Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Thank you, Elizabeth. And good afternoon, everyone. I'm Steve Shemesh, RBC's Hardlines, Broadlines, Food Retail & E-commerce Analyst. For our next fireside, it's my distinct pleasure to be joined by Valvoline's Chief Executive Officer, Sam Mitchell. For anyone newer to the story, a lot has happened in the last year. The company divested its Global Products business in early March for $2.65 billion and is now a pure-play oil change and preventative maintenance company, targeting 14% to 16% annual revenue growth and 16% to 18% EBITDA growth. Sam, thank you very much for joining us.

Good to be here, Steve.

Excellent. And that 30-second intro probably didn't do the story and the transition all too much justice. So maybe to start us off, if you want to give a quick overview, that would probably be helpful.

All right. Well, since we don't have a lot of time, I want to take you through the whole 150-year history of the Valvoline business. It's a great story. But I joined the business over 25 years ago, so I know it well. I would say really significant time for us, kind of new in my tenure as a President of the company. In 2006, we introduced Project Speed for the retail business to get faster at the services we provide. That was a start of 16 straight years of same-store sales growth, which we're continuing to build on. So fast forward a little bit, we were part of Ashland for a lot of our history. And we spun off from Ashland, our parent company, which was evolving into a specialty chemical business. And back in 2015, the Board made a really important decision to separate the 2 businesses. Valvoline was of significant size and growing and had a very different future than special chemical business. What that allowed us to do beginning in 2016 was to start to aggressively invest in this great retail business. And so we've basically doubled the size of the retail business by investing some of the proceeds coming from the product side of the business into retail and driving store growth and continuing to drive that same-store sales performance, too. And now here we're in 2023, 18 months after we announced that we would separate our Products business from our Retail business. So it feels really good to finally make it through this transformation. We closed on the sale of Global Products on March 1. So today, in these days, we're introducing the new Valvoline to investors, which, as Steve said, is a pure-play retail service business and one that offers very high growth and quite a bit of resiliency, too. And I'm sure we'll get into that a little bit in this little bit uncertain economic environment. So we're feeling really good about where we stand today and exciting future ahead.

That's probably a good place to go next. Obviously, a lot of reasons to like the story right now. Perhaps at the root of that is the defensiveness as this consumer backdrop becomes increasingly uncertain. Can you share some perspective about how this industry, the oil change and preventative maintenance industry has performed in past cycles and what you're seeing in the marketplace today?

Yes. And it's helpful since I was around back in 2008, 2009, in the Great Recession period, and the Valvoline business continued to perform very well during that period. And so I think in the fall of 2008, maybe we saw a little bit of a slowdown for a quarter. But by 2009, we were back and growing same-store sales both in terms of transaction and in ticket. So 2009 proved to be an excellent year for the retail business. And so it really proves out just how resilient this business is. And we've been looking for any signs of slowdown or trade-down in our business, and it's been really rock solid, seeing the same trends that we've seen over the last year plus. We've had 5 straight years averaging 10% comps. And so those comps remain really strong for us. We gave guidance that we expected to grow same-store sales at 8% to 12% in fiscal '23. And we're expecting that given the performance of the first 2 quarters to be towards the upper end of that guidance.

Excellent. And thinking about some of the components of your top line, your pro forma algorithm calls for 6% to 9% same-store sales growth annually. And you've said that you expect the contribution to be pretty evenly split between ticket and transaction growth. I think you took a larger-than-normal price increase late last year. I think that was closer to 6% to 7%. As we think about moving forward and lapping that, how should we be thinking about pricing going into the market from here? Does it need to revert back to a more normalized flattish? Or can we lap the traditional 3% to 4% on top of that larger price increase last year?

