Valvoline Inc. (VVV) Earnings Call Transcript & Summary

Okay. Hi, everyone. Thank you for joining us. You've made it to the last session of the day. Congratulations. I hope that everyone's had a good day of meetings. I know I have. It's been a real thrill to have everybody on stage. I'm excited to introduce our last session here with Valvoline with President and soon to be Chief Executive Officer, Lori Flees. Thank you for joining us today.

Pleasure to be here. Thank you.

We wanted to talk to you first about just what some of the bigger challenges this year have been for Valvoline and some of the bigger wins, and then we can go into a little bit more detail from there.

Sure. 2023 has been a significant year of transition for Valvoline. Valvoline went public as a spin-out of Ashland in 2016, and it was both a product CPG company as well as a retailer. And in this year, in 2023 on March 1, we actually separated the company in 2. And so when we think about challenges, separating all of the shared service groups into 2 organizations and closing on a transaction which basically split the business into 2 was a significant transition. Building supply chain teams that are retail-focused and all of the supporting teams that are retail-focused has definitely been the -- has been the focus of this year. We have also had leadership transitions. Our CEO is retiring after running Valvoline as a brand for 21 years. But I would say stepping back while working through that all, a few things have remained constant. One is amazing customer demand, very strong demand for our quick, easy and trusted service which is propelling continued same-store sales track record of 17 years and just great year-over-year performance despite all of those -- all the work we had to do to separate the company.

And maybe if I could just ask a little off the cuff. Given that you are stepping into the CEO role, could you maybe tell us a little bit about how you're viewing the opportunity and what you think you're bringing to the table in this new role?

Sure. I've been with Valvoline now almost 18 months. And the reason why I joined is because the incredible growth potential. As I mentioned, same-store sales has been stable in terms of growth for the company for the last 16-plus years. And the network opportunity, we currently only have 5% share, and it's a great opportunity for growth both on the company-owned stores as well as franchise growth stores or franchise unit stores. For me, coming from retail and consulting, I think bringing in both how do you drive efficient growth and then within our sector, we are best-in-class in many things within automotive services aftermarket. But when you compare us to broader retail, there's so much opportunity to be better. That's from things like digital marketing and customer acquisition and personalization of marketing that can be applied in our sector, two, how do you use technology to make the customer experience more effective for them and more efficient in the delivery model.

Great. So that dovetails well into my next question around just who your customer is. How would you describe your core customer? What's their household income? What's the average age of their car? Does your business skew more towards domestic versus imports versus luxury?

Right. Our customers look very much like the demographics around the store, and we have 18 -- over 1,800 stores across the U.S. and Canada. When you look at the U.S. demographic relative to the population, we skew slightly higher income, about 10% higher than the national average household income. We skew slightly older, which is actually more consistent with car ownership stats, and we skew a little bit more male and married. And again, the male side of our customer demographic is more consistent with car ownership. And so we look very similar to the U.S. population with -- or the population of car owners very consistent to that.

And when you acquire a new customer, do you tend to win the business for all vehicles in the household? Or does it just tend to be on a vehicle-by-vehicle basis?

So when we see a customer 3 times, we have the stickiest relationship with them. And when we win them for that third visit, we win the household. And we typically don't have a customer change unless they sell the vehicle they have and get a brand new one which may come with a service package from the OEM or the dealership. So we really work to get to the third visit and win the household.

Okay. And then with competition, just could you maybe walk through how Valvoline differentiates itself from other Quick Lube competitors? And I guess the same question against non-Quick Lube competitors as well.

Yes. Within our space, there are many people who offer oil change and other preventative maintenance. Within the Quick Lube space, about 25% of all oil changes are done by Quick Lube players like Valvoline. And we compete and differentiate ourselves in 3 ways. One, we have this proposition of quick, easy, trusted which is delivered more consistently across all of our network regardless of who's operating the store, franchise or the company. And that's really driven by a proprietary technology that guides a service experience or guides the employees to deliver that consistent process. It pulls in the customers' information as well as any vehicle history and OEM requirements for the spec of their car and that really ensures that we deliver a great service every time. The other thing is our brand. In our space, we have a 150-year-old brand, which is represented by trust and quality and that helps us with new customer acquisition. And then we actually have probably more sophisticated marketing techniques than most of our peers and that we have a robust CRM system, we have life cycle management and then more sophisticated digital performance marketing programs.

