Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Good morning, and thank you for joining us at the Jefferies Consumer Conference. It's Laurence Alexander with the Jefferies Chemicals team. And joining us today is the management team from Valvoline. We have Sam Mitchell, the CEO; and their CFO, Mary Meixelsperger; and also their Investor Relations team. And maybe just -- we'll just sort of just jump in and get started. I mean -- so Sam, would you mind just sort of introducing Valvoline at a very high level, how the company came about, how the current operating structure is set up, given you recently realigned the division?

All right. Well, thank you, Laurence. As far as how the company came about, it's -- we've got a long history. So over 150-year history, really the world's first lubricants company. And founded a long time ago, but going through, obviously, a lot of change in growth as technology has changed. And today, we are approximately a $3 billion revenue company. And it's a company that is operating with 2 operating segments, our Retail Services business, largely our Quick Lubes business, and our Global Products business. So our products business representing lubricants, automotive, chemicals, et cetera, that are sold around the world. The Retail Services business has been growing very rapidly in recent years. And since our separation from Ashland, we went through a separation, coming up on 5 years ago, through an IPO process where now we've been aggressively investing our capital generation, cash generation into our growing Retail Services business. The results have been really exceeding all of our expectations. And that business now is delivering approximately 50% of our profitability. And so essentially, we've got a very steady, strong cash-generating business in our product side of the business, and we're investing that cash into the Retail Services business, self-funding our growth and driving very strong performance for us. So we've got a brand in Valvoline that stands both for high-quality products, but more and more for the consumer and also our heavy-duty customers that stands for high-quality service, too. And so it's a combination that's really powerful for us. We recently held an investor call to provide an update on the business, shared a lot of important news in terms of how we performed since the previous Investor Day going back to May 2019 and basically ahead of our forecast and ahead of our strategic plan and driving the growth on the Retail Services side. And that concludes a really strong performance over this past year despite the impact of COVID, it hasn't been easy. First of all, a pretty big impact just on the overall demand when COVID first began. But roughly, when driving behavior kind of settled out with being down in the U.S. market, approximately 10%, we were able to manage through that and still grow the business. We -- last year, in 2020, it was our 14th straight year of same-store sales growth in our Valvoline Instant Oil Change business. This will be our 15th straight year of same-store sales growth. And so we've been taking market share pretty aggressively through this COVID period. And then on the product side of the business, good solid recovery there, too. So in 2021, and just last month, we shared an update on the business, talking about the strategy of -- the strength of our products business and then using that cash to drive growth on Retail Services, the overall forecast for the business that we shared in this next planning period through 2024 is top line growth in the 9% to 11% range; and adjusted EBITDA margins in the 21% to 23% range; EPS growth of 12% to 14%, all at a 25% plus return on invested capital. So again, overall, about a $3 billion top line business, generating our guidance is right now for fiscal '21, $615 million to $640 million EBITDA. So that's a quick overview of the business. Really pleased with how the team has performed through this pretty challenging period of COVID. And we feel like we're very well positioned as driving behavior recovers. We're seeing some growth in driving as we hit these summer months. The retail stores are obviously very busy as we continue to grow that share, and we'll talk a little bit more about the competitive advantage that we've built in that business as we get into the conversation. And then on the product side, we're seeing good solid demand. It's been definitely some stresses with a lot of businesses with regard to supply chain and inflationary pressures on that business. But we see that as more of a short-term pressure that we're managing through the summer and feel like we're very well positioned with just the basic fundamentals on both products and services as we manage through 2021. So with that, Laurence, I'll turn it back to you, and we'll get into some of the questions.

So maybe let's start with your organic growth algorithm. I mean, you sketched a path recently to about a 6% to 8% same-store sales CAGR. -- in the Retail Services. Can you break out how that plays out, how you get from miles driven to a high single-digit same-store sales growth rate?

