Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Good afternoon, everyone. Justin Kleber, I cover retail and consumer products and services here at Baird. Thank you for joining us for our next session. We're very pleased to have the team from Valvoline here. Following the sale of the company's global products business earlier this year, the new Valvoline is a pure-play retail auto service provider. The portfolio today consists of around 1,800 stores, just over half of those locations are franchised. With us from today from the company is CEO, Sam Mitchell. We have Senior Director of Finance, Elizabeth Russell; and Jordan Denny, who leads IR, CorpDev and Treasuries in the audience. I'm going to turn it over to Elizabeth for the safe harbor, and then Sam is going to walk through a brief presentation. We're going to have time for Q&A. If you want to send a question in, you can do so at [email protected], and I'll work that into the discussion.

Great. Thanks, Justin, and thanks for joining us today. Before we start, I just want to remind everyone that any statements we make today that are not historical facts are forward-looking statements. Those statements are based on assumptions that are valid as of the date that we're doing the presentation, but are subject to risks that could cause actual results to differ materially. Valvoline doesn't assume any obligations to update any forward-looking statements, unless required by law. With that, I'll turn it over to Sam.

All right. Thank you, Elizabeth. Thanks, Justin. We're glad to be here today and are excited to talk about the new Valvoline. Let's start with how we got here. Valvoline has been in a transformation over the last 18 months. In October of 2021, we announced that we were pursuing the separation of the Valvoline businesses. That culminated this March with the closing of the sale of our Global Products business. We are now working to return proceeds from the sale to shareholders to rightsize our capital structure. At the end of fiscal 2022, we announced that the Board had authorized a $1.6 billion share repurchase. We are making progress towards that goal with roughly $200 million of that share repurchase from the current authorization already purchased through April and an open tender offer for up to $1 billion. I should note that the tender expires tomorrow night, and we will provide preliminary results on that on Friday. The investment thesis for the new Valvoline is simple, straightforward, and it's compelling. Valvoline is now a pure-play automotive services company that is fast growth by margin and with high returns on invested capital. Valvoline is unique in that the business delivers both growth and is very resilient in the face of uncertain macroeconomic conditions. The new Valvoline is primed to deliver long-term value to our shareholders through our best-in-class retail platform. We've completed this slide. Let me move on. We're focused on growing system-wide store sales, increasing units through both company-operated and franchise additions and evolving the service portfolio over time. This formula for driving shareholder value is absolutely relevant now and has a long runway to take us into the future. All of this comes against the backdrop of a uniquely attractive industry: preventive automotive maintenance. The market is economically resilient with low cyclicality and established long-term growth drivers. There are over 275 million cars in the U.S. with increasing age and vehicle complexity, driving the need for auto care and increased service spend. Additionally, total miles continues to grow. This market provides essential services required in any economic environment for any car type. With our strong brand, scaled platform and convenient and trusted service, we are confident we can continue to win share in the evolving auto care market. Slide 7 provides a look at our growth since Valvoline's IPO in 2016. We have seen substantial growth across key metrics, including system-wide sales growing at 18% CAGR, same-store sales growth and store count. We continue to see resiliency and strengthen the demand for quick, easy and trusted preventive maintenance service we provide our customers and expect this to grow and continue into the future. Slide 8 lays out the 5-year targets we provided at the beginning of this fiscal year. The new Valvoline is expected to generate 20% plus EPS growth, taking Valvoline into the top tier of consumer retail growth stocks. We expect our financial and operating metrics to improve significantly now that the separation is complete, which will compound value to shareholders. In simple terms, our plan is to grow top line revenue at 14% to 16%, adjusted EBITDA between 16% and 18% and deliver adjusted EPS growth over the next 5 years. We are forecasting adjusted EBITDA margins to steadily improve with a range of 26% to 29% over the forecast period. Now I'll touch on more of how we plan to meet these growth targets. First is to focus on the growth of our core business. We have seen substantial growth of our core business since our IPO in 2016 and expect that to continue. We have 16 straight years of system-wide same-store sales growth and are on track to deliver the high end of our guidance of 8% to 12% same-store sales growth for fiscal '23. This growth comes from both transactions or vehicles we serve and average ticket. Looking at the transaction growth for our mature company stores, we have delivered 4% CAGR over the last 5 years in the number of vehicles served per day, which is faster than the DIFM oil change industry. And we expect this growth will continue for 3 reasons. Number one, the age and complexity of vehicles is driving growth for DIFM service providers; second, our value proposition of quick, easy and trusted service could not be more relevant to consumers, and it has enabled us to gain market share from our non-Quick Lube operators; third, we have significant capacity available in our existing stores and are innovating ways to improve upon our service speed to increase vehicle throughput. The other driver of same-store sales growth is ticket growth, which we have increased at 5% compound average growth over the last 5 years. We have 3 levers to drive continued ticket growth. First is the shift to synthetics, which drives a higher ticket and margin rate. We anticipate the shift to synthetics to account for approximately 1/3 of the expected growth from ticket. Second is growth in non-oil change revenue. As we offer additional services to our customers and continue to improve the sales penetration of the services we offer, we capture increased ticket growth. And last is pricing leverage. We test and analyze pricing elasticity as well as benchmark our service pricing against both Quick Lube and other competitors to ensure we are appropriately priced. Let's turn to Slide 10, where we highlight our mature company stores, which are defined as stores opened prior to October 