Does -- what are maybe some of the bigger opportunities of those competitive advantages do you see in having the ability to win some more share in the channel?

So I think when you look at customers who come into Valvoline, 80% of the customers we see in a year are customers we've seen before. And so part of it is when you deliver that quick, easy, trusted service every time, the retention rate has an amazing lifetime value. Then you have to use the marketing tools and techniques to try to acquire new customers as efficiently as you can. And we have been using techniques to acquire customers from dealerships. Dealers still perform 40% of oil changes in the United States. And the experience is not good. It's a lot of friction, it takes a lot of time, it's not fast, it's not convenient while it may be considered trusted because of the certifications that a dealer has to have. And so acquiring customers away from dealers and then having that retention rate grow is really what drives growth in our business, and it's been driving growth, and will continue to drive growth. 40% of the market in dealerships. That's a big opportunity for us.

Where was that maybe 5 years ago? Is it much higher?

It was higher because the Quick Lube space has been growing faster than the overall market. The switch from do-it-yourself to do-it-for-me is about 100 basis points of tailwind. But then you have miles driven, which is a little bit of a headwind. And really, it's the push for convenience. And Quick Lube operators offer more convenience than a dealership model. Particularly during COVID, dealerships struggled to keep people staffed and they didn't want to bring people into their service centers. And that's where I think Quick Lube really accelerated was through COVID.

Can you talk a little bit to us about pricing because I think you've had some success in taking price increases? And we wondered just with regards to that piece, we can talk about the mix piece in a second. But just with the inflationary piece, how we should think about the potential for pricing increases in the future?

Yes. So in fiscal year 2022, we saw unprecedented inflation and cost. And our franchisees move very quickly on pricing, we did as well. And we continue to benchmark our pricing. We benchmark relative to dealers on the OEM services side and then relative to Quick Lube and other operators -- independents and other operators on the oil change side. And what we're seeing is everybody move their price up in '22 and '23. We continue to introduce new stores through acquisition. We don't always change their pricing to our model in the first year of ownership. We take time to educate the customer on the type of experience that they're going to get as we move pricing in line to where we target it to be. So we're constantly reevaluating pricing. We've never as an industry had pricing go down. So while base oil pricing was going up, which increases our COGS, there's typically that becomes a reset in the pricing for our industry, and people don't pull back. You may end up seeing a little bit more discounting so the net price may change. But we're seeing very spotty pockets of discounting that's outside of norm across all the geographies we're in. And we continue to raise pricing to get to our target levels across the board. So for us, pricing will increase, our net pricing will increase. But our target pricing of where we want each tier of our service to be is still the same.

I see. And then do you -- it's so defensive your business. But have you seen any elasticity response to some of these higher prices?

Yes. So we typically have 3 or more pricing tests in the market at any time. We do A/B testing to look at elasticity. We typically keep them in market for 3 months to get a read on retention or return rate as well as ticket impact. And we don't roll out a pricing unless we have confidence that, that pricing is appropriate for the market. So we haven't seen any elasticity. Last year, in 2022, when we raised prices to catch up with cost, we didn't have as much data as we typically would, and we were a little slower because of that, but we haven't seen any fall off. In fact, vehicle growth or vehicle serve growth in our business is stronger than it has been. And so we're really positive about the momentum in the business.

You have that piece of it, that's contributed to the top line and then there is the mix piece as well.

Correct.

So can you maybe talk to us about how that mix has changed over time? And is it really about technicians selling the customer up to that?