Yes. So I mentioned that miles driven has been off roughly in the 10% range through the COVID period. We have seen that narrow quite a bit over the last couple of months. So now we're looking at more of a down 3% to 4%. So that could be a nice tailwind as that continues to improve and return to more normal driving behaviors. So we don't look at that as our big driver. What's impressive of last year is that the performance that we saw in our stores was pretty consistent with the growth that we've seen in same-store sales over the last 5 years where we have been in that 8% range quite consistently. So basically, the breakdown of that is growing transactions and growing ticket, and they both provide a pretty nice balance. We're always concerned with our customer and growing that customer base. We feel that having a great retail business means you're taking market share and you're attracting new customers to your stores and then you're turning them into loyal customers. So we've seen that. And so breaking down -- well, we'll take the high end of the guidance of 6% to 8%, we'll say 8%. I would say expect that about 3% of that growth coming from transactions, so winning new customers and seeing that car count growth across our system. And let me just make a note, too, that of the 1,500 plus stores that we have in the system, we have a nice balance between the company stores, the franchise stores, and the performance of the stores are really consistent. Our franchisees are executing the exact same model, and as a result, their same-store sales performance is right on top of company stores, really, really close. So very pleased with that execution. So our ability to attract new customers has a lot to do with our quick, easy, trusted value proposition that we execute consistently across our stores, the digital marketing strength that we have to target customers who are likely to become loyal Valvoline customers. So that program continues to help us grow car counts consistently. And that's a big part of the mix and the strength of our business over the last few years. On the ticket side, we've got a number of drivers. One is -- probably the easiest one is the fact that more of the new cars today require synthetic oils. And the synthetic oil change has a posted price of about $90 on average across our system. And that's a significant increase versus, say, a synthetic plan in the mid-$60 range or a conventional whole change, which is only about $45 posted price. So as more and more vehicles, car owners require synthetics, that's just a really nice tailwind for us over time because it drives ticket, and obviously, it drives a lot of margin growth. And then other aspects of the ticket growth have to do with pricing. Typically, there's a couple of percentage -- a couple of hundred basis points coming from pricing actions that we take each year. And then finally, what we call non-oil-change services. Non-oil-change services make up about close to 25% of our overall ticket. And we're talking about -- on average, about a $90 average ticket. And so the non-oil-change services are particularly important for us. They include some very basic preventive maintenance like filters, wipers, bulbs, et cetera, tire rotation, but also services that are recommended by the OEMs would be other fluid maintenance like transmission, cooling system service. Those are services that we also offer and they carry a pretty high dollar ring. We're not required that frequently. It's typically in the 40,000 to 50,000 mile interval, but it's a real nice opportunity for us to continue to grow ticket. So again, so when you break down the -- say, the 8%. You've got, say, 3% coming from transaction growth and then a pretty nice balance between synthetic growth, pricing and non-oil-change revenue growth that all adds up to that strong high single-digit same-store sales growth. So that's part of our plan is that we're very confident that, this year, we have 15 straight years of same-store sales growth. And we look at the next planning period, and very confident that we'll continue to drive that because we have multiple levers. And right now, they're all working.

Sam, I would add to that. Our customer promise in our services business is quick, easy, trusted. And when you look at the quick and easy component of that, we believe there's this macro trend toward convenience that's happening in the markets we serve. And we think that's really a driver of some of the reasons why our business is resonating so well with consumers, and we're able to grow market share and even saw positive comps in our last fiscal year during the toughest part of the pandemic. I'd also point out that part of our formula for being quick and easy is asking the customer to stay in their vehicles. And that happened to serve us very well in an environment where people were very concerned, of course, about getting out of their vehicle, going into a waiting room. So our model actually really took a lot of market share during the pandemic, and we saw positive comp store sales in an environment where miles driven was down double digits last year, and we -- our model is continuing to resonate with the consumer. So it's just the right model at the right time in terms of those macro trends.