2018. Recall, we have aggressively added stores over the last 5 years so only about 60% of our store base is mature. The mature stores have provided substantial growth in recent years, with per store revenue growing from just over $1 million in 2019 to over $1.6 million over the trailing 12 months, while per store EBITDA has grown from about $360,000 to over $500,000 in the same period. There's a strong pipeline of stores that are working towards the mature store status. We believe there is about $70 million of incremental EBITDA growth in the years ahead, simply from our nonmature stores transforming into mature stores. We expect our same-store sales growth, which includes mature and nonmature stores, to continue this trajectory by compounding at 6% to 9% over the long term. Let's turn to look at our network growth. Since the IPO in 2016, we have added over 700 units with growth from both franchise and company-operated units. There is still considerable white space in our fragmented industry to further expand our footprint. We believe we can grow our store count to more than 3,500 units over the long term and continue to win share from our competitors in the DIFM space. On geographic coverage, currently 65% of our customers live within 10 miles of the stores that they visit or roughly about -- where, really, our current data shows that only 35% of the existing car park is within a 10-minute drive of the IOC location. Given convenience is an important driver for customers' provider of choice, we clearly have opportunity to expand our geographic coverage. And we have opportunity to increase our store density in key markets. As with most retailers, store share drives market share. Today, our market share in our strongest markets like Louisville, Kentucky is over 3x our network's average market share. This relationship is consistent when comparing store share across our network, with our top markets showing that we have significant store infill opportunities in many key markets. To drive this accelerated growth in units, we will need both franchise and company store growth. Let's take a look at our franchise growth plans on this next page. Franchise growth will play a key role in our network expansion. In the past 2 years, we have added about 50 new franchise units each year, and our objective is to triple this by 2027. While franchise stores deliver about 1/3 of the EBITDA of company-owned stores, they deliver a highly attractive capital return to Valvoline due to minimal investment, and they deliver approximately 30% cash-on-cash return to our franchise partners. We are working on a number of efforts to drive franchise growth, including accelerating the growth with our current franchisees; recruiting new franchise partners, which would include additional private equity partnerships; and identifying specific geographies to transition to franchise territories. While this is a multiyear focus, we are already making progress in this area. After seeing significant M&A pipeline growth on the company store side with the creation of our business development team, we expanded their focus to include franchise geographies. And this year, we have also worked with our franchise partners to shift company-focused real estate development capabilities to support high-priority market growth for our key partners. On the company side, we plan to build our scale platform by targeting 100 new company stores per year and maintaining at that level. We generate more than -- we generate 3x more EBITDA per store at these company locations than franchise stores while generating returns on invested capital in excess of 15%. We also benefit from the flexibility that company stores provide in piloting new service offerings as well as technology in a controlled environment. Our balanced approach between owned locations and franchise stores allows us to balance the financial benefits of each model, drive accelerated growth across our platform and strengthen our franchise value proposition by proving out initiatives in company stores before asking franchise partners to invest and implement. Now turning to Slide 13. The third lever in our business model is expanded services. A significant portion of that today is non-oil change service penetration and expansion. We remain committed to evolve with the car park while also driving further non-oil change revenue growth via existing offerings in the store. This includes providing fluid flushes, tire rotations and parts replacement. Nearly 25% of sales come from non-oil change services, and those dollar values continue to grow and are a core focus of the ticket growth we discussed earlier. Another positive impact on services growth is our fleet business, which has been growing at a faster rate than our consumer business. A fleet vehicle is serviced more frequently than a consumer vehicle, and the ticket is approximately 20% higher on average than a consumer. Today, our existing stores can serve light-duty fleet vehicles, and we are developing the capabilities to serve medium-duty fleet vehicles across our network. We have a strong inside and regional sales team to both increase penetration within existing fleet accounts, like Amazon and Enterprise, as well as grow our fleet customer base. And we will continue to expand into new services to meet the needs of an evolving car park. We have shared that we have expanded our EV service pilot into 2 markets. While EV penetration of the car park is only around 1% nationally, we are learning our customer expectations as we complete inspections, tire rotations, cabin air filter replacement, 12-volt battery replacement as well as wiper and key fob battery replacement for EV owners. We are committed to piloting and learning to evolve over time as customer car choices change. Meeting our customer needs for our quick, easy, trusted service will allow us to continue to grow share no matter how these vehicles are powered. All right. Let's wrap this up. Valvoline is a highly attractive investment opportunity. Yes, we have a great track record of performance. But with our separation work now behind us, you can expect us to continue investing in building our capabilities and strengthening our model. Auto care is a growing, highly fragmented market with significant white space for expansion. We see potential for our differentiated model of providing convenient and trusted service to our customers as the drive to grow 1,700-plus retail locations across North America to over 3,500 units in the future. And we're going to accelerate franchise unit growth, expanding our already-skilled footprint and platform as one of the largest preventive maintenance companies in North America. We're confident that our model of quick, easy and trusted service will allow us to continue winning market share while generating attractive margins and significant cash flows in the years to come. All right. And with that, Justin, we will open it up for questions.