Yes. So we have 3 different tiers of service. We have conventional oil, we have synthetic blend and we have full synthetic. The newer, higher-priced vehicles all require synthetic, full synthetic now but the car park is much broader than that. Our current premium mix, which is full synthetic and synthetic blend makes up 70% to 80% of our business. Now when you look at the total car park, what percentage of them require synthetic, it's closer to 30% to 40%. So there's a piece of it when a customer comes in with a car that only requires a certain type of oil, we'll service them with that oil. They sometimes do request to trade down, but very, very rarely will they go against what the manufacturer's recommending. But as the car park is aging, there are benefits to going to a synthetic blend or a full synthetic. So as our customers are holding on to their vehicles, it actually does help with their overall performance and longevity to move to a higher synthetic blend lubricant and we educate the customer on that. Once we get them to recognize the value, they typically don't trade back down. So once we get them at a tier, the next time they come in we confirm that's what they got last time, would they like to stay at that same product. Sometimes, we may ask them to consider going up another level depending on the age of their vehicle, et cetera but they don't typically trade down. It's very rare.

Okay. We wanted to ask about non-oil change revenue, especially in the context of EVs, and we'll get to some questions around that as well. But what non-oil change services do you provide? And how have those attachment rates been trending lately?

Yes. So just for context, non-oil change revenue makes up about 25% of our total sales and that has gone up and down slightly, but more it's based on the oil change price than it is on the penetration of the services. Within those services, we do parts replacement. So replacing your windshield wiper blades or replacing your battery would be examples of that. We also do safety things like tire rotation, tire inflation things that will keep the -- light bulbs, things that will keep the vehicles safe on the road. And then the last is fluid replacement. So that could be an AC, air conditioning recharge. It could be a transmission recharge, radiator flush, differential, et cetera. So all of those things are part of our service menu. We really focus on things that we can do within 15 minutes or less because we want to stay true to our commitment to customers on quick, easy, trusted. This year -- or last year, when I joined the company, one of the pieces of work that we looked at was how stores were performing on non-oil-change revenue penetration, and we saw a significant difference between stores. And so we actually invested in some training, and we ran some special programs that continue to elevate the sales presentation. So every visual thing, whether it be a cabin air filter or wiper blades, we visually can tell whether a customer needs that to be done. And we check it every time. The OEM and other services that are recommended are ones that come up with the age of the vehicle. And what we did was really focus on the training of our people to present those why should you get them replaced, why is it important for your safety, why is it important for the longevity of your vehicle. And by doing that training and then creating almost like a sports analogy scoreboard that we use, which our team loves, we've been able to keep really strong penetration rates starting with that and maintaining through the year. Typically, in the summer, we see a drop off as we have more cars and it's busier, customers don't want to wait to have more services but we actually saw year-over-year improvement even through the summer drive season. So it's been a really fantastic uplift in ticket for us this year. And we suspect that some of it will also continue into next year. We haven't fully lapped everything we've done.

Okay. And just with regards to other services, you mentioned that you try to focus on things that you can do in 15 minutes or less. Is there anything you're not touching now that could fit in well into that? And what else could we see you expand into in that non-oil revenue side?

So we're looking at things right now that given the way they're currently performed, they may not -- they may take more than 15 minutes. But the things that we're trying to do is see whether or not those can be done outside of the store, whether in our lots and/or mobilely delivered. And I think part of it is making sure that we bring -- we can bring value in quick, easy, trusted and convenience for the customers. So I would say, we do a lot of the high-volume items. Battery was the last thing that we added to the portfolio. But there are other things and what's really great in our industry is there's still innovation around tools and machines that can help make those services easier for anybody to perform with the right equipment and quicker. And so we continue to evaluate and talk to companies who are providing those tools that we could leverage.

Can you talk a little bit to us about your EV service pilot? And what services you are currently offering with regards to that specifically?