Well, we don't see the consumer shifting away from this drive for convenience. I mean everybody wants things easy and fast. And they also want to deal with people that they trust. So our stores have a heavy emphasis on the speed component, how we wire our process, how our team works together, the type of leaders that we have in our stores and how they're trained. They bring a sense of urgency every day, and that's what drives that excellent performance of the store. But we also have a system that we've created and how we communicate to the customer about the services that their car needs, and that allows us to drive ticket but at the same time not pressuring the customer at all, educating the customer of the other services that they need. And so it really builds trust. So our growth, as Mary talked about, driving share growth this past year, and when we look over the last few years, our growth isn't just coming from competing in quick lubes. Certainly, we do well competing against some of the other big names out there in the quick lube business. But a lot of our growth, in fact, even more than the growth from quick lubes is coming from car dealers, tire repair, other types of smaller repair shops and DIYers as DIYers become, what we call, do-it-for-mes. We're attracting those customers, too. So a lot of opportunity for growth. And our -- we think our share of the do-it-for-me, just the oil change business, is only about 4% to 5% right now. And so having the best model and this opportunity for growth by both adding stores and then winning customers and growing the car counts in our existing store base, we think we have a very long runway for share growth in total top line and bottom line growth.

Maybe just to flesh that out, can you give a sketch of how the runway in terms of the percentage mix of synthetic lubes in your store turnover compared to in the fleet and the percentage of non-oil-change revenue and where that could go over time?

Sure. The synthetic mix of our oil changes right now is in the mid-30% range of full synthetic, and it's pretty balanced between that full synthetic blend and then the conventional oil changes. So that compares pretty closely to the overall fleet requirements. I'd say we're probably a little bit ahead, not significantly ahead. But the newer cars today, approximately 80% of those newer cars require full synthetic. And so that's where you see like this long runway for growth going from about 1/3 of our oil changes to ultimately the vast majority of our oil changes into the future. On the non-oil-change revenue side, we think we have a long way for continued growth there, too. There's -- a lot of it has to do with the education. And so I mentioned those OEM recommended services, the transmission service, the cooling system service. These aren't services that are well understood by car owners today. And so a lot of our marketing, our education that happens both out of the store about what their car needs and then what happens when they come to the store, to present like a short video clips of what these services are and how they benefit the performance, how it's similar to you take care of your engine via oil changes. You need to take care of your transmission versus -- with the transmission service and fluid exchange there, too. So part of it is just getting better and better at execution. We have a program, too, to drive battery sales. We used to have a program that was with one of the leading battery brands, and it really wasn't going anywhere in terms of our battery penetration. The testing equipment wasn't up to snuff, but we had a team at that -- just that one service over the last couple of years, and we rolled this out this past year to company stores this year, now rolling out to our franchise stores. But in a very short period of time, our battery sales have doubled. This is $150 service, product sale and service and installing that new battery, again, at a very attractive margin, provides great support to our customers to keep their cars safe and ready for the road. So just -- there's quite a few examples and opportunities that we see to get better and better at the non-oil-change services. So I don't see -- I don't know yet what that upside is. We're nowhere close to it is a good way to talk about it right now.

And so what does this growth cycle look -- translate into for the evolution of retail services margin? That is, if you only grew organically without acquisitions or starting -- investing in new store growth, -- how much would margins rise, say, over, say, 5 years above the mix effect?

Pretty powerful. And when you look at Valvoline's profit growth, certainly, that's -- it's really our #1 driver of profit growth is when we drive same-store sales growth organically in our stores. So much of that falls to the bottom line because you've got that fixed cost in the store and the team that's servicing those vehicles. And so as they have success servicing more vehicles and providing additional services, the incremental margin is really significant. We did an analysis where we looked at same-store sales going back over a 5-year period. And I think we saw roughly 500 to 600 basis point improvement in those operating margins. And so we do expect retail service margins to grow over time. So mentioned that the EBITDA margin on retail services is in that 31% to 33% range. And so we expect incremental growth over time. With the growth of the new store investments that we're making, because obviously, you're starting at a much lower base there, it does offset some of that same-store sales margin growth. So the incremental growth is steady but smaller year-over-year while we're in this period of aggressive store growth.

