previous years were really benefiting us in fiscal '20, will continue to benefit us in fiscal '21. We did benefit from a short-term positive price lag impact as our product costs fell during the early part of the calendar year, and so benefiting from some margin expansion in the product side of our business in Core North America certainly helped and it was timely. But all in all, just a very strong year and positioning us well for a good start to the year in fiscal '21. Good forward here. Let's intervene on the Quick Lubes business. The Quick Lubes business, as I mentioned, 14 straight years of same-store sales growth, the last 5 years averaging over 8%. Adjusting for, of course, the COVID impact this past year, I think our comp stores -- same-store sales for the full fiscal year were a bit over 2%. But nonetheless, we were able to recover from that sharp hit that we took back in March and April. But same-store sales is really our #1 profit driver for this business. We're strong operators in the business. Our ability to drive same-store sales growth has to do with the growth in our share, first of all, attracting more new customers to our stores. We've been doing that for a number of years. And so growth in what we call our oil changes per day has been very consistent for us. And even this past year, in the COVID environment, as we stayed open, as we execute our stay-in-your-car model, customers do not leave their car in our Quick Lubes model, a drive-through model, and we have our POS system and all the information that the customer needs and our team needs to present effectively to the customer right outside the customer's window. And so it really helps drive that speed of execution, but also building confidence in how we communicate with our customers. Winning new customers is key, not just winning new customers say from competing Quick Lubes. About 2/3 of our new customer growth comes from outside the Quick Lubes channel. In other words, it's coming from car dealers, tire repairs, smaller garages, even as DIYers convert to becoming DIFM and want somebody else to do the work on their car. Those are all driving the growth in our oil changes per day. In addition to transaction growth, we also have very strong ticket growth. Ticket growth is driven by a couple of different things. One is the increased growth in synthetic oil changes. So the newer vehicles do require synthetic oils, and that ticket is significantly higher. Roughly, it's in a $90 range for a posted price on a synthetic oil change versus in the mid-40s for a conventional oil change. So there's significant margin pickup and value pickup for the company as more customers and more cars require synthetic oils. And then we're continuing to better penetrate our customers with non-oil change service execution. So presenting those other services that they may need. We know from our recordkeeping whether they need cooling system, transmission service differential fluid exchange, et cetera, battery service we test for. These are all services that we're continuing to get better at and are a significant source of growth for us. So we're very confident that the same-store sales that we've been delivering will continue in years to come. And we guide in the 6% to 8% range on an adjusted basis. Of course, it's going to be a lot higher than that next year, because of the weak third quarter. This is not the only lever for growth, though. We're adding new stores at a much faster pace, both company stores and franchise stores. We have franchise development agreements with our key franchisees to help them grow in the markets where they have a strong presence, and then we've been driving company store growth in a number of newer markets that we think have excellent growth opportunities for us. Acquisition is the key part of our plan, too. And we've been quite successful the last few years, closing on a number of regional acquisitions. We just announced a couple in recent months. And as a result, our fiscal '21 unit additions are expected to be in the 140 to 160 range or 10%. So bottom line here is with the Quick Lubes business, we have multiple levers for growth. Each of them are very strong and are contributing in a very significant way. Those new stores that we've been building since our spin-off from Ashland, they're beginning to contribute meaningfully in fiscal '21. This slide here summarizes the results from fiscal '20 Q4 and fiscal '20 and then summarizes the outlook for fiscal '21. So I won't go through all the information on this page. There's a lot here. If you want to dive into earnings, of course, I'd encourage you to go back and take a look at last week's presentation. And you can get the context behind the performance in each one of the businesses. As I mentioned before, Quick Lubes strong recovery in Q4, and overall delivering that positive comp for the year has been impressive. Core North America, very strong profit year in International, again, showing some really good signs of growth and momentum into fiscal '21. I mentioned that Latin America and India were severely impacted by COVID in fiscal '20. Those are 2 markets that are expected to do quite well for us in '21, even as COVID impacts are lingering. Because of some of the work that we've been doing to develop our channels to market, develop our brand, we're in very good position to see growth in the International business in '21. So you do see the guidance down below here, and the projected growth. Obviously, EBITDA growth for the Quick Lubes business is going to be exceptionally strong, driving overall profit growth for the business in '21. Core North America, we'll see a modest step back in our profitability in Core North America in '21. And that's partly due to that price lag benefit that we had in '20, which won't be there in '21. But nonetheless, the profitability of this business and the improvements that we've made are going to be significantly higher versus where we were in fiscal 2019. All right. So hopefully, that gives you a nice overview. And again, if you got to get more detail, want to dive into that, you'll have that opportunity, taking a look at last week's presentation. To summarize here, key things to take away around the cash generation of the business. We've got cash generation in the $300 million plus discretionary cash flow, that we can invest back in this business. Our maintenance capital is quite low. So when you look at our CapEx spend, 70% plus is being directed towards the growth opportunities in Quick Lubes adding units, and then the remaining discretionary cash flow goes towards dividend. We have an attractive dividend at a 2% plus yield. Share repurchase has also been part of our plan in the past with excess cash flow. But we do target a strong BB credit rating. Maintaining that strong balance sheet is also part of our approach to managing this business. So again, very strong cash generation, very consistent over the years. And so as we look forward, you can see that we're projecting accelerated growth in fiscal '21. And we believe it's a real point of inflection for the company. The investments that we have been making in the Quick Lubes business, both operationally, but adding new stores, new builds and making the acquisitions, they're really starting to create some leverage in the business model. The fundamentals in Core North America are strengthening. We've made some really nice progress there and pleased with how we're entering the year for fiscal '21. International contributing to growth next year, too. And it all adds up to good solid growth. But what you see is that over the last few years, since our separation, it's been a significant shift in the mix of the profitability of the business and what's driving that profitability, where the Quick Lubes business will be over half the company's profitability in fiscal '21 and the benefits that come from that. It is a business, obviously, that carries very attractive operating margins, tremendous growth opportunity. And it's a business that we control our destiny. We control everything from the product to the service delivery and we have a really strong franchise group that works in close concert with us. And when you take a look at their operational performance, it's really right on top of our performance in our company stores, too. So it's been a great relationship and one that we're going to continue to invest in. So this is -- I'd like to close with that company, again, I think across many metrics compares very favorably to other players in the automotive aftermarket. And when you take a look at the resiliency of the business model, what we've proven out this past year, and just the exciting future that we've got and the continued growth in the retail services side of our business, it presents a very attractive investment opportunity for the folks listening in today. And Carolina, with that, we can turn it over for a short Q&A period.