All right. Thanks for that overview. Very helpful. So first question, just -- I want to ask about your consumer. Are you seeing -- I mean, obviously, the results speak for themselves. But are you seeing any change in behavior? Any signs of deferring, extending those -- the intervals between oil changes? You mentioned the premium mix of your business. How has that been trending? And we're hearing a lot from other companies about the consumer is feeling pressure, trading down. It doesn't sound like that's happening in your business. But what can you tell us?

That's right. It's not happening in our business. In other words, we're seeing the trends very consistent when it comes to our ability to win new customers, their service intervals, the ticket, the add-on services that we sell, all very consistent in what we're seeing in the current environment and what we've seen in the past. So when it comes to preventive maintenance, the business is very resilient. When people are maybe concerned about their household budget, well, they might be putting off a new car purchase, but they're going to maintain their existing vehicle. And we're in that sweet spot of basic preventive maintenance services. So we just don't see change. I've been with the business a long time. So back in 2008, 2009, The Great Recession, we continued to grow cars in the size of the transactions ticket during that period, too. So we're not seeing -- we didn't see it then, and we don't see it now. So convenience is a sweet spot for us. That's a real tailwind. Consumers, car owners want more and more convenience, and that's what Valvoline delivers on with our quick, easy, trusted approach.

I want to ask about the growth algo you laid out same-store sales, 6% to 9%. How do you -- like the breakdown between what your mature stores are comping versus the tailwind from just new store maturation. Like what are the building blocks to get to that 6% to 9%?