Yes. Pricing has always been a component of helping us drive same-store sales growth, so as we continue to improve our value proposition, make sure we're covering any type of modest inflation. So typically, our prices are moving up, say, in the 3% to 4% range in any given year. It was much steeper than that over the last couple of years. But nonetheless, as we think about next year, most likely there could be some modest price increases, too, to offset any costs, but certainly not as significant as some of the inflation that we had to manage through over the last couple of years. So I feel pretty good about that. But just kind of getting back to the formula for our sales growth, we've been driving transaction growth very consistently over the years. That's a big part of how we're wired: how do we make sure we're turning new customers into loyal customers and then continuing to attract new customers to Valvoline. And we do that through offering a quick, easy, trusted customer experience. Consumers today, they want more and more convenience. They want it now, they want it faster, easier. And they also want -- when it comes to their car, which -- cars have become more complicated, too. And so they don't understand necessarily what the maintenance needs really are. And so we try to make it really easy for them. So building trust with them is key. So when you look -- if you go back just like right before our IPO, we were seeing roughly 40 cars per day coming through our system on an average basis. And now we're well over 50. And we've also shared that we would expect that continue to grow. So by the end of this decade, we could be at 60 cars per day across our system. And obviously, some stores do a lot more than that. So winning new customers, turning them into loyal customers, I mean, that's key to who we're, both in our company stores, our franchise operations, really consistent with our company-owned stores. And then the ticket side is really nice, too, because there's 3 big levers for that, Steve. And we talked about pricing already. The other is that more than newer cars require full synthetic oil changes. And the cost of a full synthetic oil change is closer to $100 versus a $50 price point for that entry-level conventional oil change. So there's a really nice profit pickup with that. That is driving comps, but it's also driving margin, too, for us. And then lastly is non-oil-change revenue: other services, add-on services that go with the oil change. And that's a big component, too. So it just gives us a lot of confidence, different levers to pull and nice tailwinds behind our business.

Sounds like you're pretty confident in the pricing strategy even as we lap the bigger-than-normal price increase last year. I think a concern for investors, definitely for the story to some degree but certainly in other segments of retail as well is the risk of disinflation that too much has gone into the market over the past couple of years. It sounds like you're not seeing anything in terms of change in consumer behavior and trade-down or deferral. I guess, just what's the risk that price does come the other way?

Well, I think it's very low. And so my history with the company, we have never taken a price decrease at retail or had to increase promotional spend to try to protect volume. And it doesn't mean that other competitors are in the do-it-for-me space, wouldn't be offering lower-priced oil changes to try to get customers in. But once a customer experiences Valvoline and comes back for that repeat visit, we -- they become very sticky. So again, we've -- like I said, we've never had to take a decrease. I do think when customers -- if the budget is tighter, they pay attention to value. And so it doesn't mean that value is less important. But if we're delivering great value in our stores, and that again comes from the convenience and speed, that we can command that price and protect our margins that way. So it's all about -- I feel it's just under our control.

Right. And it sounds like the value proposition has more to do with the speed and the service itself versus the price. So I guess, if you think about the competitive environment and let's just say some of your peers decide to reduce price to some degree, I guess, what's the likelihood that a consumer drives past of Valvoline to get another oil change for slightly less money? Do they even know what the price differential is?

Yes. Well, they could do the research, but we just don't see that behavior. So that's key. Take care of your customers, and they're coming back.

Got it there. The other aspect of your top line growth target is unit growth. So 14% to 16% annual revenue growth target, 7% to 10% of that -- 7% to 10% unit growth per year. You've said that you believe there's potential for 3,500 boxes long term, which is 1,750, somewhere around there today, significant growth as we look out over the next decade or so. I guess what gives you the confidence in that number of boxes over time? I mean that would make you the largest quick-lube player by a pretty large margin.

That's right. No, it's a pretty exciting part of the story. So if you think about Valvoline's position in the marketplace outperforming competitors today, so we have a really good model that once consumers discover it, they become very loyal to it. But we only have about a 5% share of the preventive maintenance market in do-it-for-me. And that is in part because we don't have enough stores. And so we have mapped out the country, and we know where these stores need to be, in which markets and what each market's potential is for new stores. And so we're working closely with our franchise system to make sure that they're leaning into those plans and that opportunity. Our real estate model is very predictive. So we can look at a site in a neighborhood and know exactly how that store should perform, particularly on those vehicles service per day. And so if we're going into a new site, obviously, we'll expect that site to outperform the system-wide average, which has some of the older stores. And so it's a great model to invest in because of the predictive nature of it. But we're only -- 35% of U.S. households are within a 10-minute drive of a Valvoline store. And so that just should give investors confidence that this 3,500-store target is definitely achievable that the need is there. And so that's a big part of the story. And again, we're -- I think we'll just get better at how we pursue that. But we're going to need increased growth from our franchisees. And we've talked a lot about this. Valvoline is pretty unique in that, we have a pretty good balance between company-operated stores at 47% of the system and 53% franchise. Most of our growth is being driven by our largest franchise partners, our top 5 partners. They're well capitalized, they're sophisticated, they work really well with us. And so that's where some of our real estate development resources. We're focused on working with those partners, refreshing some of the development agreements to keep them on track for driving faster growth with them. And they're embracing it. They see the opportunity too. But we also are looking to attract a handful of new partners that are similar profile to our well-capitalized existing partners. And so that's a process that I think will take us a few years to bring those new partnerships in that can help accelerate growth and help us get to that 3,500-store target.