Yes. So less than a year ago, we started piloting some EV services in 3 different locations. As we look at EVs or we look at the car park in general, we believe that all vehicles will require preventative maintenance regardless of the powertrain. So that's number one. But the exact services will be different than an ICE vehicle obviously. There's not lubricants involved with a battery-operated vehicle. The second thing we look at is, will customers want quick and easy. And the reality is, is when you look at EV maintenance today or even just EV services, it's a very frustrating process for EV owners and so there is demand. We get customers asking us if we do services in stores that we're not piloting because they can't get into their OEM service center. The third is what will the ticket look like? And if you look at Tesla as an example, they have a service package. It doesn't have the same frequency as what we would see an ICE needing from an oil change for example, but the ticket is much higher. So when we look at what's the recipe for an aftermarket, preventative maintenance service like ours, one, it's a valuable asset that people want to maintain, its longevity. That's going to remain. Two, they want quick, easy, trusted, and they're not sure that their current OEM service provider is going to be able to deliver that. And three, it will be an attractive enough price comparison that we can build a really strong business as the car park evolves. And we -- you asked about the pilots. We have 3 pilots. In those areas, EVs as a percentage of the car park is less than 1%. So we're not seeing a lot of volume with 1% -- less than 1%. We do -- we did purposely put them in stores that had inspections because while they don't have emissions, they still need to have the [ state ] inspection in state like Texas and that allows us to interact with the car owner and really understand do they know what maintenance their car needs. But we really did the pilot to figure out can we train our technicians on how to know how to do the services that we provide that are relevant to EVs. So the things that we do provide that will be relevant for EVs are they do have 12-volt batteries that need to be replaced. They do have windshield wipers, the tires do need to be rotated. They have key fobs that run out of juice. They have a number of things that we do. Air-conditioning recharge being another one. And we're doing research separately around the additional services. We're looking at models in Europe that have higher penetration and have more longevity in the market to see what kind of maintenance actually makes sense and how can we retrofit or leverage the stores that we have in order to provide it.

Okay. If we could maybe pivot to your long-term unit growth story because that's a big investment consideration. You've talked about the pathway to 3,500 stores, which is almost double the 1,800 stores you have today. And thinking about that target, could you walk us through your view on company-operated versus franchise stores? And should we expect franchise locations to become the more significant growth driver going forward?

Well, when I joined the company, one of the first things I asked is, how big do we think the network can be, and it was something that the leadership team hadn't sort of aligned around. I think a couple of important stats, which I think make it obvious that there's that much room to grow is first, we only have 5% market share of the total do-it-for-me oil change business and 35% of the population is located within 10 miles of VIOC location. Now 60% to 70% of the customers who visit us today live within 6 miles. So 35% of the population within 10, we have opportunity to be more penetrated across the United States. So the question is, how do you get there? And the company had been focused on growing company units for a long time for a couple of different reasons. One is they actually started investing in real estate analytics and really wanted to prove out that you could with high fidelity forecast what a unit would be in a location and how it would ramp. And so they were -- we were building out a very strong retail analytics function and capability that we have today and that our franchisees take advantage of. Second is we wanted to prove out the economics of new construction. The company had historically largely relied on acquisitions as had our franchisees. And so by building a portfolio of newbuilds, what was the return and what was that model ramp. We've since used that to convince our franchise partners that newbuilds is a very attractive return. And our -- their pipeline includes more newbuilds than it ever has. But as we build that -- as I came in and we had built up the real estate and construction capability for company-owned stores, what was clear is we weren't focused on driving franchisee growth. And when you plot our franchisees across the U.S., there is some massive whitespace opportunity that currently is within a franchisees area. And so for the last year plus, we've really been working with our franchisees around what do they need from us to grow in those opportunity sets. And so part of that was aligning our incentives which we're rolling out for FY '24, and we've been engaging in our franchisees for more than 6 months on that. We're also looking at extending services to our franchise partners, which we -- when you look at Q3, we had one net new franchise unit growth because they were experiencing issues in permitting and supply chain with some of the new construction build. So how do we help them be able to open the stores on time and at the standard that's required. So 3,500, definitely doable. It will be a little bit heavier on company builds. We'll get to 100 fairly quickly, and then we believe we can triple the franchise by 2027 fiscal year and that will come 2/3 from existing franchise and 1/3 from recruiting new franchise players.