And so can you elaborate on the store growth? What do you see as the saturation threshold in the market? Or how long can you expect to grow at a 5% to 7% top line through store acquisitions or launches before the pace needs to slow down?

So our guidance is that we expect to grow over 100 stores each year. This year, we're going to add over 150 stores. I think we're still on track for both through acquisition and store build and franchise growth. So we've got 3 levers to drive store growth. We see a long runway for store growth, too. As I mentioned, with only 4% to 5% share of the do-it-for-me market, we're reaching, we think, around 10% of households that are within 5 miles of a Valvoline store. So there's still room for significant store growth. We have a -- since we went public, we've been building our capabilities to build new stores because that wasn't part of our growth algorithm before. So we've gone from 0 to 25 stores now to approximately 50 stores a year, and we're preparing to push that towards the 70 to 75 range in the next couple of years. So really pleased with the team's -- the development team's progress in building stores into a number of new markets. But we're looking for that combination of both building stores and then making acquisitions. But where we don't see appropriate acquisitions, where the real estate is really attractive to us and we can model that store and project what kind of potential it has, we'll build. And then where we have an opportunity to acquire, we've had a lot of success over the last 4 years making those acquisitions. The one thing that's changed or we see changing in terms of our acquisition strategy is that, over the last 4 years, we've made some really nice high-quality regional acquisitions, say, chains in the 10 to 20 to 30-plus store range. But as we've made a number of those acquisitions, there's fewer of them. And so there's still, we think, roughly 4,000 independent quick lube operators out there. And so what we've done is -- through our real estate modeling is to identify those that are most attractive to us, that could be good fits for our system. And now we're marketing to some of these smaller operators that might have only 1, 2 or 3 stores in their systems. And so it's been encouraging to see the progress that, that team is making as they build that pipeline because you still have to develop that relationship with the store owner, typically, the founder of that business. And the other nice thing is that battling with the acquisitions that we've made, we've developed a good reputation as an acquirer that works really well with business owners and takes care of their teams and pays a fair price. And for us, it's great for the owner, and it's been good for us because when we apply our Valvoline model, we're typically able to increase that store's performance pretty significantly with the Valvoline brand, the Valvoline marketing tools, with the Valvoline operating system. So we've made acquisitions where maybe they're doing, say, 35 oil changes per day. And with the Valvoline system over the next -- in a few year period, be able to move that from 35 to 40 to 45, close to system-wide averages that are right now in the upper 40s. And that's just talking about -- a little bit about the productivity of our stores, say, versus some of our competitors and industry averages and how Valvoline is so unique in what we're doing with our system is that as we approach 50 oil changes per day, the industry average is closer to 30. And so the productivity of our stores is pretty dramatically different. And so it just gets back to our model, what we've been investing in over the years and how we continue to get better at delivering the quick, easy, trusted that Mary spoke of.

So the 4% share, it sounds like a very fragmented market. Is there anything significantly meaningful higher share? And what, if any, structural impediments would block you from getting to north of 10%?