Yes. So those mature stores are comping in that range. This year, we're a bit higher that I had mentioned that in the presentation that we're tracking at the high end of our guidance of 8% to 12% for this year. Part of that is the strong pricing actions that were taken last year with some of our price increases. But nonetheless, know that the mature stores are seeing growth in transactions as we continue to win new business. That's powered by consistent customer experience. It's powered by our digital marketing platforms that continue to get stronger, how we market not only to our existing customer base and building out loyalty but attracting new customers to our stores. And then, of course, its strong ticket. And I laid out in the presentation the 3 levers to driving ticket. That includes this consistent trend towards more synthetics. So more of the newer cars require synthetic oil changes. So that's adding to the comp. And then you've got the non-oil change revenue, and that really has a lot to do with how well we execute those services in our stores. It has a lot to do with building your team as we're really in a great position as we start this heavy drive season in the summer. The last 2 quarters of the year are always our busiest volume years for us. And yes, we had staffing challenges over the last couple of years, like a lot of retail service providers. But this year, we're in better shape than we've been in a long time. We've really made a concerted effort in how we onboard our new team members and get them up the training curve fast. And so the experience levels in the stores are higher, too. So when you get that right, your ability to execute well, both on the speed proposition, but also on the additional services, is really key to our formula. And then, lastly, I mentioned is good pricing power, too. When you deliver great service, that's key. When you think about the pressure if -- as consumers are feeling pressure, they want to know that they're getting great value. And so for Valvoline, the way we look at it is let's make sure we're delivering on that expected service. And you'll hear us say it over and over again, it's about being quick, easy, trusted. We have to be fast. We have to be convenient. That's number one. And then you've got to earn the customers' trust, and we do that through our process and how we train our team.

A couple of questions here, maybe not surprisingly, on EVs. I'm going to combine a few of them. But like what are the traffic and ticket trends look like in parts of the country where there's a higher density of electric vehicles? And then just longer term, how do you think about maintaining this level of AUV years down the road when EVs are a greater percentage of the car park. Does the non-oil change revenue component, does that allow you to bridge the gap and kind of maintain this level of AUV that you enjoy today?

Yes. So the first part of your question, so let's look to California, where you have the highest penetration of EVs and even in -- looking at those ZIP codes and our stores in those areas. One of our strongest franchise partners is operating those stores in California, seeing the highest -- some of the highest growth rates in the whole system. So that speaks a lot to just be in that region being understored and the opportunity for growth. Now with regard to EV services, they will -- they are different, of course, not needing the oil change itself. They need a lot of the other basic services that we offer. But EVs being heavier, there's more services around the wheel well, that means more tire rotation. That could be an important driver in terms of frequency for us. But we're strong believers that preventive maintenance will be relevant forever. And when it comes to convenience, that's where a lot of OEM dealership networks are lacking. That's where Valvoline is really strong. So we're going to continue to learn and evolve our service offering, and I'm confident that EV services will be an important part of the mix. We'll evolve with the market as it grows. We'll be piloting testing, learning, and of course, sharing appropriately with investors how that continues to progress. But it's going to take some time before they're a meaningful part of the market. But our approach is not to wait, that now is the time to invest and learn, and with that, position ourselves for success no matter how that vehicle is powered.

The other question was on just the unit growth opportunity. You alluded to 3,500 as kind of the total white space. There's -- obviously, the industry is fragmented, but you have some other scaled players in the market that have some aggressive growth aspirations as well. So just how do you really know that, that is the right number? And as you think about the next 1,700 units, that the productivity of those doesn't necessarily lag the existing chain?

Right. Yes. What's been exciting for us, Justin, is that our new stores are performing at very high levels. And so they're coming out of the ground strong, and our real estate model has gotten very sophisticated and very predictive of how the stores are going to perform. And actually, we've been tracking above the model somewhat. So we feel really good about our model itself. And with regard to the opportunity, I mentioned in the presentation that we have some markets that are more developed, like a Louisville, where our share is in the upper teens. And our share right now of the preventive maintenance space looking at, say, do-it-for-me oil changes is closer to 5% to 6%. So yes, we're going to grow share by winning new customers to our existing stores, but there's a lot of white space there for us to grow into. Regarding competition, we haven't seen any impact to those -- the performance of those new stores from anything our competitor is doing. So our model is a little bit different than some of what you might consider our Quick Lube competitors. But a lot of our growth is coming from outside of Quick Lube. So when we look at new customer wins, we're able to track like where they're coming from. And so the majority of our customer growth is coming from the car dealer channel, the tire and repair channel. Even as DIYers move to a do-it-for-me approach. We're capturing a good share there, too. So yes, we're winning share against Quick Lubes, but we're winning share against the broader market. So that's what gives us such confidence with our real estate model as we've mapped out the country in where these new stores should go, but then also the fact that we're taking from a broader industry being the whole DIFM industry.