Got it. And can you expand a little bit on attracting those new franchisees? What franchise economics look like for a box?

Yes. So the box is really attractive and that it offers 30% roughly cash-on-cash returns. And so it makes it really attractive to investors, partners to look at and say, one, look at Valvoline's track record, their approach to partnering with franchisees; and then two, what's the predictive nature of this business. So the fact that it's very consistent and predictable and the growth opportunity is well understood makes it attractive for new partners. So we're -- we've begun those conversations, and I would expect us to be able to share some good news on that in the years ahead.

Excellent. And thinking about the growth on the franchisee side, one of your partners right now is a private equity firm, which it sounds like you're learning a lot from. As you think about growth from here, would you consider other private equity partners as well? Or are you looking to adopt that route or...

Yes, absolutely, especially those that share our vision for this business and probably have a longer-term view of the investment opportunity.

Great. Wanted to talk a little bit about locations. So vehicle served per day, you talked about it going from 40, today, you're at around 53 vehicles per day. And you think you could get to or you don't see a barrier to getting to 60 over time. We get the opportunity to improve that, but first, wanted to think a little bit about how important location is. So you said some of your best locations do over 100 vehicles per day. I'm sure execution plays a pretty big role in that. But I guess it feels like location could be the swing factor. So how important is getting the location right?

Yes. Like any retail service business, location is mission-critical. So that's, again, plays back to our model and how we've continued to improve the model and its predictive nature. When you can hit a home run and have a location that's doing 80 cars a day or even -- there's a handful, not a lot, but hopefully more in the future that can do over 100 vehicles per day. It shows you the capacity that we have in our existing stores to do very high volumes. But the nature of those locations, a lot of times, they're destination shopping areas, too, so it's high traffic, high visibility. We always talk about our #1 store that's between a Chick-fil-A and a Costco. And so those are gold mines when we can be in those kind of locations.

Got it. And some of those lower-performing stores in the market right now, could those be location issues? Or do you feel that it's execution where you could improve that to a degree where you get up to near the company average?

Yes. Our -- we wouldn't be hitting these comps if the whole system wasn't seeing improvement in growth. And so there is opportunity even with some of the stores that don't have the same potential but can still add incremental growth over time, too. And that's where store operations is so important. Key to our retail business is really taking care of your team, developing your talent. And with Valvoline's success in growing, we create really nice career opportunities for the people that have a strong work ethic, show up to work on time, want to learn, want to be part of a team, want to follow a process and we can tap them on the shoulder as we see their progress and their ability to work with customers, their ability to lead a team and select the right talent. And we give them career opportunities. And that's what leads to lower turnover rates and more commitment to the business and taking care of our customers. And that's sometimes hard for investors to understand the importance of culture in a business. But in a retail service business, like culture is absolutely a source of a major competitive advantage. And so we really work hard to take care of our people, and then good things happen.

Understood. As we think about you building new boxes, how should we be thinking about cannibalization or potential cannibalization? Do you -- can you open boxes close to one another? Is that a risk that you end up taking traffic from one store to the next? I guess, where is your primary volume coming from?

Yes. So when we talk about those high-volume stores that are doing 80 cars a day or more, it's logical that there -- and we see some of the highest growth rates in those high-volume stores, it's logical that there's an opportunity for an incremental store in that neighborhood or close to it. So we don't have to be 10 minutes away from the next door. Close to our office in Lexington, we've got 3 stores within a 2-mile driving distance. And that's because the traffic patterns and the reputation of the brand, it supports that. These are all high-volume growing stores. So as far as cannibalization goes, again, the model will help us understand what to expect in terms of cannibalization. But you're taking some of the pressure off of that store because when you're up at that volume, then we know that they're getting crushed during the midday, for example. And so when you pull some of those customers away to maybe a more convenient location, you're actually freeing up capacity for them to grow back into it. And so that cannibalization, it's -- you really can't see it after a couple of years of the new store being opened.

Got it. And yes, if I remember correctly, those 3 stores right by your office are very high performing stores despite being a stone's throw away.

That's not just because I'm telling all my friends to actually be there. It's a little bit of that, but....

Coupons. It's the coupons.

Yes.

Staying on the topic of vehicle served per day and getting that from 53 up to 60. We talked about location. There's another aspect of that. That's probably efficiency. You guys recently created the central operations team, which I assume will have some sort of impact there. I guess, what is going to help you get those underperforming stores up to par with the rest of the -- and I say underperforming loosely, up to the average?