So the largest competitor in the quick lube space would be Jiffy Lube, and that's a system owned by Shell. It's basically 100% franchised. So very different philosophy versus Valvoline's approach of owning and franchising stores. And then they've also -- they're down a little bit different path with a multicare approach and adding other services. So what we see is that there's -- it's a very different model. We're focused on -- yes, we want to provide additional services over time and continue to grow that, but not at the expense of the convenience aspect of what we're able to offer. So -- but they're -- they -- while we have approximately 1,500 stores, I think they're a little over 1,900 stores. So it's not like they're significantly bigger than Valvoline in terms of units. And of course, in terms of store-level productivity, average revenue per store, Valvoline would be quite a bit higher. But it's really not about like growing versus Jiffy Lube for us. It's this broader market opportunity that creates the growth from 4% to 10%. And that is how we need to think is how do we take it from 4% to 10% as far as structural impediments, I don't see any. We have a pretty unique business and model that we're executing, and our ability to continue to build stores and make those acquisitions, we think we're the acquirer of choice. And we've got a great franchise system, too. I haven't talked too much about our franchisees. Our model is a little bit different than some in that the small number of systems are big drivers for growth. They have the capital and the capabilities to make acquisitions and to build stores. And so we have development agreements with our franchisees. So they are partners with us in terms of driving growth and figuring out how to take advantage of this tremendous opportunity in front of us to go from 4% to 5% to something much bigger than that.

And so if you look, Laurence, at the overall do-it-for-me market in the U.S., it's about 450 million oil changes that are done in that DIFM market. About 100 million are done in quick lubes and about 20 million of that 100 million is done by Valvoline Instant Oil Change. So our -- if you look at where the other parts of that 450 million are coming from, dealerships have a big piece of it. We think because of the convenience demands of the consumer that more of that dealership business will move in our direction. And then the auto -- the tire store and auto service center business has another big piece of it. And again, we think our model is really differentiated and likely to continue to attract customers from that model. And then over time, we believe that the DIY side of the business will continue to contract. And we think we're the only branded lubricant in that DIY space that can really directly market to drive that DIY share into our stores where the ticket is at multiple times. The sales ring for an oil change is at multiple times what a DIY sale is and the profit is also a multiple higher than -- many times higher than what it is for a sell to a DIY. So I think we're really well positioned across the spectrum to be able to capture more and more of that 450 million oil changes.

So I received a half dozen sort of pointed inquiries about the types of services you may try and layer in. And in particular, have you considered testing, car washes and a new box or something like that?

What was it? Car washes and what else?

It was -- the question was framed as have you considered testing car washes in a new box or in a new kind of franchise concept?

Oh, in a new box. We don't have a lot of experience on the carwash side of the business through some acquisitions. We have had some stores that operate car washes. There are some modest synergies between those businesses, but they do tend to be a little bit different business model. So it really hasn't been a key to our success in the past in driving our growth. And so it's not, say, on a road map for a business that we're looking to get into at this point. But for us, we, first and foremost, have an opportunity to better penetrate the services that are part of our offering today. And so that's a key part of our strategy is not to deviate from the quick, easy, trusted model that we've been speaking about because of the positioning that we have in preventive maintenance is so strong. The opportunity is so big there that we want to really lean into that and continue to grow there. The other services, these OEM-related services that we see nice growth in, battery checks and battery sales, et cetera, these services are still relatively fast and easy for us. So while it may add additional 15 minutes to the customer service time, it's still done without an appointment and it's something that our teams can do very proficiently, too. I think over the long term, with the strength that we have in our core capabilities, of how we how we operate stores, how we build extremely strong retail culture, how we market to our customers, we have a unique relationship with the car owner in the aftermarket because we get to see them multiple times during the year. And a lot of times, we do the families' multiple vehicles, too. So we might be seeing a customer 2 to 4 times a year. And that results in a really strong relationship. So we understand driving behavior, the vehicles that they drive and build trust with that customer. And so as we think about the long-term evolution of our business model, the opportunity to expand services is certainly there for us. And that's something that we'll evaluate over time. But as I said, we're not looking to add services that would take away from our core value proposition with preventive maintenance.

Thank you. So I think we're reaching the end of the allocated time for this morning. So thank you very, very much for the discussion. Hopefully, it's helped sketch the opportunity set on this side of the business. And then, of course, we also have the Global Products business as the source of cash. So thank you very much for the discussion this morning.

All right. Thanks, Laurence.

Thank you, Laurence.