Yes, that's perfect. I think I'll just -- 2 questions. One, just in terms of COVID, your results this quarter were significantly better than miles driven. A lot of aftermarket that did better was really do-it-yourself, but your same-store sales up significantly. Can you talk about that? And has anything changed structurally in response to COVID to how your business is going to do going forward? And then also any thoughts on fundamental growth factors?

Yes. But essentially, the question is all around COVID impact and how we think about that and how we've performed. And we're -- we certainly grew market share in this past period. And when you consider that miles driven is still off, at least in the high single-digit range. For us to be growing our same-store sales at 8% is a good indication of real share growth and outperformance. And number one is it -- this is something that we've been doing for a number of years. As I mentioned in my comments, that we've been driving share growth over the last 14 years and particularly accelerated over the last 5 years. So it's really a continuation of what we've been doing. I do think we've had some tailwinds from the fact that our stay-in-your-car model is a safety advantage too. In that as we stayed open, some of our competitors closed, and new customers came in and experienced the stay-in-your-car model. We've got a lot of great feedback from that. Our customer tracking tools help us understand that they appreciate the fact that they feel very safe and some of the additional safety precautions that our team takes with them is that safety is another advantage. But it's really executing on our quick, easy and trusted model and leveraging the digital marketing capabilities that we've been investing in over the years, that are helping us win new customers to our stores. But it's -- the ability to deliver that great customer experience is what we equal growth. Now in terms of our outlook for next year, we do expect same-store sales to continue to be strong. The -- ideally, we'd see a tailwind develop in miles driven as things will hopefully get better as we move into 2021. We have not built that into our guidance, though. So we're being conservative in our guidance. And while I certainly believe that miles driven will eventually improve, it's hard to predict the pace of that given the ongoing effects of COVID. As far as the balance of the business goes, I mentioned, we're -- we've seen good performance on the DIY side of the business and more stabilization. Not the growth, of course, that we're seeing in Quick Lubes, but it's good to see good solid performance there. Some of our installer customers, their recoveries on the service side have been a little bit slower. But nonetheless, we made significant progress in Q4. And I think we'll have performance improvements in fiscal '21 for us.

Great. And then I'll just ask this last one quickly. Monro historically trends around 13 to 14x. They are a presenter here often. We saw Mavis trade around 15x in the private market. Can you talk about Valvoline Instant Oil Change growth and then unit dynamics and any potential for acquisitions as well?