Yes. So say, some of those stores that are under the average, it does have a lot to do with making sure they've got the right leadership in the store. And we're giving the tools, the support to that service center manager because if they're too busy solving problems with equipment not working properly or more work than they should when it comes to inventory management or labor management, we want to simplify that, and that's what our central ops team is all about. So we've been supporting our stores from Lexington, our headquarters in a lot of different ways, but we've organized it under one team with one vision, and like let's pull more of that work off of the service center manager so they can be solely focused on developing their team and taking care of those customers. And that's, we think, is what's going to help us get to that next milestone of 60 cars per day. And so a lot of it does have to do with speed. Our customer satisfaction scores are really high when we're fast and the wait time is low. If our customers are pulling up to the store and seeing cars backed up, a lot of times, they will continue on buy saying well now it's not the time to get the work done. I'll come back another day. That's a lost opportunity for us. So when we continue to deliver on the speed component, then really good things happen.

And I'm sure that's a function of just efficiency, things that you can improve on your end, but also employee retention, which 2021, 2022, I think there was a lot of turnover in the industry. And you guys are kind of rebuilding right now and investing in kind of training and keeping talent for longer. So can you talk a little bit about that?

Yes. I mean the labor market was really tough for everyone over the last couple of years. And so it's good to see some signs of stabilization now here in 2023. And on top of just the overall market, we're working hard to make sure that, that employee experience is really positive, too, and so how we onboard employees, think about our training programs a little bit differently. Our new employees go through 270 hours of training to get to different levels of certification to do all the jobs within the stores. So we invest heavily in their training. But how we go about their training and bringing a productive member of that team within the first week on the job, it's really important. And so we're spending more time there. And I think that's really going to help us. And we want to see that turnover number continue to decrease year-over-year and retain the best people because we need them. We're growing, right? We're adding a lot of stores in the future, so we need to develop that talent.

Right. Excellent. I think we got a question in the audience.

Great.

It's a significant amount of store growth. How will the new store look? Will there be new products and services added to that new store base that you're going to be essentially doubling in coming years?

Yes. I think the new stores will evolve over time. Most of our stores are either 2 bays or 3 bays. And so obviously, those newer stores tend to be the 3 bays, higher-volume stores. And we think, too, about over time, especially as we see more EVs on the road, we want to position Valvoline to be servicing those EVs too. And that could involve a little bit different service offering for those vehicles. But it could be that, that third bay, for example, is dedicated towards EVs as they become a significant portion of the car population. We're, obviously, win a ways away from that happening. But that's how we're thinking about new stores and making sure we're -- we have flexibility to take on new types of services that may be needed. In the near term, while we're doing some pilot work around EVs, we're focused on growing our fleet business. And so fleets have a little bit different needs too. We've expanded our focus not to just be Class 1 and 2 vehicles, passenger car vehicles, but to include 3 through 5 vehicles, more delivery vans, et cetera. And more fleets tend to have vehicles of all types. And so the more that Valvoline can meet their needs, the bigger share of their preventive maintenance business we can win. So we refocused on our fleet business about 3 years ago, and we've seen it grow at about a 20% clip with new leadership and new approach to our sales and some of the tools, marketing tools that we offer fleet managers. And the value proposition is really around keeping those fleets which are revenue-producing vehicles for the fleet manager on the road. So when you're in the shop with that vehicle, whether it's being done in-house or going to another service provider, where you're losing that -- the use of the vehicle for half a day, if you can get that service done in, again, 15 minutes, then that vehicle is back on the road producing profits for you. That's our value proposition. And so we're really bullish on the fleet growth opportunity. There's roughly a little over 11 million Class 1 through 4 vehicles on the road. And so we have a very small share of that, but we know we have a winning proposition. So as we win new fleet business, we're seeing really high levels of loyalty there, too. Fleet management companies are a great source of winning new fleet business, too. Historically, they haven't recommended one service provider over another. But as we prove to them that Valvoline is offering superior service for preventive maintenance, they are now recommending Valvoline. And so one large FMC for us, they do a survey of their drivers of all their customers. And across 16 KPIs, Valvoline is rated #1. And so that gives them confidence to recommend Valvoline. So we're excited about that. But kind of a long answer to your question around store footprint, we do expect it to be fairly consistent with what we offer, but flexibility to evolve over time, too.

And the majority of that 11 million is not organized around an offering that you can provide them. It's mainly in-house or mom-and-pop handled now?