Okay. So that was my next question, just with regards to the franchise operators. How many do you currently partner with? How concentrated are they today? And then what you just answered, really, how much is going to come from new versus established?

We have a unique franchise base. We have 39 systems in the U.S. that operate over 850 stores. But our top 5 operators operate 70% of those stores. So very consolidated. And the cash generation for those systems really allows them to continue to invest in more growth. So they're very attractive. 4 of the top 5 are entrepreneurs. Our largest one has been with us for 34 years, has over 200 units in the system, incredibly successful and continues to want to grow the business. We recently in 2017 had our first private equity-backed franchise join the system. Carousel Capital acquired a system called QAS, and they have been aggressively growing that system to the point where they want to renegotiate development agreement and development space because they see a lot of opportunity to take the cash flow from the business and redeploy it for growth to create a higher value entity.

Okay. We're asking 4 questions of everybody today. Again, we're finding not all applied to everybody equally. So bear with me as I kind of go through these. But one thing that we haven't talked about is the health of the consumer. Obviously, you're in a very defensive business. But I have to admit, I do sometimes defer my oil changes because I'm not -- maybe I'm not the right person to be talking to you about this but I do and don't tell my husband. But have you seen that? Does the deferral happen when there is a tougher macroeconomic backdrop? And typically, how long does that deferral last?

Yes. So we don't see as much deferral of the actual oil change. And in the 2008/2009 downturn, what we did see is some trade down both in terms of extended services that they may have purchased or switching down into maybe conventional or blend from a full synthetic. But the car park is so different now than it was then. One is there are many more vehicles that require full synthetic. And it's not something that people feel they should trade off against because the value of their car is so much and they want to extend the life of it. So what you see today is, people may be trading off when they buy a new car or lease a new car and rather continue to invest in the car that they have in doing the maintenance. I will say, we've been looking for trade down on services. And I'm not sure we're seeing it, but I also know that we've invested a lot of time to explain those things and why they're valuable to the consumer. So I don't want to say we've had it perfected because I see stores that don't have it perfected. But I think our focus on educating the consumer on what their car needs and when it needs it builds trust with the customer. If they come in every time and we check the battery and it's green, green, green, green, green and we never try to sell them battery until it's yellow, they'll actually think about buying the battery when it's yellow. But if you just try to sell them the first thing that needs to be done. So for us, it's about presenting and recommending what they need and telling them when they don't need other things that begets more trust. So for us, we aren't seeing a trade down though we look at it. We actually see pockets of discounting of competitors, but it's pockets and it's not consistent. It's not even consistent by competitor within a market. So those are the things we're seeing in this environment, but we're not seeing the consumer trade down or defer to a great extent.

And then what is the company reaction if you do see that those pockets of more price competition? Is the reaction to respond? Or is it so short-lived that you just kind of keep...?

Right now, it's pretty short lived. But each store manager has some leeway in order to keep customers. If a customer comes in and said, "I've got this coupon from so and so, will you honor it? The store manager can make that determination. But we aren't seeing significant increases in discounting. In fact, our marketing team has been working on optimizing or tailoring discounting based on a lot of digital and data that we have. And so they're bringing the discounting level down. And so net-net, our discounting is down, and we don't see spikes in any one region.

Okay. And then the only other question that really applies to Valvoline, we talked about this a little bit already, it's just pricing. Just how you're anticipating pricing in '24, the same, lower or higher compared to 2023?

I think -- so we have 3 tiers of pricing full synthetic, synthetic blend and conventional. We have a target for where we want stores to be. Our Pacific Northwest is a slightly higher target than the rest of the chain. Not all our stores are at that target. And so what I would say is, I don't anticipate us needing to change those target pricing tiers but I do see our net pricing go up as more stores get to those tiers. And I think our net pricing will go up in '24, just like it did in '23.

Okay. Thank you for joining us. Thank you.

Bye.

Thank you, everyone.