A few questions on just the impact of the underlying commodity, oil and price movements, both on your cost of goods, but then how that translates into same-store sales and kind of the pricing actions you take as oil moves up and down.

Yes. So I mean this is what's so different about the new Valvoline versus the old Valvoline. So when we were combined with the products business, a lot of sensitivity to food, which would translate to base oil additive costs, et cetera, and I'd be talking about price cost lag effects through the different channels on the product side. It's really a nonissue for us now because in a period of inflation, which we had gone through, there's quite a bit of product inflation over the last couple of years. Those product costs are, of course, passed through in the company stores. We have complete control over that and in pushing through those price increases. I'll come back to pricing power in a moment. But with our franchisees, a big part of our model is in addition to royalties, actually, more of the profit stream comes from the product sales to our franchisees, too. And so it's a great way to drive consistency throughout our whole network. But the pricing, the way it works with our franchisees is they adjust on a quarterly basis, and it's based off of base oil indices. Don't need to get into too much detail there. But essentially, we've locked in the margin on the products in our sales to the franchisees. And then with regard to our stores, we'll take price increases to make sure we're covering costs, not just product costs if product costs are moving up, but labor costs, high inflation over the last couple of years. It's nice in this current environment. Now we see some stabilization, even some base oil decreases. That's a longer-term tailwind for us. But we have never taken a price decrease. So it's not like it's something that we would have to pass through to our customers. Again, it's all about providing that great service allows you to grow your margins over time. And just coming back to the guidance that we laid out to back in November. Over this next 5 years, our expectation is our EBITDA margins will grow from roughly the 26% range to the 29% range over this period. How is that going to happen? Well, first and foremost, you've got the growth in same-store sales performance, which we're very bullish on. But you also have the pricing leverage, SG&A leverage, labor leverage as you're adding more cars to the stores, and that accelerated franchise growth. Those things all add up to helping us drive stronger margins, moving forward, off of a pretty good base right now.

Yes. Okay. Is there a desire here to embark on a more aggressive refranchising strategy like we've seen in the restaurant space, for example? Or is there advantages to having a balanced portfolio company-owned versus franchisee?

Yes. I think Valvoline is really unique compared to other retail service providers in that we're not one or the other, and we have a great combination of company stores that are performing at a high level, and delivering a great return and then some really strong franchise partners too, that have been with us for decades. And those relationships are key. A lot of our growth on the franchise side is coming from our top 5 operators that are really well capitalized. And that drives a lot of consistency. We partner closely with them when it comes to our real estate model, some of our real estate services that we can support them with to make sure that they're adding stores in the right places and getting a strong return on their investments in new store growth. So we are very much focused on accelerating that franchise growth moving forward. That's first going to happen with our existing partners, but we are looking to add a handful of new partners, too. And so that could come from private equity partners that have become more interested in the space. They see the very consistent and predictive nature of this business and the strong cash generation, and so it is a very attractive model as they become educated in it. And so we've had some -- we've started a process of interviewing and presenting the business to potential new partners. So that could involve potential refranchising of certain company markets that still have a lot of room for growth to make it attractive to that new partner. So it's not an effort to say to refranchise the system, it's an effort to attract the right partners for continued growth that's going to help us get to that 3,500 stores. Because we can't do it just leaning on franchise growth or just leaning on company growth. The 2, combined, will help us get there and do it in a way that is being really smart with our capital, too. So accelerating franchise growth will help us moderate our own CapEx growth, too. And I think that bodes well for the investment profile and the ability to return cash to shareholders.

All right. We're going to have to leave it there. Appreciate it, Sam. Thanks so much for joining us.

All right. Thanks, Justin Thanks, everyone.