It's -- well, it's a combination of small local fleets that could be 5 to 10 vehicles to some of our customers with 5,000 vehicles across multiple regions.

And I think you've also said on fleet that it's higher ticket as well and off hours. So a lot of those fleet vehicles are coming through in the morning when it's a little bit quieter versus -- like I think the busy times for the store are like 11 to 2 and then after work, 4 to 6 or something like that. So it increases efficiency as well.

So we create those incentives to bring the fleets in at that time. But yes, much higher ticket. Right now, it's about 20% higher than consumer. Has a chance to be a lot higher than that, though, too. In some of our accounts, it's 80% higher.

Great. Two last topics as we're winding down on time. So store maturity, number one. Last quarter, you had talked about this being a $70 million incremental EBITDA opportunity up from, I think, prior, you had said $50 million plus. So it sounds like you're very much bullish on this idea that as stores get more mature, even if you do nothing, you're going to see this tailwind. Can you talk a little bit about your confidence level in that? And anything else you can share about -- I think it's 1/3 of the store base right now is immature. Just what's actually improving there?

Yes. There's some good solid math behind the $70 million of incremental profit that's coming our way as these newer stores mature. And that just gets back to that new store model, how they ramp up over the first 4 years. We tend to be breakeven after year 1 for that full year. And then the incremental profits grow year 2, significantly again in year 3. And then the growth starts to moderate a little bit in year 4, but the profitability of those mature stores was over $500,000 per unit on average now. So we can very much predict that for the newer stores and what we expect them to do.

That's great. And last topic here, like we need to do it, electric vehicles, probably the #1 question we get from new investors to the story. You can run the math. It's pretty far out until it's going to affect your company, especially given your core consumer drives a vehicle between 5 and 15 years old. But I guess if you could just kind of walk through how you're thinking about that transition. You had already talked about doing some test-and-learn pilots with franchisees. And then how you're thinking longer term to make that transition to service those vehicles?

Yes. Yes, it's really important for Valvoline's next 50 years. We think about our long history, right? We want to make sure that we're taking care of Valvoline, and we're well positioned to take care of EVs. The belief is that EVs also require preventive maintenance, but those needs look a little bit different, of course, than ICE where they aren't going to need an oil change. But some of the other services that we offer are also needed by EVs, that would -- some basic things like tire rotations, air conditioning service, 12-volt battery replacement, wipers, bulbs, et cetera, all those safety checks. By the way, like our business, we get swamped before all the driving holidays, not because everyone thinks they need to have an oil change done right then, it's that they want to know that their car is ready for the road. And so if -- an EV owner is not going to be any different. They're not going to necessarily want to go back to a long visit at a car dealership or tire and repair. They can have those safety checks, some of those basic services done at Valvoline and know they're ready for the trip. But it does mean that our service offering will evolve over time. And so what we're looking at are some of the OEM services that are recommended at like a year 1 service that would be provided back at the dealership, what does year 2 look like, year 3. Those carry some pretty steep cost right now, like $300, $600 for a year 2 service. And we look at those services -- and we know that they're -- and we know that the -- we understand the complexity of those services and know that Valvoline could be set up to do a number of those services, if not all of them, in the future. So that's -- so we're not afraid of the EV evolution, but we just want to stay ahead of it and be ready for it. So I would expect us to do more piloting in some of the high-density EV areas in California. As those cars come off their, say, their warranty period, those first few years. Our sweet spot is years 5 through 15 with vehicle owners. And so if you believe that convenience will continue to be important for car owners, Valvoline is going to be best positioned to offer that.

Excellent. Well, we're at time here. Is there anything else you'd like to leave investors with?

Well, I think it's important just to emphasize the fact that we have been through a massive transformation, going back to the spin from Ashland in 2016 to the separation of the business that was just completed in March. So the benefits of being a focused retail business, we feel them already internally. The strength of our management team is better than it's ever been. The discussions with the Board, just drilling down on where we can go with this business and how do we keep the momentum, how do we prepare for the long-term future too, there's real benefits to being a focused company. And it's a simple model for investors. I mean you look at what we've done and what we expect to continue to do with the capabilities that we've built, I think it should give investors a lot of confidence that we're going to deliver on these targets that we've laid out, that we can deliver on mid-teen top line growth, a little bit better than that in profit growth. And when it comes to EPS growth and the cash that we're going to be generating, we can push that into the 20%-plus range. So it's a great story, especially when you consider how resilient the model is, too. So let's close with that. Thank you.

All right. That's great. Thank you so much for joining us.

Thanks, Steve.